The slow and steady municipal bond market has been put into a frenzy as investors begin to question the financial stability of state and local governments. Add in the fact that interest rates are increasing at a rapid pace, making bonds less attractive, and the municipal bond market has literally fallen off a cliff.
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With that being said, I believe the sell-off is an opportunity for investors to become vultures and begin buying into municipal bond ETFs. In December, a so-called expert, in the bond market made a bold call on "60 Minutes" television program that 50 to 100 large municipalities will default on their bonds.
In the last 40 years there have only been 54 defaults on muni bonds. That is just over one per year. To make a call that in the next year there will be more defaults than the last four decades is unjustified. My honest opinion is that Meredith Whitney, the woman making the call, is looking for more face time in the media. I hope she comes back on the national stage in one year to admit she was wrong and apologize for spooking the innocent investors that put their faith in her analysis.
When a municipality is faced with tough times, as many are right now, there are several ways they can get out of trouble. They include raising taxes, cutting services, refinancing, and ultimately help from the states or the federal government. As bond holders you really do not care how they do it, all you want if you interest payment. (For more, see The Basics Of Municipal Bonds.)
The iShares National Municipal Bond ETF (NYSE:MUB) is a basket of over 1100 municipal bonds from around the country that current has a distribution yield of 3.6%. Because of the tax advantages of muni bonds, the tax equivalent yield on MUB is 5.6% based on a 35% tax bracket. The ETF is down about 10% from the September high, but is now a buying opportunity near $100/share. The expense ratio is 0.25%.
A competitor MUB is the PowerShares National Municipal Bond ETF (NYSE:PZA), which is composed of 167 different bonds and currently has a distribution yield of 5.7%. The expense ratio is 0.35% and the ETF has a very similar chart pattern to MUB. SPDR Lehman Municipal Bond ETF (NYSE:TFI) is composed of 301 bonds with a current yield of 4.6%. The expense ratio is 0.23% and again a similar pattern to MUB.
Investors that are willing to take on extra risk in search of a higher yield can turn to the Market Vectors High Yield Municipal Bond ETF (NYSE:HYD). The ETF is composed of a basket of 111 muni bonds that are mainly considered "junk bonds" because they are rated below investment-grade by the agencies. The distribution yield is 6.3%, resulting in a tax equivalent yield of 9.6%. The ETF took a major hit similar to MUB, however the magnitude was not much more and therefore the higher yield makes it the best play in my opinion. The expense ratio is 0.35%.
Of course there is the risk that the analyst I mentioned above is correct in her call. Obviously I believe she is incorrect or I would not my recommending buying into municipal bond ETFs at this time. Proceed with caution and always use stop-loss orders. (For more, see Municipal Bond ETF Considerations.)
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