Why I Own: HYD

June 25, 2012

Daniel Weiskopf

Name: Daniel Weiskopf
Title: Principal
Firm: Global ETF Strategies
Founded: 2004
Location: New York
AUM: $100 million
All ETFs? Yes

ETFR: What does the Market Vectors High Yield Municipal ETF (NYSE Arca: HYD) do in your overall strategy?
Weiskopf: We believe that the limitation on supply in the muni market, combined with the potential for higher taxes, made for two reasons why HYD would be expected to outperform in the long term. We remember being excited about gaining access to this market when it was launched originally. It has an interesting structure in that it’s not active, but it’s also not passive. The portfolio manager’s role is to replicate the index—which includes about 5,000 different issues—and add value on an opportunistic basis. The fund looks for yield and actually affords us some opportunities for capital appreciation. Right now, it’s up about 9 percent this year.

ETFR: But it’s not active?
Weiskopf: Typically when investors are looking to an active manager, they are looking for alpha. The portfolio manager in this case is looking to track his index, but through security selection he also hopes to improve liquidity and enhance the fund’s flexibility. It looks to track the index with certain liquidity parameters that affords it flexibility.

ETFR: What’s your strategy with the ETF?
Weiskopf: We define ourselves through a tactical methodology that involves technical analysis. We monitor the premium/discount on this ETF closely as an indication of the underlying liquidity of this market. We believe that price discovery in the ETF market plays a critical indication in determining an ETF’s direction.



ETFR: What’s the draw of an active selection strategy for the municipals?
Weiskopf: We’ve read studies that point to the fact that active management works better in fixed income than it does in equities. And we think that makes some sense because of the way credit is analyzed and because not all bonds have been rated by a credit agency. Dislocations in the muni-bond market also involve an ability to source bonds.

ETFR: It makes sense to have someone who’s paying attention to what projects are driving issuances out of these municipals. Would you agree with that?
Weiskopf: I would. The specialized expertise and infrastructure that you get for a fee of 35 basis points seems very reasonable to us. There are a lot of fixed-income, passive ETFs that are market weighted and are therefore driven mostly by what is available. If you are market weighted, you are basically liquidity driven more than you are credit driven. We think there are a lot of subtle ways in which a market like this can benefit from quasi-active management.

ETFR: Why high yield?
Weiskopf: Generally, we think yields are going to stay low for a while, so buying higher-yielding securities will attract buyers so long as underlying credits remain strong. Nevertheless, there is a lot of fear out there.

We think HYD offers a compelling opportunity to grab extra yield in a market that requires diversification. It pays a monthly yield of about 5.2 percent right now, which on a tax-adjusted basis is north of 7.5 percent. It is also worth noting that there are call features in this portfolio that potentially are targeted at the sweet spot of the yield curve. We recognize that HYD carries more risk than other munis, but that’s where our tactical management is important.

ETFR: What market conditions would then convince your firm to move out of HYD?
Weiskopf: Market rotations often reflect changing environments for risk management. As a tactical manager, we are looking very closely at how the markets are perceiving risk. For example, the flood of capital that has pushed the Treasurys to record-high prices concerns us because typical investors switch from fear to greed very rapidly. If the risk/reward doesn’t make sense to us in HYD, we would switch. A switch would most likely not be driven by direct credit concerns since HYD is a basket of securities. The challenge with HYD will be in anticipating the change in the liquidity environment.

We have always looked to ETFs as providing us with investment signals on how different markets are performing with inflows and outflows. We believe that markets are efficient and price discovery is an important dynamic to ETF investing. We might also look to sell HYD in favor of another fixed-income subsector. Our process and methodology look to reflect changing market conditions, so if we thought rates might start shifting, we might look at another subsector, like floating rates. We are currently overweight municipal bonds and high yield in the strategy.


Market Vectors High-Yield Municipal


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