Van Eck Global, as the sponsor of Market Vectors municipal bond exchange-traded funds (ETFs), naturally has serious concerns following the filing of the petition by the City of Detroit seeking protection under Chapter 9 of the bankruptcy code. What implications do I think are to be drawn?
I believe it does mean an immediate adjustment to the valuations of securities issued by the City of Detroit and its instrumentalities. The potential diminution of those values may have an impact upon some investors’ personal as well as large institutional portfolios, to varying degrees.
Market Vectors’ municipal bond ETFs seek to track indices constructed with a rigorous rules-based structure. The City of Detroit and some of its instrumentalities are, because of their prior creditworthiness and presence as large issuers of municipal bonds, included in these indices and, hence, are present in several of the ETFs (HYD, MLN, ITM and SMB).
The following table displays exposure of Market Vectors municipal bond ETFs to City of Detroit municipal bonds versus each ETF’s underlying index. As of yesterday (July 18), prior to the Chapter 9 filing, these issues were appropriate holdings, in my view. If the ratings agencies were to adjust the credit ratings of these issuers, many holdings may no longer be eligible for inclusion in the ETFs’ underlying indices. Such is the rules-based approach of index funds and, in particular, of ETFs. If removed from the index, and as the market allows, those securities may be removed from the ETFs.
