Perfect Timing: S&P Enters Fixed Income Indexing Market

With all the hoopla about the wave of municipal bond exchange-traded funds hitting the market, one detail got a bit lost in the melee. After the first muni bond ETF began trading on Monday, S&P launched the index underlying the fund on Tuesday. (The order seems a bit backward, but it has happened a couple of times before in the ETF industry.)

The index launch didn't get much coverage. Most people assumed that it was after the fact. But the index launch was actually quite a milestone: It heralded the entry of S&P into the fixed-income index realm.

In a way, the fact that S&P did not have a U.S. bond index of any sort previously is, well, just plain odd. When you're arguably the best-known index provider in the world and also one of the world's foremost ratings agencies for fixed-income securities, a bond index would seem rather like a no-brainer.

S&P has a whole bunch of fixed-income indexes, including its S&P/CITIC family covering China's bond market and a whole raft of structured finance indexes. But, until now, nothing for U.S. bonds.

S&P spokesperson Dave Guarino says that the S&P National Municipal Bond Index is just the first in a series of U.S. fixed-income indexes. With regard to municipal bonds in particular, S&P wanted to create an investable index. Other muni bond indexes, Guarino says, are "more or less benchmark indexes."

The S&P index covers about 3,000 municipal bonds rated BBB- or higher by S&P or Fitch or rated Baa3 or higher by Moody's. The minimum par amount for individual components is $50 million. Components are selected from the S&P/Investortools Municipal Bond Index, and the index is reviewed and rebalanced once a month. The index's total market value as of September 4 was roughly $305 billion. It has two state-level sub-indexes covering California and New York, two of the largest markets for muni bonds.

Nearly 50% of the index is insured municipal bonds. Another 18.5% are prerefunded or escrowed to maturity, while nearly 14% are uninsured state and local general obligation bonds. The remaining categories represent less than 5% each of the index.

Not surprisingly, given recent market activity, the index was down slightly over the 1-month, 3-month and 6-month periods ended August 31, but it was up 2.44% for the 12-month period and had a 3-year annualized return of 3.79%.

With the race to gain a foothold in the muni-bond ETF market now running at full speed, muni bond indexes are also in competition. Because it underlies the first ETF to market in this area, the S&P index will definitely have a higher profile than it would have otherwise.

The SSgA and Van Eck funds are both based on Lehman Brothers bond indexes, while the proposed PowerShares funds are based on Merrill Lynch indexes. The first SSgA fund, the SPDR Lehman Municipal Bond ETF (TFI), launched just days after the iShares S&P National Municipal Bond Fund (MUB). Although one of its major selling points was its lower expense ratio, the fact that TFI's underlying index is a Lehman Brothers-branded index may also be a selling point, since Lehman has been the dominant name in fixed income indexes for some time. TFI is based on the Lehman Brothers Municipal Managed Money Index, which requires its components have a rating of at least AA-/Aa3 from at least two different ratings agencies. The S&P index has a lower minimum required rating and only requires a rating by one firm, but is dominated by insured and prepaid contracts.

Written by Heather Bell