ETF Trends CEO Tom Lydon discussed the Columbia Multi-Sector Municipal Income ETF (MUST) on this week’s “ETF of the Week” podcast with Chuck Jaffe on the MoneyLife Show.

MUST seeks investment results that, before fees and expenses, closely correspond to the index’s performance. The fund invests at least 80% of its net assets in bonds and other debt instruments issued by or on behalf of state or local governmental units whose interests are exempted from U.S. federal income tax.

Considering the drawbacks of traditional bond index-based investments, investors can turn to alternative fixed-income ETF strategies to diversify risk and maintain income, especially in a rising interest rate environment ahead.

In the current fixed-income environment, labor markets have normalized and elevated inflation, which is here to stay for the time being. There are concerns that the Federal Reserve will begin curtailing its easy monetary policy next year. As a result, there’s a threat of rising interest rates.

Consequently, investors should consider the value in diversification rather than further upside potential, especially with the markets more at risk of rising interest rates. However, credit valuations leave little room for error, with tight spreads already reflecting high valuations in the credit markets. There may be room for fixed-income investors to find value, but people will have to go beyond their comfort zones or away from traditional bond benchmarks like the Bloomberg U.S. Aggregate Bond Index.

Bloomberg U.S. Aggregate Bond Index investors take more risk to generate less income than ever before. Over the years, the duration or maturity of bonds within the index has increased, which leaves investors open to higher interest rate risks. Meanwhile, yields are down, so investors are more at risk of rising rates hurting their capital investments with less income generation ahead.

Increase That Exposure

Investors need more credit exposure or even 80% in high yield in today’s low-rate environment to generate a 4% yield. This would expose them to risks that many may not be comfortable with.

Municipal bonds can instantly diversify an investment portfolio centered on the U.S. Aggregate Bond Index. The “Agg” does not include municipal bond exposure.

Demand for municipal bond ETFs continues to climb in 2021. Despite representing 6.8% of the fixed income ETF universe, municipal bond ETFs have gathered an 11% share of the $154 billion of net inflows for the asset category as of October 7. According to CFRA ETF data, the $16.4 billion of year-to-date net inflows for the municipal bond sub-category are higher than corporate bonds ($16.2 billion) and Treasury and Government bonds ($8.7 billion) ETF sub-categories. In addition, the net inflows for municipal bond ETFs in 2021 have already exceeded the $14.6 billion for all of 2020.

Supporting the demand for munis this year, there are growing concerns that President Joe Biden and the Democratic-controlled Congress could raise taxes. Consequently, muni bonds and the tax-free income they provide now appear more attractive to many investors.

Many states, cities, and counties have come out of the COVID-19 pandemic better than previously anticipated, mitigating fears that pandemic-related budget shortfalls would weigh down the value of local-government debt. Moody’s Investors Service even upwardly revised its outlook on state and local governments to “stable” from “negative” in March, pointing to the better-than-expected revenue and federal stimulus measures.

Listen to the Full Podcast Episode on MUST:

For more podcast episodes featuring Tom Lydon, visit our podcasts category.