This is a guest post contributed by Shishir Nigam, editor of Active ETFs in Focus.
The US municipal bond market started a massive leg down on November 8th which has now turned into what looks like an all-out collapse. In the space of a week and a half, the iShares S&P National Municipal Bond Fund (NYSEArca: MUB) which is the largest ETF for the US municipal bond market with a market cap in excess of $2 billion, has fallen by 4.55%. This may not sound like much compared to equity market movements, but it is a huge move in the muni market, as is evident from all the tiny daily moves in the chart above before November.
Municipal bonds have traditionally been held widely amongst tax-sensitive investors, especially those in higher marginal tax brackets. This is because municipal bonds provide income that is free from federal taxes and often from taxes of the state in which they are issued. However, since 2008, many states and municipalities in the US have had trouble keeping their budgets in line and have suffered large deficits. A prime example is, of course, California. Due to California’s budget problems, the state’s bonds have suffered badly. In fact, since November 8th, CMF, which tracks an index holding municipal bonds issued in California, has fallen much more than MUB, dropping close to 6%.
What is behind the panic?
Interestingly, most commentators haven’t been able to pin-point any one single trigger that may have sparked the sell-off in the general muni bond market. However, there are plenty of underlying problems that have been festering in the market for a while.
First off, as mentioned earlier, nearly every state in the US has had trouble balancing its budget and budgetary problems have reduced confidence in the ability of the issuers to meet their debt obligations. California will be auctioning off $14 billion in bonds this month to help bridge its deficit gap, in turn creating an over-supply of bonds when demand for them is dropping. Another reason speculated to be behind this recent move down has been the pending closure of the Build America Bond program. The program has been hugely successful since its launch as issuers capitalized on a cheaper way to finance their capital needs because of the credits they receive on interest payments from the government. The program though is due to expire at the end of 2010 and there has been no word on previous discussions in the US Congress of extending this program till the end of 2012. Due to the upcoming deadline, states and municipalities are rushing to issue bonds under the program, again causing a supply glut.
How do Active Muni ETFs stack up with Passive Muni ETFs?
One good opportunity that this panic does provide us with is an ideal testing ground to evaluate whether active management adds any value in times like this. In other words, are active managers earning their marks in times when they would be expected to. There are currently two actively-managed ETFs in the US that compare well, in terms of maturity, with the iShares S&P National Municipal Bond Fund (MUB) which can be taken as the passive proxy – PIMCO Intermediate Municipal Bond (NYSEAca: MUNI) and Grail McDonnell Intermediate Municipal Bond (NYSEArca: GMMB). The chart below shows how the three funds have fared in the last month.
Where MUB has fallen in excess of 5% in the last 1 month, MUNI and GMMB have been able torestrict their losses to about 2%. So at least in this panic situation, it appears that whatever active decisions that the managers made helped them avoid the worst of the downfall.