A Bond ETF Idea For The Second Half

Among the fixed income exchange-traded funds that find themselves in the sweet spot thanks to the Federal Reserve consistently passing on another interest rate hike are municipal bond funds, particularly those of the longer-dated variety.

Although there has been some chatter regarding the impact of falling oil prices on municipal bonds, conservative fixed income investors have been embracing municipal bond ETFs, even longer duration funds, as the Federal Reserve has put off raising interest rates.

A Diamond In The Rough

The iShares S&P Natnl AMT - Free Munpl Bd Fd (NYSE:MUB) is among the municipal bond ETFs benefiting from investors' renewed affinity for the asset class. MUB, home to $6.7 billion in assets under management, is up 2.2 percent year-to-date and resides just pennies below its all-time high. Of MUB's $6.7 billion in assets, more than $702 million have arrived this year.

However, investors that think they are late to the municipal bond ETF party need not fret because the asset class looks like an appealing fixed income idea for the second half.

U.S. municipal debt looks attractive against other bond sectors, and we see potential for inflows after munis recent strong performance. The sectors tax-exempt status is another plus, and munis are a portfolio diversifier, with negative correlations to equities and high yield, our analysis shows. Finally, munis also have been the least volatile fixed income sector, based on daily moves in the past three years, said BlackRock in a recent note.

Holdings, State Allocations

MUB, which is nearly nine years old, holds over 3,000 municipal bonds and has an effective duration of 4.72 years. Duration measures a bond's sensitivity to changes in interest rates. MUB's weighted average coupon is 4.66 percent.

California and New York combine for 43 percent of MUB's state lineup. No other state commands a double-digit allocation in the ETF, which has a 30-day SEC yield of 1.33 percent. MUB features munis issued by 45 states and the District of Columbia.

Within the sector, we favor revenue bonds backed by revenue streams such as water or sewer utilities over general obligation debt that is vulnerable to local pension deficits. We also favor selected exposure to high yield munis, except those of troubled Puerto Rico, added BlackRock.

Texas is MUB's third-largest state allocation, but at just 9 percent of MUB's weight, the Lone Star State does not even command half the weight the ETF devotes to New York. Following Texas, MUB's exposure to major oil-producing states is scant. The two missing: major oil producers Louisiana and North Dakota. Additionally, Oklahoma is just a quarter of a percent of the ETF's weight.