Municipal Bond ETFs Keep Working

Still low interest rates and the Federal Reserve's reluctance to change that scenario are having a positive impact on an array of longer-dated fixed income exchange traded funds, including municipal bond ETFs.

Though municipal bonds generally are not considered risky, there is high-yield debt to be found here, but the Market Vectors High-Yield Municipal ETF (NYSE:HYD) has rewarded investors this year with a gain of 1.8 percent. Comparing munis against Treasurys reveals the former might be the better for bond investors right now.

A high muni/treasury ratio implies munis are more attractive than treasuries given that the historical muni/treasury ratio has been around 0.80. As of 17th March, muni/treasury ratios show the 10-yr is currently 0.98 and the 30-yr 1.06, adds Markit.

With the interest rate environment still benign, income investors may want to consider an ETF like HYD, which has an effective duration of almost 9.1 years.

Most portfolio strategists recommend that the majority of a fixed income allocation consist of exposure to investment grade bonds, with exposure to high yield (non-investment grade bonds) limited to a subset of one's fixed income allocation, according to a Van Eck note. Investors may find using duration a more helpful guide to interest rate risk than maturity date.

HYD's performance has also been impressive when considering there were some concerns about the possible effects of low oil prices on municipal bonds issued by major oil-producing states. The ETF holds nearly 1,380 bonds, but its largest weight to a big oil state is 8.2 percent to Texas, but that is just the fund's fourth-largest state allocation.

Louisiana commands a weight of 2.3 percent in HYD, but the ETF has essentially no exposure to municipal bonds issued by Alaska, North Dakota or Oklahoma.

HYD, which follows the Barclays Municipal Custom High Yield Composite Index, has a 30-day SEC yield of nearly 4.1 percent, or more than double Thursday's closing yield on 10-year Treasurys.

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