Active Versus Passive Through Municipal Bonds

Municipal bond mutual funds gathered USD 2.8 billion in the four-week period ending Oct. 28, 2015, according to the Investment Company Institute, while muni bond ETFs added USD 593 million of inflows in October, according to SSGA.  Despite this low number, at the recent S&P Dow Jones Indices Municipal and Global Bond Forum, various panelists highlighted the relative benefits of municipal bond ETFs.

For example, J.R. Rieger, Managing Director of Fixed Income Indices for S&P Dow Jones Indices, highlighted that just one-third of all active national municipal bond funds outperformed the S&P Municipal Bond Index in the three-year period ending June 2015.  Further, just 16% of those funds that were in the top-quartile of their muni bond peer group in the 12-month period ending March 2013 retained that ranking in the subsequent period.  Both observations come from S&P Dow Jones Indices Index versus Active and Persistence Scorecard.

Similarly, a fellow panelist at the S&P Dow Jones Indices forum acknowledged one advantage index-based ETFs have over active mutual funds is explicit parameters that are not subject to a manager’s view of the world.  We think a look at a popular active New York municipal bond fund compared to an S&P Dow Jones index makes this point clear.

The S&P New York AMT-Free Municipal Bond Index consists of investment-grade general obligation bonds and essential purpose revenue bonds issued within New York.  As of the end of October 2015, 99% of the bonds were rated ‘A’ or higher by Standard & Poor’s Ratings Services.  Meanwhile, Oppenheimer Rochester AMT-Free New York Municipals (OPNYX) has a 20% stake in Puerto Rico bonds that incur greater credit risk in exchange for a higher yield, as of September 2015.

Bonds issued by Puerto Rico are exempt from federal, state, and local income taxes for individual investors.  In September 2015, Standard & Poor’s Ratings Services downgraded Puerto Rico-backed debt to ‘CC,’ citing that the bonds are highly vulnerable to nonpayment.

A separate difference between municipal bond ETFs and mutual funds is that ETFs trade on an exchange, allowing investors the liquidity to make intra-day trades.  Yet, at the same S&P Dow Jones Indices’ forum, a panelist reminded attendees that municipal bond ETFs net asset values (NAVs) are a best estimate.  Unlike Treasury bonds, it is rare for muni bonds to trade on a daily basis.  As such, according to our research, muni ETFs that hold these securities can, at times, trade at relatively wider premiums or discounts compared with NAVs.

S&P Capital IQ has researched 33 municipal bond ETFs, 22 of which have price/NAV premiums or discounts greater than 10 bps.  Meanwhile, just two of the 22 U.S. Treasury ETFs trade as widely relative to their net asset value.


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