NEW YORK -- Eaton Vance Corp. and Invesco Ltd. launched on Tuesday the first-ever mutual fund and exchange-traded fund focusing on Build America Bonds, judging investors and lawmakers will keep showing interest in these new, taxable municipal securities.

Invesco's (IVZ) PowerShares Build America Bond ETF (BAB) and Eaton Vance's Eaton Vance Build America Bond Fund (EBABX) seek to give retail investors easier ways to invest in a new type of bond that carries the lower risks of municipal debt with the higher yields of corporate debt.

Since a special government program started in April, municipalities have issued an estimated $48 billion in what's known as BABs, garnering healthy demand for the securities.

There are questions hanging over the program and investments built around it, however. The BABs program is scheduled to expire at the end of 2010. That means the supply of new debt for these funds could dry up in about a year. But some analysts anticipate lawmakers will extend the program, as they have for the popular first-time homebuyer's tax credit.

"We see BABs becoming a bigger portion of the muni market, and there is a tremendous amount of support for this type of product," including from lawmakers, said Cynthia Clemson, co-director of municipal investments at Eaton Vance (EV) and co-manager of new Eaton Vance BABs fund, in an interview. "We expect the fund to grow as we've gotten a lot of interest," said.

Popular for all

BABs give municipalities access to the much deeper pockets of the taxable bond market because the federal government subsidizes the interest rates needed to compete in that sector, paying issuers back for 35% of the higher interest cost.

"Both issuers and investors have found it a successful program but it's an expensive program, so we'll have to see how Congress reconciles that in its budget," said Philip Fischer, municipal strategist at BofA Merrill Lynch Global Research.

Fischer expects more than $60 billion to be sold by the end of the year, with another $60 billion coming next year.

Among the top issuers of the securities so far, California takes the cake, having sold $6.75 billion already, according to Merrill data. The Los Angeles Unified School District has issued $1.69 billion.

A continuation of the program is a big unknown for the new mutual fund and ETF, and a good question for investors to consider before buying in.

"I'm not sure if these funds will have very broad appeal," said Miriam Sjoblom, associate director of fund analysis at Morningstar. "You'd want to have a good long-term investment, but for a program with an expiration date, I'm not sure how useful that will be for investors."

If it's not extended, the ETF says its board could change the fund's investment strategy to invest in an index composed of taxable municipal securities beyond BABs.

There are other ways to get exposure to BABs. Taxable bond funds are already able to buy BABs, and some diversified managers have, including the Dodge & Cox Income Fund (DODIX) , which has 1% of its assets in some of California's BABs, according to Morningstar.

Multiple times over budget

So far, BABs appears to achieved what Congress wanted. The securities have been good for the broader tax-exempt municipal market, where significantly smaller amounts of debt have been sold because issuers are financing capital needs in the taxable market instead.

Investors have been receptive to the securities because municipal credits tend to have much higher ratings than companies, with a significantly lower risk of defaulting. Buyers of the Build America securities get this lower risk with yields that are closer to corporate-debt yield levels.

The program's success has come with a cost, however. The price tag has far exceeded what Congress budgeted for the program, which was part of the stimulus package -- known as the American Recovery and Reinvestment Act of 2009.

Richard Ciccarone, chief research officer at McDonnell Investment Management, estimates if issuers sell $70 billion in BABs this year the federal government could be on the hook for almost $1 billion in interest payments for fiscal 2009. That level of payment would amount to about 14 times what was budgeted in the legislation, he said.

For 2010, ARRA only budgeted $340 million in interest, Ciccarone said, when it could end up amounting to another $1.5 billion.

And most of the debt being sold is long-term, meaning those interest payments could continue for 30 or 40 years.

Still, the government may be willing to extend the program, or moderate it in some way like offer a lower subsidy than the current 35%, because it has been successful in helping states and local municipalities continue with capital projects, possibly preventing even higher unemployment.

It will be about six months before Washington undertakes a formal review of the program, Merrill's Fischer said.

"The Obama administration is doing a full court press to Congress, extolling the virtues of BABs," he said.

Tax-exempt market boosted

If new BABs issuance ends, the existing bonds become more scarce and appreciate in value, noted Domenic Vonella, a municipal-bond analyst at Thomson Reuters.

"If there is no more issuance, demand for long-term BABs is going to increase," he said.

PowerShares has said that if the BABs program is not extended, the number of BABs available in the market will be limited, and illiquidity may negatively affect the value of the BABs.

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