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Municipal bond exchange-traded funds (ETFs) provide investors with diversified access to the municipal bond market. Municipal bonds, or munis, are debt instruments issued by states, municipalities, or counties for the purpose of financing public capital expenditures, such as the construction of highways, bridges, and schools.
For investors, munis generally offer tax-free interest income. While many of these bonds are rated investment grade by ratings agencies, indicating a relatively low degree of credit risk, they are not risk free. A municipal bond ETF can help to reduce risk through holding debt issued by a broad range of states, municipal governments, or agencies.
Investors in recent weeks have pulled billions of dollars from the muni-bond market on fears of upcoming rate hikes by the U.S. Federal Reserve, marking the biggest outflow since early 2020. Muni-bond funds saw $1.4 billion in withdrawals during the week ending Jan. 26. That followed withdrawals the previous week, ending 45 weeks in a row of gains.
Key Takeaways
- Municipal bonds underperformed the broader market over the past year.
- The municipal bond exchange-traded funds (ETFs) with the best one-year trailing total returns are FMHI, HYMB, and FLMI.
- The top holdings of the first two ETFs are bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority, and the top holding of the third fund is bonds issued by the California Municipal Financial Authority.
There are 41 distinct municipal bond ETFs that trade in the United States, excluding inverse and leveraged ETFs as well as funds with less than $50 million in assets under management (AUM). Municipal bonds, as measured by the Bloomberg Municipal Bond Index, have underperformed the broader market over the past 12 months, with a total return of -1.4% compared with the S&P 500’s total return of 17.0%, as of Jan. 27, 2022. The best-performing municipal bond ETF for the second quarter (Q2) of 2022, based on performance over the past year, is the First Trust Municipal High Income ETF (FMHI). We examine the three best municipal bond ETFs below. All numbers below are as of Jan. 27, 2022.
- Performance Over One-Year: 3.0%
- Expense Ratio: 0.55%
- Annual Dividend Yield: 2.91%
- Three-Month Average Daily Volume: 54,713
- Assets Under Management: $394.7 million
- Inception Date: Nov. 1, 2017
- Issuer: First Trust
FMHI is an actively managed ETF that seeks to provide investors with tax-exempt income as well as long-term capital appreciation. The fund invests 80% or more of its net assets in municipal debt securities that make interest payments that are exempt from regular federal income taxes. FMHI invests in municipal bonds with a range of maturities, but its largest exposure is in bonds with 10–25 years remaining to maturity. The state whose bonds receive the largest exposure in the fund is Colorado. FMHI’s top three holdings are bonds issued by the following entities: the Buckeye Ohio Tobacco Settlement Financing Authority; the Black Desert Public Infrastructure District of Utah; and the Canyon Pines Metropolitan District in Colorado.
- Performance Over One-Year: 0.6%
- Expense Ratio: 0.35%
- Annual Dividend Yield: 3.54%
- Three-Month Average Daily Volume: 307,039
- Assets Under Management: $1.9 billion
- Inception Date: April 13, 2011
- Issuer: State Street
HYMB tracks the Bloomberg Municipal Yield Index, a market value-weighted index that gauges the performance of high-yield municipal bonds issued by U.S. states, the District of Columbia, U.S. territories, and local government agencies. The index includes only bonds with total outstanding amounts of $3,000,000 or more. High-yield bonds, also referred to as junk bonds, pay higher interest rates than investment-grade debt due to lower credit ratings. But they are riskier investments, with a much higher chance of default. HYMB’s biggest sector allocations are in industrial, healthcare and special tax, which make up more than half of its portfolio. The ETF’s top three holdings are bonds issued by the Buckeye Ohio Tobacco Settlement Financing Authority and two different sets of bonds issued by the Puerto Rico Sales Tax Financing Corp.
- Performance Over One-Year: 0.6%
- Expense Ratio: 0.30%
- Annual Dividend Yield: 2.34%
- Three-Month Average Daily Volume: 17,525
- Assets Under Management: $73.6 million
- Inception Date: Aug. 31, 2017
- Issuer: Franklin Templeton
FLMI is an actively-managed fund that aims to provide high levels of income exempt from federal income taxes while maintaining an average maturity of 3-10 years. It offers exposure to municipal securities across entire credit rating spectrum. The state whose bonds receive the highest exposure is Florida, followed by Texas and California. The fund’s top holdings include bonds issued by the California Municipal Financial Authority; the La Joya Texas Independent School District; and the Lower Colorado River Authority.
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