Investing in Municipal Bond ETFs

What are municipal bonds?

Municipal bonds (also called “munis”) are fixed-income securities that are issued by government entities which are NOT at the national level. Most investors are aware of the infamous US treasuries, which are government-backed securities issued by the US federal government. However, different states and cities, which also require funding, are able to raise capital by issuing their own bonds in the form of muni-bonds. 

Municipal bonds may be used by states or cities to fund day-to-day operations as well as large-scale projects such as:

• Schools
• Highways
• Public transportation
• Sewer systems

Muni-bonds can be purchased by anyone, and the issuing state or city retains an obligation to repay the borrowed money (principal) in addition to interest.

In the US, there are two main types of muni-bonds:

1. General obligation bonds – backed by the “full faith and credit” of the issuer, have the power to tax residents to ensure repayment of the bond
2. Revenue bonds – not backed by taxing power, however have an element of revenue generation e.g. highway tolls or lease payment collections

Why invest in muni-bonds?

Muni-bonds give the safety of investing in a government entity, which theoretically cannot default since it is able to tax residents to repay the bonds. In addition, muni-bonds generally have other benefits such as:

• Potentially higher yield than federal government bonds
• Tax benefits; interest may be exempt from taxable income
• Reliable income-generating investment due to the consistency in coupon payments

There are some risks that come with investing in municipal bonds, however, including:

1. Call risk: The issuer may be able to repay the bond before it’s due, thereby leaving the investor needing to look for an alternative investment. This risk is heightened when interest rates decline since issuers can pay back their current debt and issue new debt at lower interest rates.
2. Credit risk: While these are government entities, it is still possible for a municipal bond to default, especially in markets outside of developed countries.
3. Interest risk: Prices of municipal bonds (like all bonds) will fluctuate depending on the prevailing interest rates. With yields rising rapidly, the prices of many fixed-income securities are decreasing. 

How to gain exposure to muni-bonds through ETFs

The ETF Central screener is a great way to search and compare funds, and most importantly find one that is suitable for your personal circumstances, including risk appetite and investment horizon.  

Three ETFs that offer exposure to US municipal bonds include:

MUB – iShares National Muni Bond ETF

• AUM: $28.40B
• 1mo Performance: -1.71%
• 1mo Flows: +$1.34B

VTEB – Vanguard Tax-Exempt Bond Index ETF

• AUM: $20.21B
• 1mo Performance: -1.87%
• 1mo Flows: +$2.66B

SUB – iShares Short-Term National AMT-Free Muni Bond ETF

• AUM: $9.08B
• 1mo Performance: -0.65%
• 1mo Flows: +$169M

Data for this article is as of October 21, 2022.

Please note this article is for information purposes only and does not constitute investment advice.