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Portfolio > Mutual Funds > Bond Funds

Growing Amid Turbulence

By Staff Writer

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Investing in your own backyard may be easy enough, but what about investing in backyards around the globe? One way to do this is with ETFs focused on commodity sectors and global equity markets.

To that end, Van Eck Global has grown its ETF and ETN menu over the past few years to help investors obtain global asset coverage. The company offers exchange-traded products that cover individual countries like Russia (RSX) along with key investment themes like alternative energy (GEX).

Despite choppy waters and the worst economic recession of our generation, the New York-based firm is steadily growing. On a year-over-year basis, Van Eck has increased its ETF assets from $7 billion to $8 billion.

Research spoke with Glenn Smith, director of ETF sales at Van Eck, about today’s investment opportunities and the firm’s products.

Investing in hard assets is an investment theme used by several ETFs in Van Eck’s lineup. Why?

Van Eck has been investing in hard assets and international-themed investments since 1955. Hard assets investments are typically characterized by long-term cyclical bull and bear markets, caused by fundamental supply/demand imbalances. This decade has seen increased demand for natural resources spurred by the industrialization, population growth and the emergence of a middle class in many “emerging economies.” Furthermore, investors have become more aware of the opportunities and diversification benefits afforded by investments in hard assets.

Our ETFs are marketed under the Market Vectors brand. The lineup seeks to provide investors with the tools they need to access the broad hard assets market, as well as individual sub-sectors within the commodities-related investment arena. The RVE Hard Assets Producers ETF (HAP) provides broad exposure to global hard assets producers. Based on the Rogers-Van Eck Hard Assets Producers Index, which was developed in concert with international investor Jim Rogers, HAP provides global exposure to hard assets markets. The consumption-weighted methodology of the index lends itself to enhanced diversification among six key sub-sectors: energy, agriculture, precious metals, base metals, paper and forest products and alternatives (including water and alternative energy).

For investors seeking more targeted investments, we offer ETFs focused on: agribusiness (MOO), coal (KOL), gold mining (GDX), global alternative energy (GEX), solar energy (KWT), nuclear energy (NLR) and steel (SLX).

There’s been a lot of fiscal chaos with state and local government, and it’s impacting municipal bond investors. What are you seeing in the muni bond market right now?

Over the last year, municipal bond investors have faced many challenges. Monoline insurers have been downgraded, auction rate securities markets have dried up and credit markets began to seize after the collapse of Lehman Brothers. Such events caused bond valuations to retreat sharply.

Today, concerns remain over the financial condition of certain states and local governments. It’s important to remember, however, that municipal debt has typically had a lower rate of default than corporate debt of comparable quality. In fact, The Bond Buyer recently reported that during the first quarter of 2009, the number of credit upgrades assigned by Standard & Poor’s outweighed the number of credit downgrades which they assigned by a ratio of 4:1.

Furthermore, since June 30 of last year, municipal bond investors who have stayed the course have realized positive total returns (as measured by the Barclays Capital Total Return Municipal Bond Index). Additionally, those who have invested after the pullback have realized opportunities for additional capital appreciation as well.

From a fundamental standpoint, the municipal bond market continues to appear technically sound. Demand for municipal issues remains strong, while supply has been diminished by issuers’ lack of access to debt markets in the beginning of the year and the issuance of non-traditional muni debt (such as Build America Bonds) over the last quarter. We believe there are still attractive opportunities in municipal fixed income markets. However, diversification by issuer, credit quality and geography is important.

What are some ways muni bond investors can diversify their risk away from individual bonds or bonds concentrated in geographically depressed areas?

Diversification can be obtained by investing in a high number of different individual bonds, or through a fund approach. We offer five Market Vectors Municipal Bond ETFs. Each focuses on a different segment of the municipal bond market, but each is well-diversified within its particular market.

For example, we offer a Short Term Municipal Bond Index ETF (SMB) covering bonds with maturities of 1-6 years, an Intermediate Term Municipal Bond ETF (ITM) covering bonds with maturities of 6-17 years and a Long Term Municipal Bond Index ETF (MLN) covering bonds with more than 17 years to maturity. These allow investors to target the segment of the yield curve that is of greatest interest and meets their appetite for risk.

For investors seeking credit-specific opportunities, we offer two additional products. The Pre-Refunded Municipal Bond Index ETF (PRB) is a portfolio comprised of bonds with the highest quality among municipal bond issues. We also offer the High-Yield Municipal Bond Index ETF (HYD), designed for investors aggressively seeking higher tax-free yield.

Generally speaking, what type of investors should look at investing in municipal bonds?

Historically, investors in the highest tax brackets have been most attracted to municipal bonds. This is due to the tax advantages presented by municipal bond investments, whose after-tax returns become more attractive to higher yielding taxable bonds (particularly for investors taxed at higher rates). Of course, if federal tax rates rise, as many expect, the benefits of municipal bonds will become more attractive to a broader base of investors.

At current values, however, investors in lower tax brackets may find opportunities in municipal bonds, particularly those with maturities of 10 years or more [from now], as they have recently presented relative values not seen in quite some time.

Investors concerned about credit quality and safety may also be attracted to municipal bonds, as they have had a historically low rate of default, particularly in comparison to similarly rated corporate debt issues.

Van Eck manages the Pre-Refunded Muni Bond ETF (PRB). How is PRB different from conventional muni bond funds?

Pre-refunded municipal bonds are bonds that are refinanced by their issuers and remain outstanding in the marketplace. They are created when municipal issuers refinance outstanding debt to take advantage of lower interest rates and reduce their financing costs. They accomplish this by issuing so-called refunding bonds whose proceeds are used to buy securities that are placed in escrow and dedicated to paying the interest and principal on the original issue, which then becomes “pre-refunded.”

These bonds derive their high credit quality from the escrowed securities that secure them. In general, those securities consist solely of obligations directly issued or unconditionally guaranteed by the U.S. government — specifically, U.S. Treasury bonds as well as State and Local Government Series bonds, or SLGs, a type of Treasury security issued specifically for escrow use by municipal issuers. Therefore, the portfolio is diversified, but unlike other municipal bond funds, PRB takes on no issuer [credit] risk related to individual states or municipalities.

Some see the U.S. government’s unprecedented increase of the money supply as hyperinflationary. What are some ways advisors can protect their clients against the destructive forces of inflation?

Somewhere down the road, the increase in money supply is likely to lead to inflation. Investors have several strategies for hedging this inflation risk. Commodities-related investments, particularly gold-related investments may provide a hedge against inflation.

Gold and other commodities have historically been positively correlated to inflation. Additionally, most are priced in U.S. dollars, which offers additional upside potential should inflation lead to a declining dollar. In this situation, many commodities become cheaper for foreign investors, as these commodities are priced in U.S. dollar terms. TIPS may also have some appealing qualities, as they are designed to help investors protect against inflation.
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Ron DeLegge is the San Diego-based editor of www.etfguide.com

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