In the fixed-income space, interest rate risk is the largest single concern. MUB has a 6.42 year effective duration and ITM has a 6.76 year duration. Consequently, a 1% increase in interest rates would translate to about a 6.4% decline in MUB and a 6.8% decline in ITM. However, Colby points out that the Federal Reserve won’t likely change its rate stance anytime soon, so bond investors can expect rates to remain low for the foreseeable future.
Credit risk, though, may be a more short-term concern. Investors could see short-term shocks from downgrades to muni debt, such as what happened with Puerto Rico. Puerto Rico headlines could continue to drive swings as the island is the third largest issuer of muni debt.
Investment-grade muni bond ETFs, like MUB and ITM, do not include the speculative-grade quality Puerto Rican debt. However, high-yield muni funds, like the Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD), include some Puerto Rico exposure. HYD has a 3.8% tilt toward Puerto Rico. The ETF has a 4.67% 30-day SEC yield, or a 7.74% taxable equivalent yield for those in the highest income bracket, and a 10.25 year duration.
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.