Alternatively, “tax-exempt income and total return can be extracted from two primary risk factors: duration and credit –each uncorrelated and capable of performing well in different stages of economic cycle,” Stienstra added. “By allocating across both the maturity and quality spectrums, investors broaden their opportunity set and introduce increased propensity for desirable outcomes.”
Potential muni bond ETF investors may look to the recently launched Columbia Multi-Sector Municipal Income ETF (NYSEArca: MUST) as a way to broaden their opportunity set.
“In order to maximize the potential for risk-adjusted returns and income, the index is designed to exploit inefficiencies inherent in traditional passive approaches,” Stienstra said.
Jay McAndrew, National Sales Manager for Strategic Beta at Columbia Threadneedle Investments, argued that a strategy like MUST could help complement a traditional approach to municipal bond investing and improve investor outcomes. The smart beta methodology leans toward potential opportunity as opposed to traditional market cap-weighting or indebtedness. As a result, the portfolio takes a more active approach to enhance yield and generate improved risk-adjusted returns over conventional municipal benchmarks while following a passive ,rules-based indexing methodology.
Specifically, the underlying portfolio includes a 25% tilt toward shorter, high quality muni debt securities, which provides stability and buoys lower-rated, higher yielding bonds; 45% toward all-weather core positions, which balance duration and credit risk by targeting lower-rated investment grade and intermediate-term revenue bonds; and 30% in longer, low quality debt, which pursues a higher level of income via credit risk in an attempt to mitigate interest rate sensitivity.
Furthermore, the smart beta strategy excludes pre-refunded bonds due to their lower yield potential, California bonds due to high in-state demand leading to lower yields and relatively higher premiums, and U.S. territories and Tobacco to dampen volatility.
Financial advisors who are interested in learning more about the municipal bond market can watch the webcast here on demand.