Why June Is Important For Muni Bond Investors

‘Summer redemption season’ could mean more demand for muni bond ETFs.

Patrick Luby is the municipals strategist with CreditSights Wealth.

While Puerto Rico continues to dominate the muni market headlines, trading in Puerto Rico bonds has totaled less than 3% of muni trading volume so far this quarter (through May 15, according to MSRB data from Bloomberg).

With the bulk of attention focused elsewhere, muni yields have generally moved lower so far this year, lifting most of the muni indices into positive territory. Bond prices rise when yields fall.

President Trump’s proposed change in the maximum federal income tax bracket from 39.6% to 35% has a larger impact on municipal bond taxable equivalent yields (TEYs) than may be expected, but muni yields at their present levels will still be attractive versus taxable bonds, even with the slight decline in the max tax rate.

For example, 2.50% tax free = TEY 4.14% at 39.6% and 3.84% at 35%. The proposal to eliminate the alternative minimum tax could be a boon for current holders of AMT munis, which have historically traded cheaper (high yields) than non-AMT munis. However, buying AMT munis now with the expectation of a “pop” in prices would be speculative.

The elimination of the deductibility of state and local taxes from federal income taxes could make double- or triple-exempt munis more attractive relative to taxable investments.

Flows

Year-to-date, the 37 muni bond ETFs have attracted almost $1.4 billion in net new assets, bringing total AUM to $26.5 billion. Most of the activity in muni ETFs, however, has been in trading, with the ratio of dollar volume traded to net flows at more than 14:1 ($19.3 billion traded to $1.3 billion in new assets).

The iShares National Muni Bond ETF (MUB), the largest of the muni ETFs, having $8 billion in assets, dominates the trading, with $7 billion traded this year, even though its AUM is down $272 million.

The bulk of new assets have been in the top four muni ETFs. With $491 million in net new assets, the Vanguard Tax-Exempt Bond Index Fund ETF (VTEB) is ranked No. 1 so far in flows, but has also had strong trading volume as well, with $1.2 billion in shares traded.

In addition to VTEB, the VanEck Vectors High-Yield Municipal Index ETF (HYD), which has around 1% exposure to Puerto Rico, is up $351 million. It is noteworthy that the other long-duration, noninvestment grade muni ETF, the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB), with 8.7% in Puerto Rico, is up by only $28 million in new assets.

Rounding out the top four asset gathers are: the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), which is up $187 million, and the PowerShares National AMT-Free Municipal Bond Portfolio (PZA), which is up $175 million. Together, VTEB, HYD, TFI and PZA have attracted $1.2 billion in new assets.

June will mark the beginning of the muni market’s annual “summer redemption season,” when maturing and called bond flows pick up.

June redemptions are expected to exceed $31 billion, likely resulting in strong reinvestment demand that could make it difficult to find appropriate replacement for redeemed bonds. Investors who will need to replace maturing or called bonds in the coming months may wish to consider using the most liquid muni ETFs as placeholders to maintain exposure until suitable bonds can be found.

At the time of writing, the author held no positions in the securities mentioned. Patrick Luby is the municipals strategist with CreditSights Wealth. He can be reached at [email protected], or call us at 212-340-3898 or 1-800-460-3320.

This article is not intended as an offer or solicitation with respect to the purchase or sale of any security or as personalized investment advice. CreditSights Wealth publishes investment research but does not recommend the purchase or sale of financial products or securities, and does not give personalized financial or investment advice. Recommendations made in a report may not be suitable for all investors. See Important Disclosures at cswealth.com/disclaimer.