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]
Credit quality is not a concern with most muni ETFs and that is certainly the case with SHM as over 99% of the fund’s holdings are rated either AAA or AA. Despite fewer concerns about credit quality, “the 10-year Treasury yield rose sharply in 2013 amid expectations that the Federal Reserve would begin to taper its bond buying program (which is occurring this month). We think the issue of potentially higher rates remains a concern for 2014,” said S&P Capital IQ.
The research firm also has marketweight ratings on the $226.3 million Market Vectors-Short Municipal ETF (NYSEArca: SMB). SMB’s modified duration is less than 3.2 years and nearly a third of the fund’s 251 are state general obligation bonds. Issues from New York, Illinois and California combine for nearly 36% of the fund’s weight.
The iShares Short Term National AMT-Free Muni Bond ETF (NYSEArca: SUB) also garnered a marketweight rating from S&P. That $812.9 million ETF has 756 holdings and an effective duration of just two years, according to iShares data. SUB is down 0.2% over the past year. California and New York issues combine for over a third of SUB’s weight.
SPDR Nuveen Barclays Short Term Municipal Bond ETF
