As benchmark yields retreated in early 2014, things began to look very different for muni bonds and for BABs.
There are three BABs ETFs on the market. They are the SPDR Nuveen Barclays Capital Build America Bond ETF (BABS | C-99), the PowerShares Build America Bond Portfolio ETF (BAB | B-61) and the actively managed Pimco Build America Bond Strategy Fund (BABZ | B-69).
All three funds have returns in excess of 5 percent thus far this year, which is as impressive as muni returns go. SPDR’s BABS, in particular, has returned more than 6.9 percent.
So what exactly has been driving the solid returns in excess to the broad muni market?
It’s a combination of duration and convexity, and investors’ continuous hunt for yield, according to Patrick Smith, chief investment officer of Granite Springs Asset Management.
Duration And Convexity: A Catch-22
As I pointed out, munis generally have longer maturities and durations than many other bonds, and because of that, they are more sensitive to interest-rate changes. Again, as Treasury yields started to rise in May 2013, the muni market took a big hit, and the BABs market was hit even harder.
But it is, as I said, a different story so far this year. Benchmark 10-year Treasury yields have retreated from their post-financial-crisis high of more than 3 percent in December 2013 to about 2.7 percent.
This drop in benchmark yields has benefited portfolios with longer durations and higher convexity. So it’s no surprise that BABS, with their longer durations, outperformed their shorter-duration peers and the broad U.S. investment-grade bond market.
The following portfolio attribution analysis clearly shows that much—almost half of BABS’s total return, or 341 basis points, has come from changes to the yield curve, depicted at “YC” in the table below.