Speculation that the Federal Reserve is close to raising interest rates is not chasing investors from fixed income exchange traded funds.
Investors added $35.7 billion to bond ETFs in the first quarter. Municipal bond funds got in on the action. In the first quarter 2015, investors put $1.4 billion of fresh money into municipal bond ETFs compared to $1.9 billion during all of 2014, said S&P Capital IQ in a new research note. In fact, demand for munis is outstripping supply.
“Demand for tax-exempt bonds is in large part driven by the current tax environment. Demand still outpaces supply. While new issues have been increasing, the volume is partly driven by refunding bonds replacing higher yielding bond issues,” said J.R. Rieger, global head of fixed income, S&P Dow Jones Indices, in a recent note.
The iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), the largest muni ETF, has accounted for the bulk of this year’s inflows to these ETFs with nearly $685 million in new assets added. MUB “recently had 99% of its bonds rated A or higher by rating agencies,” according to S&P Capital IQ. The research firm rates the ETF marketweight. [Muni Bond ETFs for Diversity]
Investors also have not shied away high-yield muni ETFs. For example, the Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD) has added over $106 million of its $1.6 billion in assets this year. HYD has a 30-day SEC yield of 4.32%, more than double the yield on 10-year Treasurys. [Investors Flock to Muni Bond ETFs]
As Rieger notes, there are headwinds to consider with municipal bonds, including the massive public pension problems in Illinois and New Jersey. Bonds from those states combine for 9.4% of HYD’s weight.
“Each of these states has pretty large pension short falls to negotiate and this may result in headline after headline of bad press,” said Rieger.