Funds With Even Shorter Duration Exposure
Investors seeking shorter duration exposure may wish to look at the VanEck Vectors AMT-Free Short Municipal Index ETF (SMB) as well as the iShares Short-Term National Muni Bond ETF (SUB) and the PIMCO Short Term Municipal Bond Active ETF (SMMU), all of which have shorter durations and reasonable dividends.
The VanEck Vectors Pre-Refunded Municipal Index ETF (PRB) invests in prerefunded munis, so because of the very high credit quality, the dividends are lower than from some of the other short-term muni ETFs. However, the very high quality can also serve to offset credit risk exposure for investors with heavier allocations to muni high yield, such as the VanEck Vectors High-Yield Municipal Index ETF (HYD) and the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB).
(For overall portfolio diversification, it can make sense to have a small portion of the fixed-income allocation invested in high yield, and because the exchange listing and share prices are much lower than for individual bond lots, investors can more easily fine-tune their high-yield exposure with ETFs.)
Most long-term investors don’t have the luxury to withdraw from the market or to wait for the Fed or more predictable times. Municipal bonds remain a key component of the portfolios of many investors, and ETFs are an increasingly popular way to access the muni market. For muni investors who have been waiting and are ready to get into the market, please start by reading How to Pick The Right Muni ETF.
How much duration is too much? Modified duration provides an estimate of how much a bond or a portfolio will move in price for an immediate 1% change in interest rates. For example, if an ETF had a duration of 5.0, it would be expected to decline in price by 5% if there were an instantaneous 1% increase in interest rates. Duration is only an estimate, and the actual change in market price will be affected by many factors, but the measure can be a helpful tool for comparing interest-rate risk exposure between bonds or portfolios.
As a point of reference, based on current benchmark rates and assuming new purchases of all par bonds, a hypothetical 10-year laddered high-grade (double or triple “A”-rated) portfolio right now would have an average weighted duration of 5.2, while a 15-year laddered portfolio would be 7.2. While it is possible to take on more duration than you may be comfortable with, it is also possible to take on too little.
Patrick Luby is a municipal bond portfolio strategy specialist and the author of www.IncomeInvestorPerspectives.com. He will be a speaker at the Inside ETFs Inside Fixed Income Conference in Newport Beach, California, Nov. 2-3.
First-half holders data are from the Federal Reserve Quarterly Flow of Funds Report, Sept. 16, 2016.
At the time of writing, the author held none of the securities referenced. This is not a recommendation to buy, sell or hold any of the securities or strategies mentioned. The author does not provide investment, tax, legal or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Information is based on sources believed to be reliable, but its accuracy is not guaranteed. Additional information is available upon request.