While fixed-income investors may not experience another robust run in traditional bond assets, municipal bonds and related exchange traded funds may still offer stability in a volatile market environment.
The munis market has been pressured this year by rising new issues, or greater supply, but Christopher Alwine, head of the municipal bond group at Vanguard, calculates that about 60% of muni issues this year will be refinancing, so the net new volume will be less than actual volume of new bonds, reports Kelley Holland for CNBC.
The Vanguard Group also recently launched its first municipal bond ETF, the Vanguard Tax-Exempt Bond Index Fund (NYSEArca: VTEB), last month. VTEB tries to reflect the performance of the Standard & Poor’s National AMT-Free Municipal Bond Index, the same underlying benchmark for the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), the largest muni-related bond ETF. [Vanguard Launches Its First Muni Bond ETF]
“Debt issuance in the muni market has been more robust in 2015, driven largely by issuers trying to capitalize on today’s lower interest rates before the expected Federal Reserve rate hikes,” Elizabeth Foos, a senior analyst at Morningstar, said in a note.
Some market observers also argue that the Federal Reserve could be loath to hike interest rates, especially after the weak jobs report and recent market volatility. With near-zero rates, munis may offer some attractive yields.
For instance, MUB has a 1.74% 30-day SEC yield, or a 4.38% taxable equivalent 30-day SEC yield for those in the highest income bracket.
Additionally, Alwine points out that inflation is closer to bottoming. The low inflation makes real yields, or yields adjusted after accounting for inflation, more attractive.
However, there are some caveats on a state-to-state basis. For example, New Jersey’s pensions are underfunded, and Chicago’s debt was recently downgraded to below investment grade, adding to concerns over general obligation bonds that are backed by an issuer’s general revenue from sources like taxes. VTEB and MUB, though, only have about a 4.5% tilt toward New Jersey and only include investment-grade muni debt.
Alternatively, investors can take a look at the Deutsche X-Trackers Municipal Infrastructure Revenue Bond Fund (NYSEArca: RVNU), which seeks to reduce exposure to public pension risk, not avoid or eliminate it, by focusing solely on bonds that fund, state and local infrastructure projects such as water and sewer systems, public power systems, toll roads, bridges, tunnels, and many other public use projects. The interest and principal repayments are generated from dedicated revenue sources as opposed to general obligation bonds that have come under greater scrutiny. RVNU has a 3.08% 12-month yield. [Alternative Income ETF Strategies for a Shifting Environment]
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.