In the ongoing search for yield, some have branched out to high-yield municipal bond exchange traded funds, but investors will need to consider specific risks associated with the muni market.

Investors funneled $43 billion into muni bond funds, with $10 billion going into high-yield municipals, over the first nine months, reports Steven Rosenbush for The Wall Street Journal. Year-to-date, the muni market has gained about 13%.

Municipal bond ETFs have been rallying recently on expectations that the Obama administration will raise taxes, which would make the tax-exempt status of munis that much more attractive. However, there is speculation that the government may potentially remove the tax-exempt status to help with the deficit problems. [Muni Bond ETFs Hit on Tax Worries]

“We think high-yield municipal debt is compelling and will remain so for some time, but certainly, there are risks,” Gary M. Fuqua, managing director and head of high-yield and distressed municipal strategies at Spring Mountain Capital LP, said in the article. [Muni Bond ETFs and Tax Uncertainty]

Municipal bond holders will have to consider event risks. High-yield munis include riskier issues, such as municipal entities that own airport terminals and rely on airliners. For instance, late 2011, AMR Corp., the parent company of American Airlines, filed for bankruptcy protection.

Investors will also have to deal with liquidity concerns as the overall munis fund market is $65 billion. Additionally, the underlying municipals market is very illiquid compared to equities, futures or U.S. Treasuries. “It can be difficult to buy in or sell out,” James Colby, senior municipal strategist at Van Eck Global, said in the article.

Additionally, the cumulative default rate on high-yield muni debt since the 1970s is 7.94%, according to Morningstar, whereas the cumulative default rate for investment grade munis is 0.08%. Still, investors are receiving higher yields for the added risks – the Barclays Municipal Bond High Yield Index offered a 5.37% yield as of Oct. 31, compared to the 2.16% yield on the Barclays Municipal Bond Index.

High-yield municipal bond ETF options include:

  • Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD): 4.39% 30-day SEC yield; 0.35% expense ratio; credit quality breakdown includes BAA 25.0%, BA 17.8%, B 29.5% and CAA1/C 3.0%.
  • SPDR Nuveen S&P High Yield Municipal Bond ETF (NYSEArca: HYMB): 4.18% 30-day SEC yield; 0.45% expense ratio; credit quality breakdown includes A 12.2%, BBB 20.4% and below B 44.0%.

Broad municipal bond ETFs include:

  • iShares S&P National Municipal Bond Fund ETF (NYSEArca: MUB): 1.61% 30-day SEC yield; 0.25% expense ratio; credit quality breakdown includes AAA 17.7%, AA 48.4%, A 26.3% and BBB 4.8%.
  • SPDR Barclays Capital Municipal Bond ETF (NYSEArca: TFI): 1.51% 30-day SEC yield; 0.23% expense ratio; credit quality breakdown includes AAA 21.7%, AA 78.0%, A 0.3%.

For more information on the munis, visit our municipal bonds category.

Max Chen contributed to this article.

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