As investors look to suitable ways to diversify their fixed-income portfolios, people should look to municipal bonds and related ETFs.
In a research note, Michael Cohick, ETF Product Manager argued that “muni credits remain highly rated and that muni bankruptcies and defaults remain rare overall, should lead investors seriously to consider munis as a portfolio investment. And these benefits are in addition to the tax advantages an investment in muni bonds also offers.”
Moody’s Investors Service ratings agency recently confirmed that municipal debt remains highly rated with upgrades narrowly outpacing downgrades. Moody’s bond ratings for munis skewed slightly towards notch-weighted “upgrades” than “downgrades,” marking a turning point for muni bond ratings drift.
Consequently, the ratings agency believed that “most credits are recovering or are stable in the aftermath of the recess.”
Furthermore, default rates remain low relative to the larger bond market. Since 1970, there have been just 103 defaults of the many thousands of rated muni bond issued. Of these, 72.8% were accounted for by competitive enterprises, 20.4% by general governments and 6.8% by muni utilities, with most of the competitive enterprise defaults occurring during the 2004 to 2008 period as the housing sector became stressed.
Among the major defaults in 2016, four were attributed to Puerto Rico, which continues to wrestle with shaky finances. Moody’s anticipates Puerto Rico’s number of individual defaults to rise in 2017, totaling as high as $64.3 billion by the end of the year.
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The defaults have a greater effect on the high-yield muni market, but high-yield munis like the VanEck Vectors High Yield Municipal Index ETF (NYSEArca: HYD) include attractive yields to somewhat cushion any potential pullbacks. HYD shows a 3.96% 30-day SEC yield, or a 6.55% taxable equivalent 30-day SEC yield.
Alternatively, bond investors can still enjoy stable and attractive yields through investment-grade municipal bond exposure through options like the VanEck Vectors AMT-Free Intermediate Municipal Index ETF (NYSEArca: ITM) to diversify their fixed-income portfolios with a tax-exempt offering. ITM has a 6.92 year effective duration and a 1.93% 30-day SEC yield, or a 3.19% taxable equivalent yield.