2 ETF Plays For Puerto Rico Munis

March 12, 2014

Puerto Rico’s return to capital markets could soon show up in these ETFs.

Puerto Rico sold $3.5 billion of junk municipal bonds this week in a sale that attracted more than $16 billion worth of bids. Income-focused ETF investors, too, could soon access these high yield munis through two ETFs.

Puerto Rico has been in the limelight recently because it had its credit rating downgraded due to its ongoing financial challenges centered on heavy loads of debt. The munis were auctioned at an interest rate of over 8 percent. They mature in 2035, and were sold with a coupon of 8 percent and a yield of 8.72 percent—attractive yields for income-focused investors.

The Market Vectors High-Yield Municipal ETF (HYD | C-83) is the bigger of the two with $823 million in total assets. HYD tracks a market-weighted index of high-yield long-term tax-exempt municipal bonds.

Meanwhile, the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB | D-69), tracks a market-weighted index of high-yield fixed-rate municipal U.S. bonds with at least one year to maturity, and has $184.2 million in assets.

So far this year, both HYD and HYMB have posted solid total returns—gains of 5.75 percent, and 7.45 percent, respectively—compared to losses in the previous 12-months ended December 2013 of 8.73 percent for HYD, and 9.25 percent for HYMB.

HYD_HYMB_YTD_Perf-png

Chart courtesy of StockCharts.com

There’s no question that municipal bond ETFs in general fell out of favor in 2013 amid rising fears of higher rates, and concerns about potential defaults due heavy debt at state- and city-levels. But so far this year, this fixed income segment is picking up steam as investors look for tax-exempt income at attractive valuations, as S&P/Dow Jones fixed-income expert J.R. Rieger recently pointed out in an interview.

The sale is expected to help the financially-troubled island fill in its current budget gap, and refinance some of its debt, according to media reports. And its success speaks volumes to growing investor confidence in Puerto Rico’s efforts to address its financial challenges.

But there are risks. The U.S. Territory has been battling a recession that began eight years ago, mired by high unemployment rates and years of negative growth. A Reuters article characterizing Puerto Rico as “America’s Greece,” went as far as arguing that the U.S. territory might not be solvent long enough to repay its longer-term debt.

 

One of the big appeals of Puerto Rican munis is the fact that they are tax exempt for any U.S. investor—which is not the case for other states’ debt, according to the Reuters article—but Puerto Rico’s government is said to be considering a restructuring of its debt, something that some say is yet another source of uncertainty.

Here’s how these ETFs differ from one another:

Market Vectors' HYD, which came to market five years ago, already holds Puerto Rico as its third largest state allocation with a 6.7 percent weighting. California and Texas top its list of state holdings.

HYD’s portfolio comprises 473 securities in a mix that’s delivering a 30-day SEC yield of 5.75 percent and an effective duration of just over 10 years. Duration is a useful metric in determining how sensitive a portfolio is to changes in interest rates.

So far this year, HYD has seen total returns of 5.75 percent. Nearly 17 percent of HYD, however, is tied to investment grade bonds for “liquidity and balance,” according to the issuer’s website. The fund costs 0.35 percent in expense ratio, or $35 per $10,000 invested.

State Street's HYMB, which is three-years-old, is a tad more expense at 0.45 percent in expense ratio, and is smaller in terms of assets—it has attracted $184.2 million since inception.

Puerto Rico represents only about 3.3 percent of the overall portfolio, clocking in as the fund’s 10th largest state allocation. What’s more, HYMB owns roughly half the number of holdings of competing HYD—232 to be exact. California is the fund’s biggest state at 18 percent, followed by Florida at 7 percent.

In all, the strategy is delivering a 30-day SEC yield of 5.10 percent in a portfolio with a modified adjusted duration of just under 10 years. Still, HYMB’s performance year-to-date has so far outshined HYD’s, with gains of 7.45 percent.

About 40 percent of the portfolio is actually tied to investment-grade debt.

 

 

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