Update On Puerto Rico Munis For ETF Investors

by: Patrick Luby

Exposure to P.R. is determined by the index used.

If the ETF was appropriate before, it may not be appropriate to sell now.

Of 7 ETFs with P.R. exposure, one holds only pre-refunded bonds.

While the news about Puerto Rico's default on some of its municipal bonds is not a surprise, this is a good time to look at the impact on muni ETFs. While most investors probably do not need to be worried about what's going on with Puerto Rico bonds, everyone should be paying attention because the precedents being set now could affect how easy it will be for the next issuer that feels forced to choose which of their promises to honor.

Of the 36 muni ETFs, 7 had exposure to Puerto Rico bonds as of May 6 (see the table, below). In all of them, the exposure is broadly diversified, and in most of them, has actually declined in the last several months. (Note that the index which PRB follows includes only pre-refunded bonds, so in that case, the credit risk exposure would not be to the Puerto Rico-based issuer but to the collateral held in the escrow accounts.)


SPDR Nuveen S&P High Yield Municipal Bond



VanEck Vectors Short High-Yield Municipal



PowerShares New York AMT-Free Municipal Bond



VanEck Vectors High-Yield Municipal



PowerShares National AMT-Free Municipal Bond



PowerShares California AMT-Free Municipal Bond



VanEck Vectors Pre-Refunded Municipal


Source: Manager websites, based on holdings as of May 6, 2016.

Keep in mind that the composition of an ETF portfolio is determined by the index--not by the discretion of the manager, whose job is to track the index as closely as possible. As ratings change or issuers have a material event, such as a late or unpaid interest or principal payment, bonds may become ineligible to be included in the index, and would be sold by the manager in due course--reducing the investors exposure.

The low-cost index-based portfolio management methodology available with ETFs means that investors can assemble their muni ETF portfolio based on exposure to the factors (such as maturity/duration or credit risk) they want while reducing the emotional biases that can influence a self-directed portfolio.

Investors with existing positions in any of these ETFs do not necessarily need to consider selling unless there has been a change in their objectives. If the ETF was appropriate before, consider whether a desire to sell is an emotional reaction to recent headlines, and if so, it may not be appropriate to sell.

The opinions expressed and the information contained herein are based on sources believed to be reliable, but accuracy or appropriateness is not guaranteed. Past performance is interesting but is not a guarantee of future results. The author does not provide investment, tax, legal or accounting advice-this is NOT investment advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Investments in bonds and fixed income ETFs are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Additional information available upon request.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.