2 Actively Managed Muni ETFs to Diversify a Bond Portfolio

As investors gaze upon the municipal bond landscape, many are identifying exchange traded fund (ETF) strategies to incorporate munis into a diversified fixed-income portfolio.

On the recent webcast, Top 5 Municipal Market Insights, David Dowden, Managing Director, Portfolio Manager, MacKay Municipal Managers, and Maria Rahni, ETF Product Manager, New York Life Investments, outlined a few ways for fixed income investors to diversify their bond portfolios by looking at opportunities within the municipal bond space. They argued that the munis market suffers from inefficiencies that an active manager can exploit to generate alpha, such as the complexity, product breath and passive investing base of the municipal bond market. Moreover, the markets are increasingly prone to periods of volatility, which further creates opportunities for institutional investors.

“We believe today’s municipal bond landscape requires active management,” Dowden said, adding that market inefficiencies can be exploited by investors with significant information-gather capabilities.

Looking ahead, MacKay pointed to five municipal insights that munis investors should consider. For starters, dedicated tax and general obligation debt outperforms as tax revenue streams grow. Municipal issuance exceeds market expectations. The restructuring of Puerto Rico’s debt provides opportunity to increase allocation to high yield munis. Municipal financing with embedded real estate risk underperforms. Lastly, tactical portfolio positioning drives performance.

Dowden also contended that a broad muni ETF strategy may also be a better way to gain diversified exposure to this market segment.

“Actively managed municipal bond ETFs combine the best features of ETFs and mutual funds into one solution. They offer investors access to professional management of an inefficient asset class within a cost effective, liquid investment vehicle,” Rahni said.

Financial advisors may find it challenging to buy individual muni securities, given the post 2008 regulatory environment coupled with recent passage of tax reforms. Meanwhile, banks and broker dealers have committed less of their capital, which leaves a lower inventory for financial advisors. Prices of munis, or at least for those not receiving institutional pricing, have also added on to increased trading costs.

Investors who are interested in an active municipal bond strategy may consider something like the MacKay Shields Municipal Intermediate ETF (NYSE Arca: MMIT) and the IQ MacKay Shields Municipal Insured ETF (NYSE Arca: MMIN).

The two strategies both seek to maintain 100% of assets in investment-grade munis diversified across states and sectors with a duration neutral approach, an expected annual turnover of 20% to 30% and no leverage exposure. MMIT invests primarily in investment grade municipal bonds. MMIN principally invests in investment-grade municipal bonds covered by an insurance policy guaranteeing the payment of principal and interest.

Municipal bond insurance is a guarantee from an insurance company that the holder of a muni bond will receive scheduled interest and principal payments when due, even if the issuer is in default. The bond insurance may provide increased price stability and greater market liquidity. Examples of such occurrences are highlighted by prominent defaults of Detroit and Puerto Rico.

If a financial advisor is thinking about incorporating an active muni bond ETF strategy, one may replace beta exposure and use active muni ETFs as a diversified core muni holding, complement beta exposure with a muni strategy that has the potenail for alpha generation, shift muni exposures within client portfolios, replace underperforming or more expensive active ETF exposure, replace laddered muni strategy or diversify a fixed-income allocation, especially for more tax-aware clients.

Financial advisors who are interested in learning more about munis market strategies can watch the webcast here on demand.