Should Investors Be Cautious with New Muni Bond ETFs?

Municipal bond exchange traded funds (ETFs) have given investors a new approach to a sought-after segment of the market, but are they the best tools for this opaque area of the industry?

There are a total of 16 muni-bond ETFs to choose from right now, as two new ETFs were launched this month with this focus. The two new ETFs are:

• Market Vectors High Yield Municipal Index ETF (HYD)
• Market Vectors Pre-Refunded Municipal Index ETF (PRB)

David Hoffman for InvestmentNews reports that these funds are the first ETFs to invest in an underlying index of junk and pre-refunded muni bonds, respectively. These segments of the muni market are at opposite ends of the risk spectrum. High-yield muni bonds are rated BB or below.

With a pre-refunded bond, the income and principal are backed by an irrevocable trust of Treasury securities, making them of the highest quality. The main reason investors are shy about these types of ETF is that last year, when credit markets froze in September, bond ETFs, especially muni-bond ETFs, ended up trading at an unusually wide discount to their net asset value.This is not characteristic of an ETF.

Although the situation in muni-markets has improved, there is still an ounce of caution to be had. The muni-ETFs discounts have narrowed, restoring the luster that investors had found so attractive.