In the case of Detroit’s general obligation bonds, they were removed from the index that MUB tracks all the way back in 2009. Most bond indexes are rebalanced on a monthly basis as are most bond ETFs. This means that within a month of the downgrades, these Detroit bonds would have been removed from the index; our MUB fund exited its positions around the same time as the index.
There is still much uncertainty at this point around Detroit. The city, which listed its liabilities at $18 billion, must prove its insolvency to a federal judge to qualify for Chapter 9 protection. It is expected to be a long and protracted battle. The bottom line for ETF investors is that investment grade muni bonds rarely “jump to default” (i.e. default while they still carry investment grade ratings).
If you hold an investment grade muni ETF, your risks are much lower than if you own, say, a high yield ETF which holds below investment grade bonds that are more prone to default. Finally, ETF investors with questions about holdings can always take advantage of the transparency of ETFs; all fund holdings are published on a daily basis.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.