When was the last time municipal bond yields were higher than those of U.S. Treasury bonds?
As of March 5, the SPDR Lehman Municipal Bond ETF (TFI) had a 30-day SEC yield of 3.71 percent. The TFI had a tax equivalent yield of 7.02 percent. By comparison, the SPDR Lehman Long Term Treasury ETF (TLO) had a 30-day SEC yield of 4.23 percent.
Under normal circumstances, municipal bond yields are lower than Treasuries because of their tax-free treatment. Income received from munibonds is exempt from federal income tax and from income tax in the state in which they’re issued.
These bond yield discrepancies have recently caught the attention of successful money managers.
During the first week of March, renowned bond manager Pimco scooped up $1.5 billion in municipal bonds. WL Ross & Co., which manages $10 billion, bought up $1 billion in municipal bonds.
What explains the yield discrepancies between munibonds and Treasuries?
The best answer is probably that herd-mentality investors are now more concerned with credit risk than with yields. The current perception is that munibonds aren’t as safe as U.S. Treasuries. As a result, assets have been flooding into ultra-safe Treasury-oriented bonds. This has driven up the price of Treasury bonds and decimated yields.
Despite their yield differences, the average duration of bonds in both TLO and TFI are an identical 11.5 years. Also, the munibonds in TFI have an average credit rating of AA2, which isn’t as solid as government-backed bonds but is still considered strong.
One of the advantages of bond ETFs over actively managed bond mutual funds are their attractive attributes, such as full transparency. The ability to know and view underlying fund holdings has become especially important given the recent credit-market woes. Many investors who believed they owned “safe” securities have been caught by surprise to learn that the liquidity and value of their investments has dried up.
For those looking to invest in state specific munibonds, there’s the SPDR Lehman California Municipal Bond ETF (CXA) and the SPDR Lehman New York Municipal Bond ETF (INY).
Another benefit of bond ETFs are low fees and trading flexibility.
According to ETFguide.com, the average expense ratio for all broad bond market ETFs is 0.17 percent and just 0.20 percent for munibond ETFs.
With bond funds, costs are even more crucial since there doesn’t tend to be a wide variation in performance like sometimes seen with stock funds.
Ron DeLegge is the San Diego-based editor of www.etfguide.com.