Fixed-income investors should focus on municipal bond exchange traded funds ahead as favorable fundamentals may support further gains.
Municipal bond ETFs are rebounding after the election sent munis reeling. Many muni investors feared that President Donald Trump’s big plans for an infrastructure revival would inundate the market with a new supply of municipal debt issuance.
Many were also concerned that Trump’s plans to lower income taxes would weaken the appeal of tax-exempt munis and that the president’s pro-growth agenda would push the Federal Reserve to hike interest rates sooner and faster.
However, the muni bond ETF market has more or less made up its precipitous post-election plunge. Jim Colby, Portfolio Manager at VanEck, argued that the current muni market environment is being fueled by increasing doubts over the Trump administration’s ability to push through its agenda, along with other concerns that have fueled bets for safer assets and yields, which helped fuel greater interest for munis this year.
“As of May 23, the 37 municipal bond ETFs had, year-to-date, garnered $1.6 billion in net new assets, resulting in total assets under management of $26.0 billion, compared to $21.0 billion approximately a year ago,” Colby said in a note.
Looking ahead, the muni market is entering a reinvestment season that could bolster the market, with three consecutive months of significant reinvestment demand generated by coupons, maturities and calls ahead.
“As things currently look, 2017 is going to be historic in terms of just how much cash is going to be returned to investors,” Colby said.
According to Citigroup data, the state and local government debt market will shrink by $39.5 billion as bonds mature faster than they are being issued. Meanwhile, $44 billion in interest payments will be made to investors, contributing to some $84 billion available to be reinvested. Muni investors are basically in a position to enjoy the benefits of positive supply and demand dynamics.
According to Siebert Cisneros Shank & Co., the U.S. municipal bond market is expected to see the largest amount of debt ever maturing this June. In addition, if calls come in as projected, June 2017 will beat July 2012 as being the single largest month ever for money going back to investors.
On the other hand, only $105 billion of new tax-exempt muni bonds have been issued, or down about 15%.
We are in a position where investors will be cash heavy, which could increase reinvestment demand for munis, but there is not enough supply to go around. Consequently, the muni bond market could continue to find support as demand outstrips supply this summer.
“The supply demand imbalance means the potential for strong performance,” Michael Cohick, Product Manager at VanEck, told ETF Trends.
Consequently, Cohick suggested that investors should look to muni bond ETFs that could benefit the most from this imbalance, including options like the VanEck Vectors High Yield Municipal Index ETF (NYSEArca: HYD), which tracks high-yield or speculative-grade municipal debt, or the VanEck Vectors AMT-Free Intermediate Municipal Index ETF (NYSEArca: ITM) tracks intermediate duration investment-grade munis.
HYD shows a 0.35% expense ratio, a 7.49 year duration and a 3.84% 30-day SEC yield, or 6.35% taxable equivalent 30-day SEC yield. ITM has a 0.24% expense ratio, a 6.89 year duration and a 2.10% 30-day SEC yield, or a 3.48% taxable equivalent 30-day SEC yield.