There are multiple reasons to consider municipal bonds, including tax benefits, decent yields and in many cases, benign credit risk. However, in today’s low-yield environment, the fair yields on some municipal bonds may not be enough for income-hungry investors.
The VanEck Vectors High-Yield Municipal ETF (CBOE: HYD) is an ideal avenue for investors looking to juice yield with municipal bond investments. The $3.2 billion HYD has a 30-day SEC yield of 3.31%, which is well above-average for the municipal bond space.
Municipal debt and bond-related ETFs have been used as a relatively stable fixed-income stream for many investment portfolios.
Since muni bond interest is exempt from federal taxes, muni ETFs are a good way for investors seeking tax-exempt income, especially those in higher tax brackets. Due to its tax-exempt status, the asset category is also best utilized in taxable accounts.
“In municipal high-yield–and this is a little bit debatable on the part of certain people–but generally speaking, in the municipal world, most people think of BBB as being part of the high-yield muni universe,” said Morningstar in a recent note.
Assessing HYD Credit Risk
HYD, which has an effective duration of 6.33 years, holds nearly 2,100 bonds. Over 29% actually carry investment-grade ratings while just over 35% are rated junk. Another 35% aren’t rated.
“So, even though BBB is technically investment-grade if you look at outside ratings, those bonds tend to be favored by high-yield muni funds,” according to Morningstar. “They tend to get lumped together with them. You’ll hear arguments that their default occurrence is a lot lower than corporate BBB, for example, and there’s some truth to that in terms of the default history. But if you’re looking at the universe that high-yield muni funds are involved in, it starts there. The other issue is that there are a lot of smaller nonrated issues.”
Munis also help diversify fixed-income portfolios. Investors who typically follow the Barclays U.S. Aggregate Bond Index will not have municipal bond exposure, so a muni bond ETF can complement core fixed-income positions.
As of the end of the third quarter, municipal debt issued by California and Illinois combined for 26% of HYD’s weight.
For more news on Muni Bond ETFs, visit our Muni Bonds category.
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.