Muni ETFs In A Portfolio

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Includes: HYD, ITM, MLN, PRB, SHYD, SMB, XMPT
by: VanEck

Using ETFs to access the muni market can make it easier to maintain an appropriate and more comfortable level of risk in one's "core" allocation than using individual muni bonds. Muni ETFs may also open up possibilities to take on incremental risk in a more liquid and broadly diversified way. 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.

Investors may find using duration a more helpful guide to interest rate risk than maturity date. The tables below illustrate the durations of VanEck muni ETFs, as well as correlations, as a reminder that the benefits of diversification can vary, depending on the objectives and characteristics of each ETF.

The five ETFs in this first table may be a good way to start or replace some core fixed-income exposure.

VanEck Muni ETFs for the Core

ETF Name Ticker Duration to Worst 30-Day SEC Yield 12-Month Yield Yield to Maturity Correlation to S&P 500® (based on market price, calendar year 2015)
Market Vectors Pre-Refunded Municipal Index ETF PRB 2.45 0.75% 0.82% 0.88% -0.25
Market Vectors AMT-Free Short Municipal Index ETF SMB 2.76 0.94% 1.13% 1.04% 0.13
Market Vectors AMT-Free Intermediate Municipal Index ETF ITM 6.11 1.78% 2.24% 2.55% -0.44
Market Vectors AMT-Free Long Municipal Index ETF MLN 6.41 2.69% 3.25% 3.85% -0.17
Market Vectors CEF Municipal Income ETF XMPT 12.88 4.88%1 4.93% -- -0.13
Click to enlarge


Click for standardized performance.
Characteristics source: VanEck as of 4/8/16. Correlation source: FactSet as of 12/31/15.
1In the absence of temporary expense waivers or reimbursements, the 30-Day SEC Yield for Market Vectors CEF Municipal Income ETF would have been 4.64% on 4/8/2016.

Investors seeking incremental income, or those who are comfortable with lower credit quality may wish to consider supplementing their core holdings by using the Market Vectors Short High-Yield Municipal Index ETF (NYSEARCA:SHYD), the Market Vectors High-Yield Municipal Index ETF (NYSEARCA:HYD), or XMPT. Using an ETF for the higher risk portion of one's fixed income allocation provides very broad diversification as well as intra-day liquidity. However, it's important to remember that diversification alone does not necessarily assure a profit or a loss.

VanEck Muni ETFs for Incremental Income

ETF Name Ticker Duration to Worst 30-Day SEC Yield 12-Month Yield Yield to Maturity Correlation to S&P 500 (based on market price, calendar year 2015)
Market Vectors Short High-Yield Municipal Index ETF SHYD 3.61 3.42% 3.23% 4.23% 0.04
Market Vectors High-Yield Municipal Index ETF HYD 6.47 4.18% 4.59% 5.22% 0.05
Market Vectors CEF Municipal Income ETF XMPT 6.47 4.88%1 4.93% -- -0.13
Click to enlarge


Characteristics source: VanEck as of 4/8/16. Correlation source: FactSet as of 12/31/15.
1In the absence of temporary expense waivers or reimbursements, the 30-Day SEC Yield for Market Vectors CEF Municipal Income ETF would have been 4.64% on 4/8/2016.

XMPT is included in both tables due to its unusual characteristics; because the leveraged closed-end funds in which it invests are generally overcollateralized, exposure to credit risk may be greatly reduced. However, because of the leverage employed by the underlying funds, there is greater interest rate risk. Prudent investors might use it for a portion of the long duration part of the core of their portfolios or to supplement or supplant their high yield allocation.

Conclusion

Because of the changes and challenges in the municipal bond market and the exchange-traded liquidity available via ETFs, even experienced investors may find that they can more easily tailor a diversified portfolio with a mix of muni ETFs than with individual bonds.

This is not a recommendation to buy, sell, or hold any of the securities or strategies mentioned. The author does not provide investment, tax, legal, or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics, or individual investments.

Post Disclosure

If your financial plan provides a recommended asset allocation mix, compare the duration of the fixed income benchmark used to determine your mix against your proposed ETF. Using a lower duration ETF than the benchmark could be a less effective diversifier. Conversely, an ETF with a higher duration should bring greater non-correlating performance than modeled in your plan. Duration is the estimated percentage change of the price of a security for an immediate 1% change in rates. An ETF with a duration of 5.0 would be expected to decline in market value by 5% if rates immediately moved higher by 1%. The reverse would also be true-if rates decline by 1%, then that security would be expected to move higher in value by 5%. Duration to Worst measures the duration of a bond computed using the bond's nearest call date or maturity, whichever comes first. This measure ignores future cash flow fluctuations due to embedded optionality. 30-Day SEC Yield is a standard yield calculation developed by the Securities and Exchange Commission that allows for fairer comparisons primarily among bond funds. It is based on the most recent 30-day period. This yield figure reflects the interest earned during the period after deducting the Fund's expenses for the period. It does not reflect the yield an investor would have received if they had held the Fund over the last twelve months assuming the most recent net asset value (NYSE:NAV). 12-Month Yield is the yield an investor would have received if they had held the fund over the last 12 months assuming the most recent NAV. The 12-month yield is calculated by summing any income distributions over the past 12 months and dividing by the sum of the most recent NAV and any capital gain distributions made over the past 12 months. Yield information reflects temporary waivers of expenses and/or fees. Yields would have been reduced had these fees/expenses been included. Yield to Maturity is the annualized return on a bond held to maturity.

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Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer's financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

Diversification does not assure a profit or protect against loss.

Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a fund carefully before investing.