Active Municipal Bond ETFs
The growing popularity of actively managed ETFs applies to both equities and fixed income, and within the fixed income space investors can focus on specific asset classes.
US municipal bonds can offer varying levels of tax breaks on yields for US investors. Rather like National Savings products in the UK, they pay income gross of tax, and the tax benefit is greatest for those paying the highest income tax rates.
New York and California munis are of special interest because they have extra high tax rates. The top rate in California is 50.3%: Federal income tax of 37% plus top rate California tax of 13.3%. The effective top rate in New York is 51.776%, made up of Federal Income tax of 37%, New York State tax of 10.9% and New York City tax of 3.876%.
This means that a California or New York muni bond paying 3.7% is equivalent to about 7.5% before tax for the highest rate local taxpayers, which is massively more than 5% on cash or short term Treasuries.
Rockefeller Capital Management has just launched three ETFs investing in US municipals
- Rockefeller Opportunistic Municipal Bond ETF (RMOP)
- Rockefeller California Municipal Bond ETF (RMCA)
- Rockefeller New York Municipal Bond ETF (RMNY)
Expense ratios of 0.55% for all three are above the average 0.33% for municipal bond ETFs reported by VettaFi, and also cost more than some other active muni bond ETFs.
PGIM also launched active municipal bond ETFs, PGIM Ultra Short Municipal Bond ETF (PUSH) and PGIM Municipal Income Opportunities ETF (PMIO), in June this year. Their expense ratios are 0.15% and 0.25% respectively.
Passive index tracking muni bond ETFs such as iShares National Muni Bond ETF (MUB), tracking investment grade US municipal bonds, can cost as little as 0.05%.
iShares belongs to BlackRock, which also has an actively managed product: BlackRock High Yield Muni Income Bond ETF (HYMU), with a net expense ratio of 0.35%. Over one year, HYMU has beaten its benchmark by about 0.50%.
The case for active management is that municipals can be a relatively inefficient market because the issuance cycle can take time to digest and many buyers are individuals investing directly into them, who may be making their decisions partly based on tax year dates and other tax considerations.
There are now over 20 ETF issuers offering US municipal bond ETFs. They include the largest US and global ETF players – eg BlackRock, Vanguard, State Street, VanEck, Franklin Templeton, as well as a few others such as Rockefeller who are not (yet?) giants of the ETF world.
The US Municipal bond market has about USD 4.1 trillion of debt outstanding, which is about three times larger than US high yield corporate debt at USD 1.4 billion and roughly half the size of US investment grade corporate debt at USD 7 trillion. Municipal bonds can have either an investment grade or a high yield credit rating, and very occasionally may default and have no credit rating.
Defaults are however extremely rare in US municipals. The average 5 year default rate has been 0.08% and has been steady for over 50 years, according to Moodys. For corporate bonds the average default rate is nearly 100 times larger over a 5 year period.
The main risk on municipal bonds under normal circumstances is interest rate sensitivity, and in 2022 the asset class did see a double-digit drawdown.
In contrast, the Covid related crash in March 2020, when MUB dropped about 10%, was recovered within a few months as the coordinated policy response to the Coronavirus reassured investors, who realized that local governments would be able to carry on raising taxes to service their debt.
