As people digest the changing Federal Reserve outlook, fixed-income investors may want to hold onto their municipal debt and bond-related exchange traded fund positions.
“One area of the U.S. bond market that does merit attention is the municipal market,” according to Russ Koesterich, Global Chief Investment Strategist and Head of the Model Portfolio & Solutions Business at BlackRock. “To be sure, there is a prospect for some headline risk, as we saw last week when Puerto Rico announced it will default on $37 million of bond payments that were due Jan. 1. However, that has long been expected, and we believe the broader tax-exempt market remains on solid footing. The bottom line: We continue to favor municipal bonds within a fixed income portfolio.”
Municipal bonds have been outpacing U.S. Treasuries. Over the past year, the intermediate-term iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) rose 2.9%, SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) gained 3.1% and Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM) increased 3.7%. Meanwhile, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which tracks intermediate-term Treasuries, was up 1.4% over the past year.
Furthermore, within the muni space, high-yield debt has outperformed. Over the past year, the Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD) gained 5.2% and SPDR Nuveen S&P High Yield Municipal Bond ETF (NYSEArca: HYMB) advanced 3.7%.
The divergence in global central bank policy, lower inflation expectations and rather soft Federal Reserve rhetoric have calmed fears of a sudden spike in interest rates.
Consequently, muni bond ETFs, which offer attractive tax-free income, may still attract investor interest. For instance, MUB has a 2.81% taxable equivalent 30-day SEC yield for those in the highest income bracket. TFI has a 3.35% taxable equivalent yield. ITM shows a 3.27% taxable equivalent 30-day SEC yield. The high-yield muni bond ETFs have even higher income opportunities, with HYD’s 7.38% taxable equivalent yield and HYMB’s 7.61% taxable equivalent yield.
While the Federal Reserve has embarked on the start of interest rate normalization, many still believe that rate hikes will be gradual, so long-term debt may still have some breathing room
“We still think that the end of the yield curve won’t move much,” Ed Lopez, marketing director at Van Eck Global, told ETF Trends in a call.
Consequently, investors may also look to longer duration muni funds, such as the Market Vectors Long Municipal Index ETF (NYSEArca: MLN), which has a 11.5 year duration and a 2.90% 30-day SEC yield or a 4.8% taxable equivalent yield.
Max Chen contributed to this article.