Some Positives About Municipal Bond ETFs

By Kevin Grewal

After several sessions of declines, municipal bonds and the exchange traded funds (ETFs) that track the sector seem to be attractive and might be a great bargain.

• Yields on AAA-rated general obligation muni bonds are about 1.5% higher than those of Treasuries and these tools are generally tax-exempt.
• Another reason muni bonds have appeal is that rising deficits, especially in states such as California, Minnesota and Ohio, will keep yields high. Muni bonds will eventually deviate back to their normal prices, may give you a gain, but will not translate into quick riches.

Although muni bonds are tempting, they aren’t foolproof. The bond market has been hit by leveraged investors fleeing causing a severe lack of liquidity and credit downgrades to bond insurers, states Mina Kimes of Fortune Magazine. This raises the issue of default in these bonds - in tough times like these, many cities are nearing bankruptcy.

Another issue coming up in the bond market is a new nationwide inquiry that’s been launched. Federal agencies and some state attorneys general have been gathering evidence of what might be collusions among banks and companies that have helped state and local governments take about $400 billion worth of municipal notes and bonds to market every year, reports Mary Williams Walsh for The New York Times.

The issue is concerning now, because the incoming administration is preparing a stimulus package that would spawn projects carried out and financed at the state and local level. Some estimates have as much as $4 billion a year vanishing into the system.

If interested in this market, a sampling of the many funds are: PowerShares Insured National Muni Bond (PZA) has a yield of 5.11% , with a taxable equivalent of about 7.8% ; iShares S&P National Municipal Bond Fund (MUB) has a yield of 3.7%, with a taxable equivalent of about 5.6%; SPDR Lehman Municipal Bond ETF (TFI) has a yield of 3.9%, with a taxable equivalent of about 6%.

Comments

[Lonestar1:]

Frankly, the muni market is just another subprime market to explode in 2009. The only positive is the possibility of bailout by Treasury or the Fed. The Treasury bailout would blur the political structure of the nation, while the Fed lacks the legal authority to step in. The Congress is trying to solve both issues in its proposed new bill.

Muni ETFs are way over priced, if you look at the underlying bonds. The bottom line is this: without bailout, defaults should be massive across board. At states level, mere reduction of work force (20% ?) or services, won't do it.

Deleveraging has and will continue to cause much more pain. In fact, theortically one can not deleverage a system which is so highly leveraged. Either more capital is found, or, asset prices have to come down to appropriate levels.

For munis, those 5% or 7% after tax yields are not attractive if defaults are a possibility. High yield market can offer high teens, and still have no buyers. I have heard some convertible bonds offer more than 50% yields, but nobody cares.

Jan 09 03:42 PM

[driftwood2:]

Unfortunately, the only way to de-leverage with our economic system which is dependent upon continual expansion of credit is default of payments. Unfortunately, defaults produce a lot of economic dislocations.

It's our own fault for relying upon the idiotic system of perpetual credit expansion.

Jan 09 05:50 PM

[Bob Jones:]

IF YOU BELIEVE THAT STATES WILL BEGIN DEFAULT AT THE RATE
YOU ARE SUGGESTING MAYBE ITS TO TIME PULL OUT COMPLETELY!!
howeve I believe the likelyhood the government will not allow that to happen
is more likely, so my conclusion is the MUNI market is very attractive at this
point and time and if you go into for example: FRANKLIN Federal Tax
Free Fund (FKTIX) which has an attractive yield tax free you will be in a
Fund Family with many other attractive choices if you choose to change
courses at a later date (at no cost to you on an exchange)

Jan 10 10:16 AM

[searcher:]

We are flirting with executive and legislative panic. We already have a credit panic. Politician or statesman, citizen or plebian, producer or consumer, we are all closer to children in our need for the appearance of control by some entity than we admit. Many fear that the constraints of common sense we take for granted will be trampled by coming legislation. One of the more amazing facets of the depression decade is that, despite the false, and some truly dangerous, starts in managing a dubious pre-war recovery, the economic political system largely survived.

Jan 10 11:10 AM

[Lonestar1:]

There are some pockets of munis that are good, such as pre-refunded bonds, which are really the same thing as Treasuries mostly, but tax free. The issuer can not touch the debt service accounts.

I would be more interested in buying short term, best credit munis or pre-refunded bonds, not mutual funds. One must understand that MUTUAL FUNDS HAVE NO MATURITIES. If I hold a 5-year Virginia state go bond, i would be made whole in 5 years + all the coupons, unless Virginia goes belly up. Even if hyperinflation occurs, I still get back my money. But if I buy muni mutual funds, and hyperinflation occurs, my NAV may follow the pattern of MSFT after year 2000.

A friend told me that she was advised by her broker to buy a muni mutual funds in 2007, and lost about 40% by the end of 2008. Can you expect the broker to explain to her what happened given the huge decline in interest rates? I believe the broker has no clue, either. Many wealthy families were inflicted with such damage by a product they traditionally had a good faith in. It is fair to say that that faith is not there any more.

Regarding the defaults scenario, I agree the gov will have to do something before too late.

Jan 10 02:01 PM

[Bob111:]

Got any suggestions on where to find pre-funded munis? I'd be buying through my discount brokerage. I was previously looking at ETFs, including PZA, but that may be too much exposure to CA and NY, etc.
Is there such a thing as a closed end or mutual fund or a fund with a large % of pre-funded munis?

Jan 11 12:11 PM

[Lonestar1:]

you have to get a real broker to call the retail trading desk of the dealers to find some pre-refunded bonds. Be careful to check if the bond is backed by Treasuries. A small percentage of pre-refunded bonds are backed by Freddie or Fannie papers.

I don't know any closed or mutual funds are pure preres. Short duration funds may have a good percentage of preres. Again, I don't really like mutual funds in this environment.

Jan 11 06:16 PM

[Bob111:]

lonestar1, thanks for the guidance.

On Jan 11 06:16 PM lonestar1 wrote:

> you have to get a real broker to call the retail trading desk of
> the dealers to find some pre-refunded bonds. Be careful to check
> if the bond is backed by Treasuries. A small percentage of pre-refunded
> bonds are backed by Freddie or Fannie papers.
>
> I don't know any closed or mutual funds are pure preres. Short duration
> funds may have a good percentage of preres. Again, I don't really
> like mutual funds in this environment.

Jan 12 06:57 PM