Patrick Luby is the senior municipal strategist at CreditSights. He also serves on the board of directors of the Municipal Analysts Group of New York and is a member of the National Federation of Municipal Analysts and the Fixed Income Analysts Society.
In this conversation with ETF.com, Luby shares his insights on the muni ETF market, his views on interesting ETF launches for the year and his outlook for the year ahead. The following transcript has been edited for clarity and brevity.
ETF.com: The week of Dec. 13, muni bond ETFs had their biggest week ever with nearly $1 billion in net new assets. Would you give us some context for that? How have flows been throughout the rest of 2021?
Patrick Luby: Flows have been very strong in 2021, I think—counterintuitively—because the yield environment has remained low. Muni yields are not high enough to attract attention from any except the high tax bracket individual investor, yet money continues to come in. Spreads are tight, yields are low, yet money continues to come into the muni market.
[Looking at] the combined flows into mutual funds in ETFs, ETFs have only about 8% of the assets, but have gotten 20% of the flows this year. ETFs are punching above their weight in the flows.
ETF.com: What do you think is driving these flows into munis?
Luby: There are really two drivers. One is the demographics of the individual investors, who are seeking two things: protection of principal and generating income. With the low rate environment, tax advantage becomes even more important.
For older investors who are looking for their investment portfolio to generate income, fixed income makes sense. Munis make sense for individual investors in a taxable account.
The other one is the growth of the equity market this year. I follow mutual fund flows, and equity mutual funds have had net outflows every month this year, yet the total assets under management continue to grow. That tells me that a lot of investors are rebalancing portfolios, as equity markets have continued to grow. This implies that they're taking some of that money out of equity and reallocating the portfolios into fixed income.
ETF.com: Your research had identified particular ETFs that were drawing the investor flows. Would you talk about that?
Luby: It's interesting. The iShares National Muni Bond ETF (MUB) is the largest muni ETF. It's usually the go-to ETF for muni investors. It's very liquid, extremely well diversified and very broadly held.
But over the last week, we saw not just MUB with inflows, but the Vanguard Tax-Exempt Bond ETF (VTEB) and some of the other strategies. It suggests that some of those flows aren't just blindly going into munis, but that some of them went into short-term and low duration strategies. The Invesco Taxable Municipal Bond ETF (BAB), which is the only taxable muni ETF, ended last week with some good trading activity. I think investors are taking advantage of the diversity of the muni ETFs that are out there.
Ten new muni ETFs have launched so far this year, including [on Dec. 21], which was “happy birthday” for the IQ MacKay California Muni (MMCA), which made its debut. Nine of them are active strategies.
ETF.com: Are there any in particular you think are worth highlighting?
Luby: One of the early launches this year was the BlackRock High Yield Muni Income Bond ETF (HYMU). And this is proof that it takes more than just a strong brand name, because that ETF only has $26 million in assets under management so far. But I think, as we go through a market cycle, that will continue to attract investors. High yield spreads are pretty tight, so I'm not sure I'd be in a huge rush to put money into high yield. It's got the BlackRock team behind it [with] tremendous resources, so I think that will do well.
A couple of the MacKay strategies have been really strong performers. And performance speaks very loudly in this market, where yields are not terribly high. My guess is that MMCA will attract some assets. California is a very large market, and having professionally managed, active exposure there, I think they can make some progress.
The Dimensional National Municipal Bond ETF (DFNM) is a really interesting strategy to me, because Dimensional, as a quantitative manager, has an excellent reputation among financial advisors and RIAs. Converting a number of their mutual funds into ETFs was a bold move. That fund launched in November and has $23 million in assets under management already. That's a very respectable start for a fund that's only been out there about a month. That’s a shop that has really strong name recognition. Even as a relatively new strategy, I think we'll see some assets flow into DFNM.
The First Trust New York Municipal High Income ETF (FMNY) is another one that flies under the radar. This launched in May and only has $15 million in it so far. The First Trust ETFs have good performance. They're active strategies. They've done a good job of using the flexibility of being actively managed to perform well.
ETF.com: In thinking about 2022, are there any developments investors should be paying attention to when it comes to muni bonds?
Luby: From a credit perspective, municipal bond issuers themselves are emerging from the pandemic in relatively good shape. Credit ratings have been stable. We'll probably see some improvements in credit ratings.
The bigger question mark really is how the interest rate environment and inflation unfolds. We’re expecting the total new issue supply for munis to tick up a little bit next year. But we're also expecting an increase in taxable issuance. An increase in supply doesn't necessarily mean an increase in tax-exempt municipal supply.
Investors accustomed to buying individual bonds may continue to see a challenging environment. That's a large group of investors that I've long encouraged to be thinking creatively about muni ETFs. A lot of investors who have portfolios of individual bonds, as those bonds mature or have to get reinvested can't find the right bonds. You can do what the large institutional managers do—use a muni ETF for tactical exposure.
The state of politics right now reminds the state and local governments that, even though the federal government has been a great partner through the pandemic, most of state and local government infrastructure needs to figure out their own. They can't rely on politics and Washington. When Washington helps, that's great. But roads, bridges, schools, water need to be funded with local initiatives. I think we'll probably see a little bit more issuance on local infrastructure in state and local governments.