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'Positive Indicators' For High-Yield Municipal Bonds Could Benefit This ETF

Broadly speaking, municipal bonds are often viewed as conservative instruments, but there are ways for investors to add some spice to this asset class without incurring alarming levels of risk.

While it is slightly more volatile than investment-grade municipal bond benchmarks, the VanEck Vectors High-Yield Municipal Index ETF (NYSE: HYD) has moderate risk and could help investors boost their income profiles.

What Happened

HYD is up about 3 percent year-to-date, while the widely followed, investment-grade S&P National AMT-Free Municipal Bond Index is off 0.5 percent. The $2.6-billion HYD is the largest exchange traded fund dedicated to non-investment-grade municipal bonds.

The ETF, which is nine-and-a-half years old, follows the Bloomberg Barclays Municipal Custom High Yield Composite Index and is home to over 1,800 bonds.

Over the near-term, favorable municipal bond supply-demand dynamics could favor HYD and rival muni ETFs.

Why It's Important

“August is expected to bring with it an estimated (and significant) $51 billion in potential reinvestment demand from municipal bond holders,” VanEck said in a recent note. “This means the supply-demand imbalance, in place for some time now, is likely in my view to continue to be favorable for municipal bond performance. We typically experience a larger disparity between supply and cash in June and July, but this year August looks set to present the larger imbalance.”

VanEck believes increased demand amid slack supply could benefit investment-grade and junk-rated munis. For its part, HYD is not excessively risky at the credit level as nearly a third of its holdings carry investment-grade ratings. Another third are rated BB or B.

What's Next

“The high-yield municipal bond market in particular has held up well so far this year, despite the refinancings that have taken a significant portion of bonds out of the high-yield secondary universe,” said Van Eck.

“For example, tobacco issues, yielding 7 percent and generating attractive income for yield investors, were called in California and New Jersey. This led to pressure on the remaining high yield inventory and moved prices higher. We believe that these trends are positive indicators for the prospects of the high-yield municipal bond sector.”

HYD's 30-day SEC yield of 4.04 percent is more than 160 basis points above the comparable yield on the S&P National AMT-Free Municipal Bond Index.

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