However, why should investors consider these ETFs in the first place? Below are three reasons.
More Liquidity and Less Cost
Just like their corporate counterparts, as opposed to buying and selling municipal bonds directly, having local debt issues within an ETF wrapper allows investors to trade muni bond ETFs during normal market hours. It adds the element of liquidity that ETFs can provide–buying and selling an asset quickly–while at the same time, gives investors access to the municipal bond market.
Furthermore, the costs to transact municipal bond ETFs, which have no upfront or back-end sales charges translates into lower expense ratios–the administrative and operational costs associated with an ETF. Of course, lower expense ratios means investors reap more of the profits should the ETF climb past its sales price.
For the most part, municipal bonds carry tax exemptions from both state and local taxes for investors who reside within the same state or city as the issuer, but in the case of federal income taxes, they are completely exempt–making it an attractive option for individuals seeking tax-free income-producing assets. On the opposite end of the spectrum, the interest received from corporate tax bond interest from ETFs is taxed like ordinary income.
Lower Risk of Default
Versus their corporate counterparts, municipal bonds have a lower risk of default. According to a study conducted by credit rating company Moody’s, 0.8% of muni bonds rated investment grade defaulted within ten years of issuance.
Investment firm Asset Dedication cited “improved regulation, transparency, and oversight” as reasons to why municipal bonds have a such a low default rate. To the risk averse investor, muni bond ETFs offer a prime alternative for seeking low-risk yield.
For more trends in fixed income, visit the Rising Rates Channel.