Despite precarious financial positions for several large U.S.
states and an increased number of municipal bankruptcies, ETFs
tracking municipal bonds have been stellar performers in 2012.
Jim Colby, portfolio manager and senior municipal strategist,
responsible for Market Vectors municipal bond investments,
expects the ebullience to continue.
"I believe the continued value proposition embedded in
municipal yields - nominally higher than those of treasuries -
has attracted both individual and institutional buyers," Colby
said in his weekly research note on muni bonds.
Indeed, it has been a combination of high yields and
relatively low default rates that have driven investors to muni
bond ETFs. The Market Vectors High-Yield Municipal Index ETF
), which has almost $896 million in assets under management, has
surged 10.5 percent year-to-date. HYD pays a monthly dividend
with a 30-day SEC yield of 4.82 percent and a trailing 12-month
yield of five percent.
Other high-yield muni bond funds have gotten in on the act as
well. The SPDR Nuveen S&P High Yield Municipal Bond ETF
) has jumped 9.44 percent this year. With almost $144 million in
AUM, HYMB features a 30-day SEC yield of 4.53 percent.
Colby notes declining yields on muni issues have bolstered
year-to-date returns and helped drive inflows.
"Through September, municipal mutual funds and ETFs have
witnessed 43 consecutive weeks of positive cash inflows,"
Colby wrote in the note
In theory, an elevated number of municipal defaults should be
having an adverse impact on muni bond ETFs, but that has not been
the case. One fact that may be keeping ETFs such as HYD and HYMB
steady is that default rates are still not at troublesome levels.
Arguably, the default risk in the muni bond market is overstated.
Colby noted in an interview earlier this year with Benzinga that
muni bonds are a $3.7 trillion marketplace, but only 2% of that
number trades on any given day
In that interview, he said
"less than one half of one percent"
of rated bond issues default.
Even the iShares S&P California AMT-Free Municipal Bond
), which focuses on muni issues from financially-challenged
California, has soared 5.2 percent this year. California issues
also account for 22 percent of HYD's weight. The Market Vectors
Intermediate Municipal Index ETF (NYSE:
) is another example of an ETF heavy on California issues that
has thrived despite the negative headlines flowing from the
nation's largest state.
ITM has trailing 12-month yield of almost three percent and
has risen nearly four percent this year despite a 15 percent
allocation to California.
Looking ahead, Colby's forecast is bullish, but he cautions
investors that there are potential issues to be aware of.
"I believe we can expect continued good performance but with
the following two caveats: (1) political risk in the form of
potential changes to, or elimination of, the tax-exempt nature of
municipal interest, and (2) credit deterioration resulting from
weak underlying economics. Either could have an adverse impact on
the market," he wrote.
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