“First, the high-yield muni market is small, fragmented, and generally less-liquid than the investment-grade muni space. Second, because many high-yield municipal indexes are market-cap weighted, they show pronounced tilts to Puerto Rico bonds and tobacco settlement authorities, which are some of the most prolific issuers of low-quality municipal debt,” according to Morningstar.
Related: Is it Still High Times for High Yield?
Municipal bonds issued by Puerto Rico account for just 1.30% of HYD’s weight, but tobacco settlement bonds are the fund’s second-largest exposure at 15.40%. Still, HYD is underweight Puerto Rico and tobacco settlement municipal bonds relative to the Bloomberg-Barclays High Yield Municipal index.
“In 2018, that index gained a boost from the outperformance of its Puerto Rico holdings, which returned 20%, driven by performance in the Commonwealth’s Aquaduct and Sewer Authority bonds, which gained 30% as the authority cooperated with bondholders and narrowed its funding gap. This event was a surprise, and illustrates a third risk within this category: One-off events can have an outsize impact on the performance of high yield muni benchmarks,” notes Morningstar.
For more trends in fixed income, visit the Fixed Income Channel.