Why investors should consider municipal bonds despite Puerto Rico (Part 3 of 8)
Municipal bonds (or munis) are issued by state and local governments and their agencies to fund capital expenditure on public projects (like highways, bridges, schools, or hospitals). In the last article of this series, we discussed general obligation (or GO) bonds. In this article, we’ll discuss other variants of municipal bonds (RVNU).
What are revenue bonds?
Revenue bonds are munis issued to finance a particular project, like a toll bridge or highway. The revenue stream from the project would be used to pay the interest and principal repayments for the revenue bond. Revenue bonds are usually issued by entities like hospitals, utilities, and public transportation companies, which hope to service the debt through revenues generated from the project.
The db X-trackers Municipal Infrastructure Revenue Bond Fund (RVNU) tracks the DBIQ Municipal Infrastructure Revenue Bond Index. The index comprises tax-exempt municipal securities issued by states, cities, counties, districts, their respective agencies, and other tax-exempt issuers. RVNU has an expense ratio of 0.3% and has returned 4.86% and 8.21% year-to-date and over the past six months, respectively. However, readers should note that RVNU is a new ETF launched in June last year, and therefore we can’t compare its track record with similar ETFs. The top holdings in RVNU include the Massachusetts Bay Transportation Authority 5% (5.92% of assets) and San Antonio Texas Electric & Gas Revenue 5.25% (3.47% of assets).
Infrastructure requirement of ~$3.6 trillion could see more muni ETFs
According to the American Society of Civil Engineers, the U.S. would have to spend ~$3.6 by 2020 to make needed infrastructure improvements. This requirement, which has been postponed in the past few years due to fiscal austerity following the financial crisis, will see a boom in the sector. Due to the huge spending requirement, there should be more municipal revenue issues to finance projects and also more ETFs like RVNU with exposure to these munis.
Increased construction spending would also benefit companies like Vulcan Materials (VMC), a construction materials supplier listed on the S&P 500 Index (VOO). It would also benefit construction and engineering ETFs like the ISE Global Engineering and Construction Index Fund (FLM), which has posted total returns of ~100% over the past five years.
Some municipal bonds may also be covered by insurance policies that would protect the investor in the event the issuer defaults. The insurance company would pay the principal and interest payments to bondholders in the event of default. The only catch is that the investor must consider both the insurer’s and the issuer’s creditworthiness before investing in these bonds.
The PowerShares Insured National Municipal Bond Portfolio (PZA) is invested primarily in AAA-rated, insured, tax-exempt, long-term debt publicly issued by the U.S. states or their political sub-divisions. Puerto Rico Commonwealth Public Impt 5% is the top holding in PZA, at 5.69% of assets. Unlike most debt issued by the Commonwealth of Puerto Rico (which has made a splash recently due to its questionable ability to service its ~$70 billion debt burden), the issue is insured—which should protect investors. For more on the Puerto Rico debt downgrade, please read the Market Realist series A Puerto Rican default: Its effect on the municipal bond market.
In the next part of this series, we’ll discuss another municipal bond variant that could protect investors from rising rates. Please read on to Part 4 to learn more.
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