Following Detroit’s record-breaking municipal bankruptcy filing, we’ve been fielding a lot of questions from investors. For the broader municipal bond market, we do not anticipate a widespread systemic effect and investors should expect little market impact as Motown’s problems have long been known to bond traders. But what does this event mean for holders of muni bond ETFs?

In terms of exposure, none of our iShares ETFs hold Detroit general obligation bonds. While the iShares National AMT-Free Muni Bond ETF (MUB) does hold some Detroit-related paper, these bonds are not included in the bankruptcy and are currently highly-rated by the credit agencies. Further, these bonds only make up 0.12% of the ETF’s $3.3 billion in assets.

At the same time, this event does raise questions about how a fixed income ETF could be impacted if one of its holdings defaulted or filed for bankruptcy. We have had more questions of this sort around our muni funds recently as there have been several bankruptcies since 2011, with Detroit following Stockton and Vallejo, two cities in northern California.

The first thing to know is that our muni bond ETFs’ track muni indices that use a fairly conservative approach when it comes to determining eligibility. The indices include only investment grade bonds, and all it takes is one of the agencies (S&P, Moody’s or Fitch) to downgrade an issuer to below investment grade (lower than BBB-/Baa3) and the issuer’s bonds will be removed from the index at the next monthly rebalance.

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