For Duration "Sweet Spot" In Muni Bonds, Investigate ITM

Investors often toss around the phrase “sweet spot” in relation to the equity markets, most commonly for mid-cap stocks. However, it applies elsewhere — such as in muni bonds, where advisors and investors are increasingly searching for the “sweet spot” of duration.

Right now, investors may find the duration sweet spot of muni bonds in intermediate-term bonds, meaning those with maturities of more than two years and less than 10 years.

One ETF that tracks this range is the VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM), which turns 16 years old in December. ITM follows the ICE Intermediate AMT-Free Broad National Municipal Index.

The fund could especially appeal to income investors when factoring in its attractive roll yield prospects. In simple terms, roll yield describes the tendency for bonds to appreciate in price as maturity nears, forcing yields lower because bond prices and yields move inversely. Those price gains are known as roll yield.

ITM: Right Duration In Muni Bonds, Combined With Roll Yield Play

The $1.8 billion ITM currently sports a 30-day SEC yield of 2.82% — decent, but not alarmingly high. However, the ETF does have potentially noteworthy roll-yield prospects.

“The muni yield curve is an important indicator of the health of the municipal bond market and the broader economy,” noted VanEck product manager John Patrick Lee. “The muni yield curve has recently become inverted in the short end, meaning that yields of some longer-dated municipal bonds are lower than those of shorter-term bonds. However, the intermediate part of the curve remains positively sloped and steep, providing attractive roll yield for investors who target these maturities. Steepness refers to the degree of absolute difference between yields of different maturities.”

ITM allocates 99.50% of its weight to investment-grade bonds. More than 95% of those issues carry A, AA, or AAA ratings, confirming credit risk is minimal with the VanEck ETF.

As for interest rate risk, ITM’s modified duration is 8.25 years, but intermediate-term bonds offer investors the added perk of reduced correlations to equities relative to long-dated bonds. While that duration is toward the higher end of intermediate-term territory, ITM does feature the goods when it comes to harnessing roll yield.

The fund “targets bonds with maturities of 6 through 17 years. Municipal bonds in this maturity range have historically provided a greater roll yield effect due to these wider yield differentials between maturities,” concluded VanEck’s Lee.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.