Like other fixed income segments, municipal bonds are incurring punishment at the hands of rising interest rates, but some market observers believe that munis are being too harshly repudiated and that there’s opportunity in the group.
That includes high yield municipal bonds, an asset class easily accessible with the VanEck Vectors High Yield Muni ETF (HYD). The $2.9 billion HYD follows the ICE High Yield Crossover Municipal Bond Transition Index and is one of the elder statesmen among high yield municipal bond exchange traded funds, as it debuted more than 13 years ago.
While municipal bonds funds are struggling this year at the hands of Federal Reserve rate tightening, investors are allocating to muni bonds. That could signal long-term support for assets and ETFs such as HYD.
“June and July represent the heaviest period of maturing bonds and coupon payments and these two months normally represent up to 60% of annual redemptions,” noted Michael Cohick, VanEck senior product manager. “Typically, municipal issuers come to market during this time, which offsets the demand pressure from reinvestment. Over the past several years, municipalities have been paying down debt and reducing debt issuance, which has created a net negative supply environment. We believe that as long as new issuance remains below long-term averages, municipal bonds will be attractive during June and July.”
HYD holds nearly 1,700 bonds, and with its focus on junk debt, investors need to be mindful of credit quality. Fortunately, 21.34% of HYD components carry the lowest investment grades, and another 19% are rated BB or B, according to issuer data. The case for HYD is supported by the fact that credit quality is decent while default rates are benign.
“Barclay’s reports that the high yield muni default rate remains low and is expected to remain so for the next several months. Moody’s reports that the 10-year average cumulative default rates for investment grate-rated municipals resides at 0.09% while the average 10-year cumulative default rates for high yield stands at 6.94%,” added Cohick.
Historically, municipal bonds, even junk issues, have proven durable against challenging economic backdrops, and that could be the case again in the current economic environment, as some states that are major municipal bond issuers are enjoying strong revenue collections. For example, California is currently running a record budget surplus of a staggering $97 billion. The largest state by population is the largest geographic exposure in HYD at 13.1% of the fund’s weight.
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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.