Municipal bond investors who are worried about the negative effects of a Federal Reserve interest rate hike could switch into short-term munis exchange traded funds to mitigate the risks.
“Sticking to intermediate and short-term funds of all flavors is generally a good idea,” Scott Brewster, president of Brewster Financial Planning, said in a Wall Street Journal article. “I would get out of anything extremely long-term, because you’re just an interest-rate spike away from heartache.”
Short-term bond funds are typically less sensitive to changes in interest rates. For instance, the largest short-term munis ETF, SPDR Nuveen Barclays Short Term Municipal Bond ETF (SHM) , has a 0.8% 30-day yield and a 2.84 year duration – a 1% rise in interest rates would only translate to about a 2.84% dip the ETF’s price. [Investors Still Favoring Muni Bond ETFs]
There are a number of other short-term muni bond ETFs to choose from. The Market Vectors-Short Municipal ETF (SMB) has 1.08% 30-day SEC yield and a 2.97 year duration. The iShares Short Term National AMT-Free Muni Bond ETF (SUB) , has a 0.5% 30-day SEC yield and a 1.99 year duration. The PIMCO Short Term Municipal Bond ETF (SMMU) has a 0.59% 30-day SEC yield and a 2.13 year effective duration. Lastly, the iShares Short Maturity Municipal Bond ETF (MEAR) has a 0.67% 30-day SEC yield and a 1.39 year duration.
Market observers argue that fixed-income investors may also find opportunities in short-term munis after interest rates rise.
“In those periods where the market sells off, I would view those as an opportunity to put some money to work and buy,” Peter Hayes, head of municipal bonds at BlackRock (BLK), said in the WSJ article.
Moreover, Hayes argues that munis are relatively inexpensive relative to other fixed-income assets, like Treasuries and corporate debt, even after the impressive rally last year.
Municipal bonds also offer investors favorable tax advantages as muni investors do not pay federal income taxes on interest payments. Additionally, munis issued from an investor’s home state do not come with state income taxes on interest as well. Consequently, muni bonds typically yield more attractive tax equivalent yields. For instance, SHM has a 1.41% taxable equivalent 30-day SEC yield for those in the highest income bracket.
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.