The Market Vectors High-Yield Municipal Index ETF (NYSEARCA:HYD) began trading Thursday. This marks the second time this week that Van Eck Global provided access to an asset class previously unavailable to ETF investors. On Tuesday, they introduced Market Vectors Pre-Refunded Municipal Index Fund (NYSEARCA:PRB).
The high-yield municipal asset class, otherwise known as “junk munis,” represents the segment of the municipal bond market that failed to achieve investment grade ratings. The new ETF intends to track the Barclays Capital Municipal Custom High Yield Index. The word “custom” in the index name implies there is a twist for this ETF. Instead of having a 100% allocation to high-yield munis, HYD will have 25% allocated to investment grade triple-B bonds and 75% to non-investment grade bonds.
Muni yields relative to Treasurys are at historically high levels because current market turmoil has increased the risk of default. That is especially true in the high-yield segment. According to Barclays, the yields on high-yield munis were more than 6% higher than on investment grade munis at the end of 2008. The likelihood of default by any of the underlying issues is hard to estimate, and historic default rates are of little use in the current environment.
The Van Eck Global website has additional background material, including an informative piece called The Investment Case for High-Yield Municipal Bonds.
With HYD, high-yield munis are now easily accessible to ETF investors. Just remember, they are kicking out those high yields for a reason - the risk of default.