Muni ETFs Could Defy Seasonal Trend

The month of March is known for not being very kind to municipal bonds. It’s more common than not to see muni ETFs falter in the third month of the year, as cities and states climb out of their winter blues and begin to issue new debt to finance their needs.

In fact, in the past 26 years since 1990, munis have delivered positive returns in March only 10 times—or less than half the time—according to Van Eck data. But this year, the muni market could very well defy tradition, because supply/demand imbalances might prove just significant enough to support this market.

An Exceptional Year

Consider the performance of the largest muni ETF, the iShares National Muni Bond (MUB | B-79), in 2015. The chart below shows one-year total returns of 2.91% for the $6.3 billion fund, but it also shows a noticeable plunge during the month of March, before the fund attempted another rally.

That pattern seen for other giants in the broad investment-grade muni space, such as the $1.7 billion SPDR Nuveen Barclays Municipal Bond (TFI | B-62), the $1.4 billion Market Vectors AMT-Free Intermediate Municipal (ITM | B-04) and the $1.1 billion PowerShares National AMT-Free Municipal Bond (PZA | C-59). And according to Jim Colby, Van Eck’s muni expert, what we saw in 2015 is more the rule than the exception.

But so far this year, March hasn’t brought too deep a decline—MUB is down 0.2% in the first two weeks of the month—and it could find its footing going forward. In fact, the chart below shows that the biggest funds in the segment are range-bound at worst, rising at best.

Charts courtesy of StockCharts.com

When March rolls around, we expect to see a rise in supply to meet whatever demand is there,” Colby said. “But for the past two years, we’ve seen an imbalance between supply and demand.”

“Despite low interest rates, we haven’t really seen a spike in issuance,” he added.

An Appealing Asset Class

If strong demand relative to supply has supported muni prices in the past two years or so, we are also seeing reinvested cash and new investor dollars flowing into munis as a way to protect capital from volatile market action. Many investors have found that munis are a good place to wait for the storm to pass, according to Colby.

After all, munis are used to raise capital for schools, water systems, infrastructure plans, etc. As an asset class, munis are known for being tax-exempt, and offering low volatility, solid credit quality and attractive yields.

What’s also interesting about the dynamics of the muni market is that supply begets demand. As more munis come to market in the spring, prices are compressed and yields rise. That, in turn, attracts new investors looking to buy at cheaper valuations, and to capture attractive yields, leading to positive performance in the segment.

The bottom line, Colby says, is that investors should ignore any urge to exit the muni market in March based on historical performance alone. Instead, stay invested, he notes.

“We’re all watching what the Fed is planning to do, and none of us is really believing that we’re going to see the Fed raise rates four times in 2016,” he said. “If you exit now, you might end up trying to get back into the marketplace in April at a price equivalent to what you exited in March and you’d forgone the benefits of the taxes and coupons for a period of time.”

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Contact Cinthia Murphy at [email protected].