Doomsayers who depicted an imminent implosion in the municipal bonds market back in 2010 helped drive a mass exodus from munis related exchange traded funds. However, as no real threat manifested, the attractive yields and tax advantages in muni bonds helped bring investors back to the market.
In 2011, the Barclays Capital Municipal Bond Index jumped 10.7%, whereas the S&P 500 only returned 2.1% and the overall bond market gained 7.9%, as measured by the Barclays Capital U.S. Aggregate Float Adjusted Index, according to Vanguard.
"Despite a challenging economy, muni bonds did remarkably well," Daniel Wallick, a principal in Vanguard Investment Strategy Group, said. "The hysteria around expectations of disruption in the muni market was not justified."
Analysts previously based their pessimistic outlooks based on default rates in 2010 and 2011 that were higher than the historical average - the defaults came from those of one-time projects funded by special revenue bonds as opposed to the general obligation bonds that fund municipalities.
According to Moody's Investors Service, only one general obligation default occurred in the past three years out of 9,700 issues.
"What matters in the future is whether issuers will have the ability and willingness to repay," as stated in a Vanguard research paper. "We think they do and will."
Nevertheless, Vanguard notes that a correction in muni bonds may eventually manifest. Muni downgrades have exceeded upgrades over the last 27 months through year-end 2011 as a result of the poor housing prices, poor income growth and high unemployment rate. Still, it is not as dire as analysts have painted it last year.
"If a municipal investment is part of your core strategic asset allocation, you should think twice before reacting to headline news that may not have a significant impact on a muni market that measures $3.7 trillion in issuance," Wallick added.
Some municipal bond ETFs include:
- iShares S&P National Municipal Bond Fund ETF (NYSEARCA:MUB): 3.14% yield
- SPDR Barclays Capital Short Term Municipal Bond ETF (NYSEARCA:SHM): 1.38% yield
- SPDR Barclays Capital Municipal Bond ETF (NYSEARCA:TFI): 3.12% yield
- Powershares Insured National Municipal Bond Portfolio ETF (NYSEARCA:PZA): 4.28% yield
- Market Vectors High Yield Municipal Index ETF (NYSEARCA:HYD): 5.26% yield
Max Chen contributed to this article.
Disclosure: I am long HYD. Tom Lydon's clients own HYD.