Municipal Bond ETFs Have Attractive Yields

February 11, 2008 at 2:00 pm by Tom Lydon

Competitive yields are suddenly giving municipal bond exchange traded funds (ETFs) a new level of attractiveness to investors.

Muni bond ETFs are the new kids on the block; the first ones didn’t appear until last September.

On Feb. 1, the Market Vectors Lehman Brothers AMT-Free Intermediate Municipal Index (ITM) was yielding 3.49%. It targets the 6- to 16-year part of the yield curve, reports David Hoffman for Investment News. Another bonus: the yield paid out by munis is free from federal taxation, making their effective income greater than the taxable yield offered right now by Treasury bonds.

Other comparable muni ETFs tell a similar story: the PowerShares Insured National Muni Bond (PZA) had a yield of 4.2% yield, with a tax equivalent yield of 6.46%.The iShares S&P National Municipal Bond Fund (MUB) had a yield of 3.44%, but the tax equivalent yield was 5.07%. The SPDR Lehman Municipal Bond ETF (TFI) yielded 3.34%, with a tax equivalent of 5.14%.

James Colby, Van Eck’s senior municipal strategist, says muni bond ETFs are a good option for those investors uncertain about what’s going to happen in the Treasury markets. I don’t see anything wrong with this strategy, and the municipal bond ETF environment appears relatively safe.

There’s always risk, though, including with these types of bonds. That’s because the governments behind them pay companies to insure them so that ratings agencies will give them a better rating. However, these companies are at risk of defaulting because they also insured subprime mortgage-backed securities and they’re not as in sound financial shape as investors previously believed.

As a result, ratings agencies have started to downgrade bond insurers. At least one agency lost its AAA rating, reports Martin Z. Braun for Bloomberg. The default rate on municipal bonds in 0.1%, but Moody’s Investors Service says state and local government debt is still tainted. The threat of more downgrades is something to watch out for.

Tags: Financial, Media, S&P 500