Municipal bond ETFs offer investors a diversified approach to the municipal bond market. Municipal bond ETFs, also known as high-yield munis ETFs, are financial instruments that states, counties, or municipalities issue to pay for public capital projects like building roads, bridges, and schools.
Generally, municipal bond ETFs provide tax-free interest income to investors. While many municipal bonds have received investment grade ratings from rating agencies, which denote a relatively low level of credit risk, they still include some inherent risks. By holding debt issued by numerous states, municipalities, or government agencies, municipal bond ETFs can help to lower risk.
Types of Municipal Bonds ETF
There exist two types of municipal bonds: revenue bonds and general obligation bonds.
- Revenue bonds
Municipalities offer revenue bonds to fund projects that generate high revenue, such as a concert hall or toll road. The income generated from the project would pay back investors in those bond ETFs. In these bonds, money is utilized for a project that might or might not be finished on schedule, within budget, and with the expected revenues. Thus, revenue bonds have more effective default rates as compared to general obligation bonds. Therefore, before putting your money at risk, it's crucial to examine the issuer's credit rating.
- General obligation Bonds
General obligation bonds finance public initiatives that don't necessarily produce money but benefit the communities they serve, like establishing parks or upgrading education systems. Any particular security does not secure these bonds that bondholders could get back because they are backed by the issuer's complete faith and credit. As a result, general obligation bonds have long been considered to be among the safest types of bonds to purchase.
Investing in Municipal Bond ETFs
Municipal bond ETFs are a popular investment instrument because they are simple to get started with and easy to use. However, doing much research before you call your broker is recommended. Here is a list of the best municipal bond ETFs to assist you. Only then can you choose which muni bond ETF(s) is the best fit for your investment portfolio after carefully examining each ETF and observing how it responds to changing market conditions.
Best Municipal Bonds ETFs for 2022
Based on the past year's performance, three best-performing municipal bonds ETFs exist.
- iShares iBonds Dec 2022 Term Muni Bond ETF (IBMK)
Inception date: September 1, 2015
Expense Ratio: 0.18%
Past year performance: -0.1%
AUM: $434.5 million
iShares municipal bond ETF monitors the S&P AMT-Free Municipal Series Dec 2022 Index. This Index comprises investment-grade U.S. muni bonds between December 31, 2021, and December 2, 2022. Tax-exempt income and interest rate risk management are the objectives of the ETF. The most considerable portion of holdings, at 47.5%, are cash and derivatives, followed by prerefund/escrow and municipal tax-backed bonds. iShares ETF owns bonds issued by almost every state in the United States, with the larger amounts coming from Maryland and California.
- Invesco VRDO Tax-Free ETF (PVI)
Inception date: November 15, 2007
Expense Ratio: 0.25%
Past year performance: -0.2%
AUM: $63.5 million
PVI tracks the ICE US Muni AMT-Free VRDO Constrained Index. The Index tracks the working of publicly issued U.S. states and their political subdivisions' tax-exempt variable rate demand obligations (VRDOs) denominated in U.S. dollars. Their interest rates can change daily, weekly, or monthly.
PVI adopts a sampling strategy rather than purchasing each asset in the Index. The ETF carries minimal to no interest rate risk because it concentrates on the shortest portion of the maturity curve. In times of severe volatility, this makes it a safer investment, but it also restricts earnings.
- Invesco BulletShares 2022 Municipal Bond ETF (BSMM)
Inception date: September 25, 2019
Expense Ratio: 0.18%
Past year performance: -0.2
AUM: $80.8 million
BSMM seeks to track the Invesco BulletShares USD Municipal Bond 2022 Index. The Index monitors the working of a portfolio of municipal bonds denominated in U.S. dollars with 2022 effective maturities. Local or state governments or U.S. states are the issuers of the bonds. The fund will close around December 15, 2022, because BSMM concentrates on bonds having maturity in 2022.
The distinctive feature of BulletShares funds is that they return investors' money at the specified maturity date. This benefits investors who want to lock in a set coupon rate while simultaneously taking advantage of the diversity offered by an ETF.
Advantages and Disadvantages of Municipal Bond ETFs
- Advantages of Municipal Bond ETFs
Municipal bonds often have a low credit risk. There were only 99 muni bond defaults between 1970 and 2015. Only nine of these general obligation bonds went bankrupt, and none of the municipal bonds with the best credit ratings either. Municipal bonds have a default rate of 50 to 100 times lower than corporate bonds.
The tax benefit is the main perk of most ETFs. Muni bonds ETFs are tax-free because you put money into a local government.
The AMT, or alternative minimum tax, is one restriction on the tax benefit of municipal bond holdings being "tax-free." The profit stream from municipal bonds may occasionally be taxable if it is subject to the AMT.
Municipal bond ETFs, such as MUNI, and the PIMCO Intermediate Municipal Bond Strategy Fund, exist to address this problem. Including securities exempt from the federal AMT is a tactic used by this municipal bond ETF.
- Disadvantages of Municipal Bond ETFs
There is "interest rate risk" with municipal bonds. You will receive a lesser yield if interest rates rise while you still hold a specific muni bond. Changes in interest rates will also have an impact on your bonds' secondary market value. If you need to sell a bond in the future to make up for the reduced return if rates rise, you have to sell the bond below the redemption value.
Bottom Line
The decision to include municipal bonds in your investment portfolio ultimately rests with you. If so, investors should consider ETFs an effective and affordable choice. An investor's revenue stream will be worth it in the long run. This is especially true for retirees, individuals in high-income tax categories, or anyone seeking a reliable source of income.
