Finding Value In Long-Dated Muni ETFs

August 04, 2014

A bit of duration in the muni market may be just what the doctor ordered.

Interest-rate hikes are just around the corner, and one investor is taking a long-dated view on muni bonds to shore up his portfolio while keeping a short leash on the corporate and sovereign debt space.

Brian Lockhart, chief investment officer at Colorado Springs, Colo.-based Peak Capital Management, a $125 million ETF strategist shop, spoke recently to staff writer Hung Tran about his take on the muni-bond space. Lockhart, who has built up an existing position in the PowerShares National Muni Portfolio (PZA | C-49), talked why his view on the flagging Puerto Rico muni bond market is one reason he did so. What fund have you recently added to your portfolio?

Brian Lockhart: In terms of a very recent purchase, as well as kind of a significant holding in our fund, that addition would be the PowerShares National Muni Portfolio (PZA | C-49). We initially took that position in January, and we just added to it. Why did you buy PZA in January?

Lockhart: One reason is we felt that the value in the muni-bond space was probably the most compelling part of the fixed-income universe from a valuation standpoint, and we continue to believe that today. So we believe the risk-adjusted yields on muni bonds are very favorable compared to the rest of the fixed-income universe. Why did you choose PZA over something like the iShares National AMT-Free Muni Bond ETF (MUB | B-75)?

Lockhart: The reason we rotated from MUB into PZA and why we just added to that position is a core conviction we have that the short end of the yield curve will continue to steepen in 2014, but that the long end of the curve will flatten.

And with that expectation, we would view long-dated munis to outperform shorter-dated munis on a relative performance standpoint. So with the rest of our portfolio, we’re essentially shortening duration in the corporate and sovereign debt space. But specific to munis, we’ve been trying to move out on the yield curve to longer duration.

When you compare PZA with MUB, nearly 80 percent of PZA’s portfolio has maturities 20 years and out. In fact, almost 30 percent of the fund has durations that are 25 years and longer, but only 15 percent for MUB. So, in line with our research, PZA is a good fit for us because we want to be longer duration in the muni space. So this is a long-term hold for your firm?

Lockhart: Yes. Just looking at some of the holdings for PZA, I see Puerto Rico munis are in the fund’s portfolio. Any reservations on your part in terms of headline risk?

Lockhart: It was a conversation we had with the portfolio manager before we took the position, knowing they had exposure to Puerto Rico. Frankly, we believe that’s part of some of the pricing value that we’ve gotten in that.

We were very comfortable with the due diligence they had done on the Puerto Rico holdings, and felt confident that that didn’t represent a threat to the portfolio.



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