Build America Muni Bond ETFs Hot For Now

April 10, 2014

Performance And Attribution Comparison
Ticker Total Return Price Return Total YC Return YC Change YC Carry TC Convexity Modified Duration Convexity (Opt Adj)
BABS 6.92% 5.58% 3.41% 2.48% 0.56% 0.01% 12.81 2.14
BABZ 5.99% 4.68% 2.81% 2.33% 0.48% 0.01% 10.39 1.23
BAB 5.18% 3.74% 2.36% 1.90% 0.46% 0.00% 8.71 0.61
TFI 3.91% 2.83% 2.03% 1.62% 0.40% 0.00% 5.80 0.47
AGG 1.83% 1.12% 1.08% 0.87% 0.21% 0.01% 5.39 0.39

Data source: Bloomberg (as of 3/31/2014)

When Treasury yields didn’t rise as much and as fast as some have anticipated, it resulted in a “snap back” in performance in munis and to BAB portfolios, according to Smith.

Of course, all this comes with a note of caution: When interest rates and Treasury yields again start moving higher, BABs—and BABS in particular—will again take a big hit because their longer durations make them sensitive to changes in yields and the interest-rate outlook.

The Never-Ending Quest For Yields

Smith also pointed out that muni bonds—BABs in particular—are carrying higher yields.

As investors continue to hunt for yields in this ultra-low-rate environment, BABs look rather attractive for those looking for steady income streams. All three BABs funds have yields to maturity (see the YTM column in the table below) of more than 4.5 percent, which is quite attractive relative to broad munis or U.S. agg funds.

Performance And Attribution Comparison
Ticker Total Return Income Return Coupon YTM Current Yield
BABS 6.92% 1.33% 6.25% 4.83% 5.20%
BABZ 5.99% 1.31% 5.79% 4.83% 5.36%
BAB 5.18% 1.44% 6.36% 5.33% 5.70%
TFI 3.91% 1.08% 4.79% 2.97% 4.32%
AGG 1.83% 0.74% 3.63% 2.21% 3.40%

Data source: Bloomberg (as of 3/31/2014)

Bottom line: Driven by significant improvement in fiscal condition across many localities, record-low new issuance and limited supply, as well as strong investor demand for tax-free bonds, the muni market has seen a broad rally in the first quarter of 2014.

Having even longer durations and higher yields, BABs—and the ETF “BABS” in particular— have benefited as yields retreated from post-crisis highs and investors’ continuous quest for yields.

But as I said, as interest rates resume their upward path toward historical norms, it will be difficult for munis and BABs to repeat their recent impressive performances.

Afterthoughts: Since the federal government has discounted the BAB program, no new issues will come to market. Smith believes BABs funds will eventually turn into target-date funds and will gradually unwind as underlying bonds mature.

Stay tuned for the next blog in the series on the U.S. government category. There was a surprising outperformer.


At the time this article was written, the author held no positions in the securities mentioned. Contact Howard Lee at [email protected].

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