High-Yield Muni ETF Navigates its way to New Highs

Despite Puerto Rico debt restructuring concerns, ongoing debt settlement talks in Detroit and elevated fears of additional public pension-induced municipal bankruptcies in other parts of the U.S., municipal bond ETFs have been solid performers in 2014.

That includes the high-yield variety, such as the Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD). Muni bond ETFs have also been supported by dwindling supply. The market has strengthened as demand outstripped low muni sales, Bloomberg reports. In July, new supply was 16% lower for the same period year-over-year. States and cities are expected to borrow $21 billion this month, the least amount for July since 2001. [Muni Bond ETFs Lifted by Declining New Issuance]

With over 41% of its portfolio allocated to junk issues compared to 24.5% to investment-grade fare, HYD would appear to be a predictable candidate to struggle on the back of Puerto Rico and pension fears. That has not been the case as the ETF has climbed 7.5% this year, closing Tuesday within pennies of its 52-week high.

“Though an ETF of this size would experience a significant pull back in a rising rate environment, the portfolio managers have rebalanced it well after the Puerto Rico and Detroit downgrades and the duration is attractive. Obviously, there are others who feel that municipals may be under further pressure if credit conditions decrease or deteriorate. Our opinion is that baring a rising rate environment for long-term debt, we see an attractive ETF and should be purchased for both tax free yield and total return investors,” said analyst Reuben Sushman of HYD in a post on Seeking Alpha.

Like other high-yield muni ETFs, HYD has navigated Puerto Rico concerns with aplomb because although the ETF is passively managed, it is not bound to hold every issue found in the Barclays Municipal Custom High Yield Composite Index (LMEHTR), the ETF’s underlying index.

In fact, HYD’s exposure to Puerto Rico has been declining. HYD allocated just 4.3% of its weight to Puerto Rico at the end of June, according to Market Vectors data. That allocation was down to 3.9% at the end of July, making Puerto Rico the ninth-largest geographic weight in HYD with an allocation that is not even half the 8.8% the ETF devotes to California issues. [Passive Muni ETFs Shed Puerto Rico Exposure]