Municipal bond exchange traded funds have been among the best performing fixed-income assets this year. For those who are thinking about a shift over to munis now, there are some factors to considers.
The robust returns has attracted a lot of attention, and investors who are thinking about including some munis exposure should also keep in mind that munis benefit some more than others, the asset class is not risk free, some may offer local tax perks, and munis are growing less attractive, writes Ian Salisbury for TIME.
Specifically, investors in a higher tax bracket will benefit more from the federal tax-exempt status on munis’ interest payments.
For instance, MUB comes with a 1.56% 30-day SEC yield, but for those in the highest income bracket, the tax equivalent yield is 2.76%. ITM has a 2.04% 30-day SEC yield. According to Market Vectors, ITM has a 2.40% yield for those in the federal tax rate of 15%, and the taxable equivalent yield rises to 3.38% for those in the federal tax rate of 39.6%. The taxable equivalent yield is equal to the tax-free municipal bond yield divided by the 1 minus your tax rate.
Munis also come with credit risks. As some investors may remember the hoopla with Detroit and Puerto Rico, there are default risks. While the municipal bond ETFs track investment-grade municipal debt securities, there is always the risk of an outlier. [Elections Could Rattle Muni Bond ETFs]
Along with their federal tax perks, some municipal bonds also carry state and local tax breaks. Munis issued by a state is exempt from state income taxes for residents of that state. For state-specific muni exposure, there are a few that cover California and New York debt, two of the largest muni markets.
For California exposure, investors can take a look at the iShares California AMT-Free Muni Bond ETF (NYSEArca: CMF), SPDR Nuveen Barclays California Municipal Bond ETF (NYSEArca: CXA) and PowerShares Insured California Municipal Bond Portfolio (NYSEArca: PWZ).
The iShares New York AMT-Free Muni Bond ETF (NYSEArca: NYF), PowerShares New York AMT-Free Municipal Bond Portfolio (NYArca: PZT) and SPDR Nuveen Barclays NY Muni Bond (NYSEArca: INY) provide exposure to New York debt.
Lastly, potential investors should be aware that the munis market has been rallying on its longest monthly winning streak in two decades, so any deals are less attractive. [Muni Bond ETF Rally Could Wane]
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.