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A Pair of Cost-Effective Municipal Bond ETFs to Consider

This article was originally published on ETFTrends.com.

Municipal bonds are a specific corner of the bond market that has its own nuances to be wary of, such as costs and tracking errors, but this pair of ETFs eliminates the guess work involved--the Vanguard Tax-Exempt Bond ETF (VTEB) and iShares National Muni Bond ETF (MUB) .

With bond market mavens warning investors of headwinds in the fixed income space like the possibility of an inverted yield curve, rising rates and BBB debt sliding out of investment-grade, investors need to be keen on where to look for opportunities.

One area is within the municipal bond space, which may have gotten a boost following last November’s midterm elections. In particular, with respect to infrastructure spending—it’s one of the few things, if any, that Democrats and Republicans can agree on, but with the newly-divided Congress, this could fuel municipal bond ETFs.

Still, investors need to be aware of the costs associated with investing in this fixed income space, as well as certain tracking errors that could arise with respect to their prices.

"Municipal bonds have historically been a tricky asset class for index-tracking strategies," said Morningstar analyst Daniel Sotiroff. "The municipal-bond market is composed of tens of thousands of individual bonds, many of which are small and expensive to trade, meaning they can hurt returns and lead to high tracking error."

Low-Cost, Low-Error Options

As such, it's appropriate to select the necessary ETFs that address these concerns like VTEB and MUB.

VTEB tracks the Standard & Poor's National AMT-Free Municipal Bond Index, which measures the performance of the investment-grade segment of the U.S. municipal bond market. MUB seeks to track the investment results of the S&P National AMT-Free Municipal Bond IndexTM, which also measures the performance of the investment-grade segment of the U.S. municipal bond market.

"Two of our favorite index-tracking municipal-bond funds at the moment are Vanguard Tax-Exempt Bond ETF and iShares National Muni Bond ETF," said Sotiroff. "The management teams at Vanguard and BlackRock both use a sampling approach to track the S&P National AMT-Free Municipal Bond Index."

Related: Howard Marks: Investing in a Low Return World

The sampling approach means that both funds hold a subset of bonds within the index in order to replicate the yield, duration, and credit quality of the debt. This method allows the funds to avoid trading expensive bonds that could harm performance and in addition, minimize tracking errors.

"This approach has been effective so far as these two funds both delivered incredibly low tracking error over the past few years," Sotiroff said.

With respect to an average net expense ratio of 0.32 percent in their category, both funds deliver very low costs--0.08 percent for VTEB and 0.07 percent for MUB.

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