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Target Goldilocks Muni Duration with ETFs

Fixed-income exchange traded fund investors have been hearing about the rate risk in long-term bonds, but now some are sounding the alarm on short-duration debt.

“Last year, we were concerned primarily with reducing interest-rate risk by selling high grade (largely AAA and AA-rated) long-maturity municipal bonds and reinvesting in a combination of intermediate-term, investment-grade municipal bonds and long high-yield municipal bonds,” writes Guy Davidson, director of municipal investments at AllianceBernstein, for InvestmentNews. “Now we are also worried about the heightened risk in portfolios of strictly short-maturity bonds.”

Davidson argues that both short and long ends of the yield curve are a risk to investment-grade municipal bonds. Specifically, short-term yields are at a low 0.3% on two-year triple-A munis and 0.4% on comparable Treasuries. Because of the low rates, upside potential is diminished and downside risk has increased.

“If short rates rise quicker than expected, investors could experience losses,” Davidson said. “As a result, we’re advising against portfolios constructed entirely of short bonds.”

Nevertheless, Davidson does not dismiss short-duration munis entirely as they can help dampen volatility and help bring a portfolio closer to an intermediate-duration target.

ETF investors have a number of options to gain exposure to intermediate-duration municipal bonds. For example, the iShares National AMT-Free Muni Bond ETF (MUB) has a 6.09 year effective duration and a 1.82% 30-day SEC yield. The SPDR Nuveen Barclays Municipal Bond ETF (TFI) has a 7.88 year duration and a 2.05% 30-day SEC yield. The Market Vectors Intermediate Municipal Index ETF (ITM) has a 7.15 effective duration and a 2.17% 30-day SEC yield. The PIMCO Intermediate Municipal Bond ETF (MUNI) has a 5.17 year duration and a 1.2% 30-day SEC yield. [7 Reasons to Include Muni ETFs in Your Portfolio]

“For investors who can tolerate more volatility than a traditional high-quality bond portfolio and who want (or need) extra income, adding credit exposure from high-yield bonds to a municipal portfolio is a good idea,” Davidson added.

High-yield munis can find further support ahead as credit risk remains low, supply declined and demand for yield remains strong.

Two high-yield muni options include the he Market Vectors High Yield Municipal Index ETF (HYD) and SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) . However, the funds have a longer duration. HYD has a a 10.47 year duration and a 5.03% 30-day SEC yield. HYMB has a 9.41 year duration and a 4.49% 30-day SEC yield. [A High-Yield Municipal Bond ETF Option]

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.