Unheralded Election Play: Build America Bond ETFs

Published October 31, 2012

| Benzinga

Created as part of the American Recovery and Reinvestment Act, Build America Bonds and the corresponding ETFs have arguably been lost in the shuffle of investment ideas that could be potentially impacted by the result of next week's presidential election.

That is odd for several reasons. For starters, yields on Build America Bond ETFs are far superior to U.S. Treasuries or high-grade corporate bond funds. The PowerShares Build America Bond Portfolio (BAB), home to almost $1.1 billion in assets under management, has a 30-day SEC yield of 4.4 percent. The 30-day SEC yield on the SPDR Nuveen Barclays Build America Bond ETF (BABS) is 4.1 percent while the actively managed PIMCO Build America Bond ETF (BABZ) has a 30-day SEC yield of almost 4.2 percent.

Some background on these bonds is necessary to highlight why these ETFs could be affected by the outcome of the election. Build America Bonds are taxable, but the federal government pays issuers subsidy payments equal to 35 percent of their interest costs, according to The Bond Buyer.

Said another way, Build America Bonds are not 100 percent tax-free, but they are conservative, tax-efficient investments with decent yields.

More background from the Treasury Department: The Obama Administration's Build America Bonds program helps states and localities pursue needed capital projects which build infrastructure and create jobs. Treasury Secretary Timothy Geithner overtly endorsed the concept of these bonds in early 2009.

By November of that year, PowerShares had rolled out BAB. BABS debuted in May 2010 and BABZ would follow in September 2010.

Year-to-date, the trio has performed well, led by a 6.9 percent gain for BABS, the smallest ETF of the group. BABZ, the PIMCO offering, is up 5.8 percent while BAB has added over five percent. Noteworthy is the fact that all three are in the red over the past 90 days. Those declines coincide with a spate of polls that show the Obama/Romney showdown is likely to be tight.

As the Bond Buyer notes, Republicans view BABs as a relic of of the Obama stimulus program. That program has been chided as largely ineffective by the GOP and conventional thinking goes that if Mitt Romney wins next week, Build America Bonds could be imperiled.

Another fact investors need to realize is that these ETFs have been benefiting almost solely from a flight to yield as no new Build America Bonds have been issued since the program terminated in 2010. Add to that, these ETFs are vulnerable to interest rate hikes because these bonds have long duration. For example, the effective duration on BABZ is 12.66 years. On BAB, it is 11.91 years.

Without the benefit of a crystal ball, all investors have is conjecture, opinion and speculation regarding next week's election. That means BAB, BABS and BABZ may not be buys at the moment, but panic selling of these ETFs probably is not warranted, either.

Along those lines, it must be noted that President Obama wants to make Build America Bonds a permanent program. Should he win reelection and ultimately prove successful in solidifying the permanency of Build America Bonds, the ETFs highlighted here will likely benefit.

For more on Build America Bonds, click here.

(c) 2012 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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