In the fixed-income market, investors may find that municipal bonds and related exchange traded funds are a more attractive play than Treasuries or corporate debt.
“Overall, municipal bonds maintain their high-quality appeal and continue
to look attractive versus both Treasuries and corporate bonds,” according to BlackRock. “We’re seeing competitive yields on a before-tax basis—which only further illuminates the after-tax value.”
For instance, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), which has a 6.43 year effective duration, has a 2.19% 30-day SEC yield and a 3.87% tax equivalent 30-day SEC yield for those in the highest income bracket. In comparison, the iShares 3-7 Year Treasury Bond ETF (NYSEArca: IEI), which has a 4.53 year effective duration, has a 1.52% 30-day SEC yield and the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which has a 7.81 year effective duration, has a 2.43% 30-day SEC yield.
Moreover, the BlackRock strategists point out a couple of factors that continue to support the munis market: high demand, relatively low supply, tax-season-inspired appreciation for the tax-exempt status and improving credit among states and local issuers.
Nevertheless, potential investors should still be aware that bond prices could fall as rates rise, even though investors saw benchmark 10-year Treasury yields drop about 25 basis points at the start of the year.
“This does not take away from munis’ appeal as an attractive source of tax-advantaged income, but it does suggest that a diversified and unconstrained approach is a smart call in the tax-exempt space as well,” the BlackRock strategists added.
BlackRock suggests investors with higher taxes should add munis to garner attractive income yields.
Investors who are more concerned about rate risk can go down the yield curve. For instance, the iShares Short-Term National AMT-Free Muni Bond ETF (NYSEArca: SUB) and SPDR Nuveen Barclays Short Term Municipal Bond ETF (NYSEArca: SHM) come with shorter durations at 1.98 years and 2.87 years, respectively. Duration is a measure of a fund’s sensitivity to changes in the interest rates, and a lower duration translates to a smaller effect on the ETF. However, the lower durations mean lower yields as SUB has a 0.25% 30-day SEC yield or a 0.45% tax equivalent 30-day SEC yield, and SHM has a 0.52% 30-day SEC yield or a 0.93% tax equivalent 30-day SEC yield. [Muni Nation: Second-Quarter Muni Outlook]
Alternatively, investors can juice up yields with something like the Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD), which has a 5.64% 30-day SEC yield or a 9.33% tax equivalent 30-day SEC yield. However, the fund has a longer 10.59 year duration and holds speculative grade debt. [Muni ETFs Outperforming, but Watch Interest Rates]
For more information on munis, visit our municipal bonds category.