ETF Trends
ETF Trends

Municipal bonds — debt issued by state or local governments to finance public projects — are fashionably late to the exchange traded fund (ETF) party. The first one arrived on the scene in September, and now it’s time to get to know them better. Matt Fabian, Municipal Market Advisors, sat down for a Q&A with Carolyn Cui at the Wall Street Journal to help us.

iShares launched the S&P National Municipal Bond (MUB) first, followed closely by the SPDR Lehman Municipal Bond (TFI). These and other muni-bond ETFs aim to replicate the price and yield performance of a designated benchmark. Fabian says that muni-bond ETFs took so long to appear on the scene because it can sometimes be a challenge to physically locate the bonds that make up an index, coupled with the fact that many municipal bond investors tend to be of the "buy-and-hold" variety.

In other news, the Supreme Court heard arguments in a case that could have a major impact on the municipal bond market and, in turn, muni-bond ETFs. Lisa Lambert of Reuters says the justices need to decide: are muni-bonds a commodity or a means by which states can finance unique public services. The justices need to figure out if Kentucky can give tax breaks on interest from muni-bonds (a big selling point to them) while taxing interest earned on bonds sold in other states.

If the court decides that the tax breaks for residents are unconstitutional, states will need to decide to tax interest on in-state muni-bonds or stop taxing out-of-state ones, say experts. We won’t even get into what kind of retroactive mess it could create. Plus, the nearly 500 mutual funds invested in bonds from specific states would have to find new investments, reorganize or disband altogether.

Muni-bond ETF holders should keep an eye on this one.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.