Muni Bond ETFs Have Trials in Their First Year

November 22, 2008 at 1:00 pm by Max Chen

ETF municipal bond Low-fee mechanisms in tax-exempt municipal debt, liquidity and transparency. What more could one ask for in an exchange traded fund (ETF)?

In the first year of their existence, ETFs with the primary goal of coupling price with the underlying muni index experienced the illiquidity of a hectic bond insurance industry, according to Dan Seymour for On Wall Street.

Muni ETFs try to mimic their indexes with holdings in a sample of bonds from the indexes. The ETFs collect coupon payments from bonds they hold, then distribute them as dividends. These ETFs are not known for their fat returns, but merely reflect the performances of their underlying indexes.

Among the many markets vying for President-elect Barack Obama’s attention is that of the muni bond. Obama’s tax plan could be conducive to the future performance of muni-bond ETFS, because of the after-tax yield.

It should be noted that the design of muni ETFs face two risks during market unrest: The price of the ETF may drift from the value of its assets or the the value of an ETF’s bond sampling may fail to reflect the overall index.

With greater diversity than individual muni bonds, muni ETFs spread the risk that potential investors would have be exposed to.

Short muni ETFs are designed to provide income and some protection against wild vacillations in the market while the long index carries a greater interest rate risk. But for the intrepid investor, the long index and its greater risk carries with it a greater annualized yield.

The benefits of muni bond ETFs that most investors enjoy are the ability easily sell the ETF to move to another investment and the exposure to tax-exempt debt without researching individual muni credits.

Muni ETFs vary by maturity and by location. ETFs offer exposure to indexes in municipal credit from California and New York.

Among the many such ETFs available include: