Fixed-income exchange traded fund investors have been hearing about the rate risk in long-term bonds, but now some are sounding the alarm on short-duration debt.
“Last year, we were concerned primarily with reducing interest-rate risk by selling high grade (largely AAA and AA-rated) long-maturity municipal bonds and reinvesting in a combination of intermediate-term, investment-grade municipal bonds and long high-yield municipal bonds,” writes Guy Davidson, director of municipal investments at AllianceBernstein, for InvestmentNews. “Now we are also worried about the heightened risk in portfolios of strictly short-maturity bonds.”
Davidson argues that both short and long ends of the yield curve are a risk to investment-grade municipal bonds. Specifically, short-term yields are at a low 0.3% on two-year triple-A munis and 0.4% on comparable Treasuries. Because of the low rates, upside potential is diminished and downside risk has increased.
“If short rates rise quicker than expected, investors could experience losses,” Davidson said. “As a result, we’re advising against portfolios constructed entirely of short bonds.”
Nevertheless, Davidson does not dismiss short-duration munis entirely as they can help dampen volatility and help bring a portfolio closer to an intermediate-duration target.
ETF investors have a number of options to gain exposure to intermediate-duration municipal bonds. For example, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) has a 6.09 year effective duration and a 1.82% 30-day SEC yield. The SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) has a 7.88 year duration and a 2.05% 30-day SEC yield. The Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM) has a 7.15 effective duration and a 2.17% 30-day SEC yield. The PIMCO Intermediate Municipal Bond ETF (NYSEArca: MUNI) has a 5.17 year duration and a 1.2% 30-day SEC yield. [7 Reasons to Include Muni ETFs in Your Portfolio]