How To Pick A Muni Bond ETF
Muni bonds—as measured by the ICE BofAML Municipal Index—have already delivered higher returns this year than they did in the entire 2018 calendar year. It’s a pocket of the fixed-income market that has been benefiting from strong demand and limited supply, and many are calling for more growth ahead.
That demand could remain supported by new rules impacting state and local tax (SALT) deductions. Until last tax season, taxpayers could deduct local and state taxes—things like income and property taxes—in their federal income tax returns without limits. But new legislation under the Tax Cuts and Jobs Act now caps SALT deductions to $10,000.
This limitation may have you looking for other ways to manage your tax bill—and munis are well-known for delivering tax-exempt interest. It’s a fixed-income darling for tax-sensitive investors.
Broad Set Of Choices
There are 45 muni bond ETFs available today. To many, a minimum-asset threshold is one of the first metrics considered when choosing an ETF. In the muni space, there are at least eight ETFs that boast more than $1 billion each in total assets.
Some of the biggest funds include the iShares National Muni Bond ETF (MUB), which has $11.8 billion in assets under management; the Vanguard Tax-Exempt Bond ETF (VTEB), with $4.3 billion; the SPDR Nuveen Bloomberg Barclays Short Term Municipal Bond ETF (SHM), with $3.6 billion; the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), with $2.8 billion; and the VanEck Vectors High-Yield Municipal Index ETF (HYD), with $2.5 billion. Their year-to-date performance is below:
Chart courtesy of StockCharts.com
These are all big, popular, liquid choices for investors. They are all, also, passively managed. However, there are those who think the constraints of an index leave too much opportunity on the table.
Consider Maria Rahni, senior associate for product management at New York Life Investments, who argues that the inefficient and illiquid nature of the muni space is a prime playground for active managers and alpha seekers.
“When should investors consider actively managed ETFs? Typically, inefficient markets lend themselves well to active management—one such market is U.S. municipal bonds,” Rahni said in a recent blog. “Actively managed municipal bond ETFs combine the best features of ETFs and mutual funds into one solution: They offer investors access to professional management of an inefficient asset class within a cost-effective, liquid investment vehicle.”
Active Muni Products
If you agree with Rahni, your list of biggest ETFs to choose from looks a little different. They’d include funds such as the actively managed First Trust Managed Municipal ETF (FMB), with $609 million in assets; the PIMCO Intermediate Municipal Bond Active ETF (MUNI), with $276 million; and the iShares Short Maturity Municipal Bond ETF (MEAR), with $174 million. Their year-to-date performance is below:
Chart courtesy of StockCharts.com
Stacking Up The Leaders
If you were to compare the broad, biggest passive MUB to the broad, biggest active FMB, allocation differences are stark.
The comparison isn’t really apples to apples given that MUB is constrained by its investment-grade index and FMB is free to roam—and can even own some high-yield exposure. Still, both ETFs have duration of about 5.6-5.9 years, according to ETF.com data.
Notable here is that MUB allocates heavily to California- and New York-issued debt, while FMB holds cash as its second-largest holding, and New York is nowhere in its top 10 allocations—differences that lead to different results.
FMB Portfolio Breakdown
MUB Portfolio Breakdown
So far this year, FMB has outperformed MUB, as the chart below shows:
MUB Vs. FMB YTD Performance
Chart courtesy of StockCharts.com
Active Vs. Passive Individual Choice
But when it comes to picking passive or active management in an ETF wrapper, there’s no right or wrong mousetrap. As CreditSights municipal strategist Patrick Luby puts it, it all boils down to individual investor goals.
When does it make sense to choose a passive approach to munis versus an active muni ETF? Luby offers the following guidelines:
“For investors with existing portfolios of individual bonds who want to have access to the exchange-traded liquidity that comes with ETFs, it may be difficult to build an investment policy around the bond portfolio plus an active strategy. It can be done, but requires comfort with both the specifics of building a fixed income portfolio as well as the mechanics of the ETF marketplace.
“On the other hand, for investors who are in the wealth-accumulation phase, an actively managed fixed income ETF could be a really great solution because it delegates to the portfolio manager the ability to react to prevailing market conditions in a way that cannot be done when constrained by an index. As a ‘core’ position for the investor accumulating assets, ETFs can be a great solution, and actively managed ETFs would be especially appropriate to consider in that situation.”
Opting for an active strategy in the muni market, he adds, shouldn’t be driven by the notion that the muni market is inefficient, but by a conviction that your chosen professional manager may be able to better navigate changes and opportunities in the market.
Do Your Homework
To that end, manager due diligence is crucial to your process of finding the right ETF, “because it is that experience that the ETF investor is looking to guide their money through economic and interest rate cycles,” Luby said.
That’s especially true because you’ll also be paying a lot more for the access. FMB’s active approach comes with a 0.50% expense ratio versus MUB’s 0.07% price tag. You are paying 7x the passive choice’s cost for that chance to capture outperformance. It goes without saying that having conviction in your manager is really important.
For a complete list of muni ETFs, check out our muni ETF channel.
Contact Cinthia Murphy at cmurphy@etf.com
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