After a rocky start to 2018, the municipal bond market rallied to finish up as the fifth-consecutive year, and is up so far this year.
Demand for municipal bonds has been very strong. Expect that to continue as tax-paying individual investors (especially those in the high-tax states, such as California, New York, New Jersey and Connecticut) begin to understand the dollars-and-cents impact resulting from the new limitation on the deductibility of state and local taxes (the SALT deduction) from their federal taxes. The interest in tax-exempt income will go higher.
(We calculate that even with the reduction in the maximum federal individual income tax rate from 39.6% to 37%, the cap on the SALT deduction means the combined state and federal maximum effective income tax rates went up in seven states: California, Connecticut, Minnesota, New Jersey, New York, South Carolina and Wisconsin.)
Municipal Bond ETF Assets Grow
While the municipal bond market has long been dominated by the demand for individual bonds, the appetite for professionally managed products has grown and the market for muni ETFs has grown as well: Out of the 47 muni ETFs currently available, all but 10 grew in assets last year.
So far this year (through Feb. 13), 24 muni ETFs have grown in assets, while 12 have lost assets. The other measure of investor activity is trading, and year-to-date, the overall pace of muni ETF trading (based on market value traded) is more than 45% heavier than last year. (YTD average daily trading is running at $393 million, compared with $270 million per day in 2018.)
Green Returns Across Muni ETFs
For 2018, the majority of the muni ETFs had positive returns, led by the high-yield ETFs—which was the best-performing credit sector last year, and through the end of January, only two of the 47 municipal bond ETFs had negative total returns, and those two funds are ultra-low-duration funds that are most sensitive to the changes in short-term rates. (They were the Invesco VRDO Tax-Free Weekly ETF (PVI) and the First Trust Ultra Short Duration Municipal ETF (FUMB.)
In January, the top five most actively traded ETFs captured 71% of the total trading volume. In 2018, those five funds had 69% of total volume. They were the iShares National Muni Bond ETF (MUB), the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), the Vanguard Tax-Exempt Bond ETF (VTEB), the iShares Short-Term National Muni Bond ETF (SUB) and the SPDR Nuveen Bloomberg Barclays Short Term Municipal Bond ETF (SHM).
As we have suggested here before, tactical investors contemplating the use of a muni ETF as a tool for temporarily implementing a particular view may wish to focus on the largest and most actively traded muni ETFs, such as the ones listed above.
Investors seeking core “buy and hold”-type exposure to municipals through ETFs can expand their search to include some of the other funds, but should be mindful of their own future liquidity needs and be comfortable with the liquidity of any ETF they are considering.