It’s Not All Bad for Muni Bond ETFs

It is easy to get wrapped up in the sensational headlines surrounding the municipal bond market these days. Namely those pertaining to Detroit’s bankruptcy filing, Illinois’ unfunded pension obligations and Puerto Rico distress.

That headlines and others prompted investors to pull nearly $800 million from municipal bond exchange traded funds last year, but the multi-trillion muni bond market may not be the lost cause some critics purport it to be.

“When we look beyond these high-profile issues, we believe the municipal bond market’s fundamentals are improving and that there are ETFs that give investors the opportunity to limit their exposure to rising rates,” according to a new research note by S&P Capital IQ. [Problems Mount for Muni Bond Investors]

Improving trends in the residential real estate market coupled with still low default rates could bolster the attractiveness of normally conservative muni ETFs.

“Many municipalities run balanced budgets and through the second quarter of 2013, there were positive trends in state and local government tax collections. Lastly, despite the shock of Detroit’s bankruptcy filing, municipal bond defaults among the 2,848 deals in the S&P Municipal Bond High Yield Index occurred less frequently in 2013 than in 2012 and 2011. Indeed, just 23 deals, or 0.81%, defaulted, down from 1.0% and 1.5%, respectively, in the prior two years,” said S&P Capital IQ in the note.

In terms of ETFs, S&P Capital IQ has an overweight rating on the $2.1 billion SPDR Nuveen Barclays Short Term Municipal Bond ETF (NYSEArca: SHM). Although SHM has a 30-day SEC yield of just 0.54%, its modified adjusted duration is less than three years. That reduces the fund’s sensitivity to changes in interest rates, a fact confirmed by SHM’s meager 0.04% loss over the past year. [Muni Bond Sell-Off May be Overdone]