In the face of election year volatility and speculation about the Federal Reserve’s plans for interest rates, municipal bond ETFs faced some headwinds last year.
The iShares S&P National AMT-Free Muni Bond ETF (NYSEArca: MUB), the largest municipal bond ETF, notched a modest decline last year.
Some bond market analysts and participants are concerned about the impact a Trump presidency will have on municipal bonds. Prior to the Fed raising interest rates for the only time last year in December, income investors widely embraced muni ETFs. However, the Fed is targeting three rate hikes for 2017, a scenario that could pressure fixed income assets.
“The devastation of municipal bond prices following the U.S. presidential election has created opportunities as the yields of non-callable, investment grade, tax-exempt municipal bonds have risen to a point where they cannot be ignored,” said S&P Dow Jones Indices in a recent note.
Since muni bond interest is exempt from federal taxes, muni ETFs are a good way for investors seeking tax-exempt income, especially those in higher tax brackets. Due to its tax-exempt status, the asset category is also best utilized in taxable accounts. The tax-exempt status also creates high demand for municipal bonds. Consequently, the perceived bond yields are typically lower than their taxable counterparts.
Munis also help diversify fixed-income portfolios. Investors who typically follow the Barclays U.S. Aggregate Bond Index will not have municipal bond exposure, so a muni bond ETF can complement core fixed-income positions.
“The five year range tracked in the S&P AMT-Free Municipal Series Dec 2022 and the ten year range tracked in the S&P AMT-Free Municipal Series Dec 2026 had year-ending yields higher than their U.S. Treasury bond equivalents and when viewed from the perspective of Taxable Equivalent Yield the yields of municipal bonds ended incrementally higher in yield than similar U.S. corporate bonds,” adds S&P Dow Jones.
The municipal market also comes with high quality and low volatility traits. The asset category has experienced lower volatility than other bond categories and tends to be less affected by Federal Reserve rate uncertainty than high-quality taxable investments, like Treasuries.
For more information on the munis market, visit our municipal bonds category.