Municipal bond yields may be low, but the total returns for most municipal bond ETFs have been very strong—higher than some equity returns, in fact.
|Index||Duration||July||YTD||Trailing 12 Months|
|Barclays U.S. Aggregate||5.47||0.63%||5.98%||5.94%|
|Barclays Municipal Bond||5.71||0.06%||4.40%||6.94%|
|S&P Municipal Bond Index||4.70||0.02%||4.37%||7.06%|
|S&P Taxable Municipal Bond Index||8.60||1.80%||10.13%||11.53%|
Sources: us.spindices.com and index.barcap.com
Data as of 7-29-2016
Bond market returns have been helped of course by the continuing decline in yields around the world, which have pushed bond prices higher.
In the municipal bond market—which is dominated by income-seeking individual investors—declining yields have historically sent buyers to the sidelines, but this year, investors have been adding significant amounts of new money to the muni market.
Net flows into muni ETFs have already eclipsed last year's total. However, not all of the flows into muni ETFs have been in just the top income-producing ETFs.
Looking at the flows into the top dozen muni ETFs (which represent 90% of the total year-to-date muni inflows) illustrates some of the different reasons why investors buy municipal bonds: income, diversification and safety.
Three of the top 12 ETFs rank high in dividend income: The VanEck Vectors High-Yield Municipal Index ETF (HYD), the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) and the PowerShares Build America Bond Portfolio (BAB) all have a dividend yield higher than 4%. (BAB invests in federally taxable Build America Bonds, making it potentially appropriate for tax-deferred and tax-exempt accounts.)
While HYD and HYMB have generated high levels of dividend income and have been inversely correlated to the SPDR S&P 500 ETF Trust (SPY), there are other muni ETFs that have been better portfolio diversifiers.
Bonds are frequently used to add a counterbalance to equity risk, so that a balanced portfolio will (hopefully) show less volatility than an all-equity portfolio. Comparing the muni ETFs to SPY (as a proxy for equity risk exposure) reveals that almost all muni ETFs have been negatively correlated over the last six months; yet some muni ETFs have been better diversifiers than others.
Among the top dozen asset attractors, BAB, the SPDR Nuveen Barclays Municipal Bond ETF (TFI), the Vanguard Tax-Exempt Bond Index Fund ETF (VTEB), the VanEck Vectors AMT-Free Intermediate Municipal Index ETF (ITM), the iShares California Muni Bond ETF (CMF) and the iShares National Muni Bond ETF (MUB) demonstrated the lowest correlations with SPY, suggesting that many investors made the decision to accept less than the "max income" to also pursue better portfolio diversification.
Of course, there are also occasions when investors want a higher-than-zero return, but need to maintain minimal risk to their principal. The iShares Short-Term National Muni Bond ETF (SUB) has a short duration, has had a reasonable dividend yield as well as positive total returns. As a diversifier, however, it is ranked in the bottom half of the field. Investors who hold SUB as a lower-risk, short-to-intermediate-term investment and who also want to balance their equity risk may wish to complement the position with another muni ETF with a lower equity correlation.