Ride the Muni Bond Bubble With ETFs

Includes: IBMF, MUAA, PZA
by: Robert Kane

It's a tale of two cities: With interest rates at close to zero, there is only one way for rates to move - UP. But with income tax rates also headed up in 2011, the last great tax shelter is the muni bond.

While it's too hard to predict if the bond bubble will burst, a bond ladder comprised of an ETF based barbell strategy enables investors to comfortably buy, and continue to own, muni bonds in this uncertain environment.

The advantages of muni bond ETFs include instant diversification, professional management and complete liquidity. And while ETFs are more often thought of as tools for small portfolios (less than $250k), there is growing use to fill gaps in large portfolios.

ETF Laddered Barbell Approach

The laddered barbell strategy is a hybrid of two bond ladders

  1. A liquidity generator on the short end comprised of one-to-five year maturities. This provides fresh money to put to work if interest rates rise.
  2. A yield generator that targets higher yielding 10-30 year maturities bonds.

Together, this barbell provides liquidity in the short term but juices up the investment’s total return using long term bonds.

This strategy can be easily implemented by equally allocating half the investment bucket into an end-date muni bond ETF such as the S&P AMT-Free Municipal Series Index, which is available in various years from 2012 (NYSEARCA:MUAA) through 2017 (MUAF). S&P says the funds will invest in AMT-free, investment grade, noncallable national municipal bond debt and will distribute substantially all of its assets on August 31 of the year in the fund's name.

The longer term ladder can be easily implemented by putting the other half of the investment into the PowerShares Insured National Municipal Bond Portfolio ETF (NYSEARCA:PZA), whose holdings are mostly A+ rated with 50% in maturities of more than 25 years.

Investors owning individual muni bonds can test their portfolio’s sensitivity to rising interest rates with BondView's free portfolio Report Card, which is based on an expert system. 

Disclosure: No positions