Muni Fund Ownership Growing

Individual investor dollars are flowing away from individual muni bonds and into muni mutual funds and ETFs.

Reviewed by: Patrick Luby
Edited by: Patrick Luby

Rates are low and the Fed is on hold; municipal finances are stressed and bond market liquidity is down. While there would seem to be many reasons for investors to be avoiding municipal bonds, individual investors were actually net buyers of municipal bonds last year—but not through the traditional means of adding individual bonds to their portfolios.

Last year, according to data from the Federal Reserve, fewer individual investors were opting for the DIY (“do it yourself”) model of managing individual bonds on their own, and there was growth in the use of professionally managed (“do it for me,” or DIFM) mutual funds and ETFs.

As shown in the chart below, the municipal bond market is dominated by demand from individual investors. However, while the Fed data show that direct individual investor ownership of municipal bonds declined by more than $25 billion last year, indirect ownership through muni bond mutual funds and ETFs grew significantly.

holders of municipal bonds

For a larger view, please click on the image above.

Total Outstanding$3,652.4B$3,714.8B+$62.4B+2%
Households (direct)$1,540.4B$1,514.8B-$25.6B-2%
Mutual Funds$657.7B$705.4B+$47.7B+7%

The positive flows into mutual funds and ETFs are continuing this year. Through March 9, muni bond mutual funds have attracted $10.7 billion in new assets (according to the Investment Company Institute), and muni ETFs have added almost $1.5 billion (according to FactSet data).

Contributing Factors

Part of what may be driving the shift away from DIY into DIFM is the continuing decline in secondary market liquidity. Since it peaked in 2006, broker/dealer support of the municipal bond market has declined by more than 72%, while the commitment to the equity market (which includes ETFs) was down only 11%. (Click here to read more about muni ETFs and secondary market liquidity.)

This decline in liquidity is not a surprise to most longtime investors and market participants, many of whom have experienced wider bid/ask spreads and greater difficulty when trying to sell out-of-favor bonds. By using mutual funds and ETFs, however, investors are able to access liquidity through a different and more predictable process.

While investors should not be buying muni ETFs (or any investments, for that matter) simply because there are other investors who are buying them, the positive flows this year suggest many investors are able to see through the current headlines to be able to put their money to work.

So far this year, there are seven muni bond ETFs that have attracted $50 million or more in net new assets, ranging from high yield to high grade and short duration, but there are many more strategies available. The ETF screener on is a good place to start a search for the right muni bond ETFs for your needs. (Read Duration As Guide With Muni ETFs to learn more about the importance of understanding duration.)

TickerSelect Municipal ETFsYTD Flows
as/of 3/16/16
AUMDurationDividend Yield
Prior 12 months income to share price
Weighted Credit QualityYTM
as of 3/16/16
HYDMarket Vectors High-Yield Municipal$235.7M$1.96B8.34.71%B+9.34%
SHMSPDR Nuveen Barclays Short Term Municipal Bond$185.6M$2.9B2.750.92%AA3.27%
TFISPDR Nuveen Barclays Municipal Bond$147.9M$1.7B7.252.27%AA7.28%
PZAPowerShares National AMT-Free Municipal Bond$136.9M$1.1B7.943.25%AA-4.06%
MUBiShares National Muni Bond$112.4M$6.3B6.32.45%AA-3.09%
VTEBVanguard Tax-Exempt Bond$94.8M$227.1M6.23--AA-2.91%
ITMMarket Vectors AMT-Free Intermediate Municipal$60.6M$1.4B7.252.27%AA-2.87%

Finally, for those investors interested in having a professional manager assemble a portfolio of municipal bond ETFs for them, Morningstar identifies several ETF strategists that offer separately managed accounts that do just that (including Caprin Asset Management LLC, Green Investment Management and New Square Capital). There may be other managers offering similar accounts or additional strategies that may include municipal bond exposure along with other fixed-income sectors or asset classes.

Patrick Luby is the author of and has decades of experience in helping advisors and investors understand the municipal bond market. This is not a recommendation to buy, sell or hold any of the securities or strategies mentioned. The author does not provide investment, tax, legal or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments.

Patrick Luby is the municipal strategist with CreditSights Wealth and has decades of experience in the municipal bond market.