Tough Times Priced In. Muni bond observers believe that all the bad news has already been priced into muni bonds. However, the second argument is that it is still a risky time to buy, since rises in prices may not necessarily reflect the actual health of the municipality.
Muni Bond Risks
Defaults. They might be rare, but it’s imprudent to ignore risk in any investment no matter how small the risk may actually be. States may be unable to repay some municipal bonds, more notably in those tied to private institutions such as hospitals, which have a higher risk of bankruptcy. Issuers may be unable to meet the financial obligation in which case they will be unable to make the interest payments or repay the principal. Credit agencies offer ratings to help investors determine the creditworthiness of insurers. Still, muni bonds are backed by insurance policies that will repay a bondholder if a default occurs.
Interest Rates. If interest rates rise, muni bonds already in circulation will be paying lower yields relative to the yields offered by newly issued bonds. If interest rates were to drop (not a likely scenario at this point, since they’re already at record lows), newly issued bonds will be paying lower yields and investors would be paying greater premiums for older bonds.
Muni Bond ETFs
For your clients’ portfolios, there are a number of muni bond ETFs to choose from, all constructed in unique ways. A sampling:
- Broad muni bonds. Funds such as Market Vectors Lehman Brothers AMT-Free Long Municipal (NYSEArca: MLN) and SPDR Barclays Capital Municipal Bond (NYSEArca: TFI) invest across a range of maturities and ratings.
- Actively managed muni bonds. PIMCO Intermediate Municipal Bond Strategy (NYSEArca: MUNI) and Grail McDonnell Intermediate Municipal Bond (NYSEArca: GMMB) are examples of this. Active management works well in bond funds, since they can adjust to changes in the interest rate environment.
- State muni bond funds. The only states getting the full muni-bond treatment are California and New York. iShares S&P CA AMT-Free Municipal Bond (NYSEArca: CMF) and PowerShares Insured New York Muni Bond (NYSEArca: PZT) are examples.
- Muni bonds with an end date. iShares launched a line of muni bond ETFs with an end date earlier this year. The iShares Muni Series trade on an exchange just like other ETFs and generate monthly income on top of an end-date distribution. Although the yield to maturity is comparable to a portfolio of municipal bonds of similar maturity and credit quality, the monthly and final payouts are not always predictable. But in order to preserve the yield to maturity, the fund dynamically adjusts its end-date distribution in line with its monthly payouts. So as monthly payouts fall, the end-date distribution will rise to compensate and vice-versa.
As a pro subscriber, you have access to all of our amazing ETF research tools. To be notified when a municipal bond ETF reaches a trading signal, sign up for alerts. You can also add municipal bond funds to your ETF watchlist and sort all of the available muni bond ETFs by price, yield and more in the ETF Analyzer.