First Muni Bond ETF Launches

September 10, 2007

Barclays Global Investors (BGI) launches the first municipal bond ETF.

Barclays Global Investors (BGI) launched the first municipal bond exchange-traded fund (ETF) today on the American Stock Exchange. The new iShares S&P National Municipal Bond Fund (MUB) charges 0.25% in annual expenses, and holds state and municipal government bonds that are exempt from federal taxes. Bonds must be rated BBB- or higher to be included in the fund, although more than half of the portfolio will be insured.

"Investors have been looking for a simple and cost-effective method of gaining exposure to the municipal market, which is traditionally a less liquid and expensive marketplace, especially for those building a portfolio of individual issues," said Noel Archard, head of U.S. iShares Product Development, adding that MUB looks to solve those problems.

According to the Investment Company Institute, the average (asset-weighted) municipal bond fund charged 0.68% in expenses in 2006. Investors have about $378 billion invested in muni funds, according to the ICI, meaning they paid out $2.6 billion in fees last year. Switching to MUB would save them more than $1.8 billion per year.

While MUB is the first muni bond ETF to make it to market, it won't be alone for long. PowerShares, State Street Global Advisors (SSgA) and Van Eck Global have all recently filed for the right to launch muni bond ETFs. BGI was the first to file, however, and now enjoys first-mover advantage n the market.

Look for SSgA's ETF tracking the Lehman Brothers Municipal Managed Money Index to follow rapidly on the heels of the BGI fund— SSgA's filing was only made 10 days after BGI's. The underlying index for SSgA's fund has higher requirements for quality, with a minimum component rating of Aa3/AA- from at least two major bond ratings agencies. Given the recent turmoil in the credit market, the higher quality could provide SSgA with an advantage, especially if the fund's expense ratio meets or beats BGI's.

Both BGI and SSgA also have New York and California muni bonds waiting in the wings for SEC approval, and SSgA has filed for a short-term muni fund as well.

Rounding out the race are Van Eck and PowerShares.

Van Eck has filed for the most muni funds—six, covering the 1-5 year term, intermediate, long, high-yield, California and New York markets. All except the high-yield fund have the same tough credit restrictions as the SSgA fund.

The Van Eck filing is rather remarkable given that Van Eck has been very conservative about launching new ETFs—the firm's total current lineup includes just seven ETFs. Moreover, they typically launch funds only in markets that could be described as sparsely populated. The ETF provider's two most recent funds were first to market in the U.S. in the areas of agribusiness and nuclear energy. The muni market, however, looks as if it will be highly populated in a very short time.

PowerShares, meanwhile, has filed for four funds tracking Merrill Lynch indexes, including New York, California and two national municipal ETFs. One of the national muni bond funds is an insured fund (with an AAA rating), while the other is similar to BGI's product. Both of the national funds feature bonds that have terms of 20 years or longer.

The question here is how much BGI's first-mover advantage will matter. Often in the ETF market, the first-mover comes to dominate the space. But with the significant differences on credit quality and term structure throughout the various funds, this competition remains wide open. 

Everything in the muni bond race up until now has been warm-up. As of today, the starter pistol has been fired.

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