The stubbornly low interest rate environment has helped bond exchange traded funds some of the most attractive investments this year. However, with most areas of the fixed-income market fully priced, ETF investors may seek out opportunities in municipal and junk-rated debt.
For 2015, Janney Montgomery Scott overweights muni bonds and believes high-yield corporate debt are “also reasonably attractive,” reports Michael Aneiro for Barron’s.
ETF investors interested in playing the brokerage firm’s suggestions have some broad options available. For example, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) and SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) both provide exposure to investment-quality intermediate-term municipal bonds. [Why an ETF May Make Sense for Munis Exposure]
MUB has a 6.37 year duration, a 1.63% 30-day SEC yield and a 0.25% expense ratio. TFI has a slightly longer 7.66 year duration, a 1.92% 30-day SEC yield and a 0.23% expense ratio.
“Municipal-bond yields are generally lower than those sported by their taxable counterparts because of their tax benefits,” according to Morningstar analyst Thomas Boccellari.
The muni ETFs can be used as a core fixed-income allocation to help alleviate some tax costs. For instance, MUB has a 2.88% 30-day taxable equivalent SEC yield for those in the highest income bracket while TFI has a 3.39% taxable equivalent yield.
In comparing debt qualities, MUB includes 10.1% Aaa-rated debt, 57.2% Aa and 20.7% A. TFI holds 17.0% Aaa, 18.6% Aa and 1.3% A.
Supporting potential gains in the fixed-income market, Janney points to continued pressure in yields, with yields on benchmark 10-year Treasuries to hover around 2.47% by the end of 2015 from their current 2.29%, and inflation to only rise 1.4%.
Yields and fixed-income prices have an inverse relationship, so falling yields correspond to rising prices. Additionally, bond yields and cash look more attractive in a low inflation environment.
Additionally, Janney projects that muni-to-Treasury yields to trend lower next year – a falling ratio reflect an outperforming munis market, due to improved confidence in municipal creditworthiness and default fears abate.
“Once again, tax-exempts represent our strongest conviction overweight call for 2015, an outgrowth of the value of tax-exempt income at a time when upper bracket tax rates are at their highest levels since 1986,” Janney Montgomery Scott said in the article. [Muni Bond ETFs Still Have Tailwinds]
Investors interested in high-yield debt exposure can take a look at broad junk bond ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK).
HYG has a 4.16 year duration, a 5.12% 30-day SEC yield and a 0.50% expense ratio. JNK has a 4.35 year duration, a 5.68% 30-day SEC yield and a 0.40% expense ratio.
Janney expects credit fundamentals to remain sold through 2015.
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.