With the equities market seesawing again, investors may want to revisit fixed-income assets like municipal bond exchange traded funds for a more conservative play.
Broad muni bond ETFs provide diverse exposure to a pool of municipal debt. For instance, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), the largest muni ETF option, has a 6.31 year duration and a 1.59% 30-day SEC yield, or 2.8% taxable equivalent 30-day SEC yield for those in the highest income bracket.
Additionally, investors who are worried about rising interest rates can utilize a short-term bond ETF, like Market Vectors-Short Municipal ETF (NYSEArca: SMB). SMB has a shorter 3.07 duration – duration is a measure of a bond fund’s sensitivity to changes in interest rates, so a lower duration reflects a smaller sensitivity or price drop in case interest rates rise. The fund also has a 1.01 30-day SEC yield, or a taxable equivalent 30-day SEC yield of 1.68% for those in the highest income bracket.
Potential investors may notice that munis come with yields that are slightly lower than fixed-income funds with similar durations. For example, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) has a 7.73 year duration and a 1.85% 30-day SEC yield. The lower muni yields are generally lower than their taxable counterparts due to the federal tax perks. Consequently, investors would typically calculate a muni fund’s tax-equivalent yield for their income bracket to get a comparable yield to other bond funds.
Tax free municipal bonds may not be the most interesting investment theme, but they provide an investor’s portfolio with a safer play during market swings, writes Dan Moskowitz for Investopedia.
Looking at the potential risk profile, the average default rate of municipal bonds was 0.10% over 2014. In contrast, investment grade corporate bond default rates were about 0.50% over the past several years. Additionally, speculative-grade or junk bonds have a historical default rate of 4.5%. The credit risk comes as no surprise since assets with greater returns typically come with greater risks.
The munis market has been supported by a growing economy and slower issuance of new debt. As the economy expanded, employment rates are up and tax revenue has been on the rise. Meanwhile, muni bond funds have been steadily gained as high demand outpaced a slower supply of new debt. Although, municipalities have been increasing new issuance this year. [Muni Bond ETFs Look Attractive After Pullback]
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.