Municipal bond exchange-traded funds (ETFs) provide investors with diversified access to the municipal bond market. Municipal bonds, or munis, are debt instruments issued by states, municipalities, or counties for the purpose of financing public capital expenditures, such as the construction of highways, bridges, and schools. For investors, munis generally offer tax-free interest income.

While many of these bonds are rated “investment grade” by ratings agencies, indicating a relatively low degree of credit risk, they are not risk free. Currently, demand for munis is soaring as investors are on the hunt for yield and tax advantages, which is pushing down borrowing costs for state and local governments to near-record lows. A municipal bond ETF can help to reduce risk through holding debt issued by a broad range of states, municipal governments, or agencies.

Key Takeaways

  • Municipal bonds dramatically underperformed the broader market over the past year.
  • The municipal bond exchange-traded funds (ETFs) with the best one-year trailing total returns are FMHI, HYMB, and HYD.
  • The top holdings of each of these ETFs are bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority.

There are 42 distinct municipal bond ETFs that trade in the United States, excluding inverse and leveraged ETFs as well as funds with less than $50 million in assets under management (AUM). Municipal bonds, as measured by the Bloomberg Barclays Municipal Bond Index, have underperformed the broader market with a total return of 2.5% over the past 12 months compared to the S&P 500’s total return of 34.0%, as of Aug. 10, 2021. The best-performing municipal bond ETF for the fourth quarter (Q4) of 2021, based on performance over the past year, is the First Trust Municipal High Income ETF (FMHI).

We examine the three best municipal bond ETFs below. All numbers are as of Aug. 10, 2021.

First Trust Municipal High Income ETF (FMHI)

  • Performance Over One-Year: 11.9%
  • Expense Ratio: 0.55%
  • Annual Dividend Yield: 2.93%
  • Three-Month Average Daily Volume: 41,388
  • Assets Under Management: $286.4 million
  • Inception Date: Nov. 1, 2017
  • Issuer: First Trust

FMHI is an actively managed ETF that seeks to provide investors with income as well as long-term capital appreciation. The fund invests 80% or more of its net assets in municipal debt securities that make interest payments that are exempt from regular federal income taxes.

FMHI invests in municipal bonds with a range of maturities, but its largest exposure is in bonds with 15–20 years remaining to maturity. The state whose bonds receive the largest exposure in the fund is Colorado.

FMHI’s top three holdings are bonds issued by the following entities: the Buckeye Ohio Tobacco Settlement Financing Authority; the Canyon Pines Metropolitan District in Colorado; and the Sawyer’s Landing Community Development District in Florida.

SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (HYMB)

  • Performance Over One-Year: 9.7%
  • Expense Ratio: 0.35%
  • Annual Dividend Yield: 3.27%
  • Three-Month Average Daily Volume: 186,531
  • Assets Under Management: $1.8 billion
  • Inception Date: April 13, 2011
  • Issuer: State Street Global Advisors

HYMB tracks the Bloomberg Barclays Municipal Yield Index, a market value-weighted index that gauges the performance of high-yield municipal bonds issued by U.S. states, the District of Columbia, U.S. territories, and local government agencies. High-yield bonds, also referred to as “junk” bonds, pay higher interest rates than investment-grade debt due to lower credit ratings. But they are riskier investments, with a much higher chance of default.

HYMB invests in a range of high-yield municipal bonds with an average maturity of 14.97 years. Its top three holdings are bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority and two different sets of bonds issued by the Puerto Rico Sales Tax Financing Corp.

VanEck High Yield Muni ETF (HYD)

  • Performance Over One-Year: 8.9%
  • Expense Ratio: 0.35%
  • Annual Dividend Yield: 3.62%
  • Three-Month Average Daily Volume: 530,098
  • Assets Under Management: $4.0 billion
  • Inception Date: Feb. 4, 2009
  • Issuer: VanEck

HYD tracks the Bloomberg Barclays Municipal Custom High Yield Composite Index, which is designed to gauge the performance of the high-yield, long-term, tax-exempt bond market. The ETF provides exposure to high-yielding municipal bonds whose income is generally exempt from federal taxes. The fund mainly targets bonds rated below investment grade but also invests 25% of its portfolio in BBB investment-grade bonds to enhance liquidity.

HYD covers a wide range of municipal sectors and securities that have historically low rates of default. The state that receives the largest allocation is California, followed by Illinois and New York.

The fund’s top three holdings include bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority, the Puerto Rico Sales Tax Financing Corp., and the Florida Development Finance Corp.

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