Is 2015 The Year For Municipal Bond ETFs?

market bondsThe U.S. muni bonds market had a great 2014 with its returns just below the S&P 500 and the Dow Jones Industrial Average. These two blue chip indices advanced a respective 15.3% and 11.5%. With the  S&P 500  also crossing the 2,000 mark, muni bonds turned out to be the third best performing category gaining 8.7% (per Wall Street), its three-year best.

Needless to say, the $3.6 trillion muni bond market breezed past the 6.97% return generated by investment grade corporate bonds and 4.6% return delivered by the safe-haven U.S. treasuries.

In fact, this outperforming corner of the bond market has not fallen behind even in a single month of 2014. This was in stark contrast to a lackluster performance in 2013 when the space crumbled thanks to poor financial health of Detroit and Puerto Rico as well as rising rate woes.

Behind the Surge 

Municipal bonds are an excellent choice for investors seeking a steady stream of tax free income. Usually the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making it especially attractive for investors in the high tax bracket looking to reduce their tax liability.

Apart from investors’ desire for a tax-shelter, the demand-supply imbalance, improving fiscal health of many municipal bond issuers and a defensive sentiment prevailing in the market on sluggish global recovery made for a rewarding combination. As per Janney Montgomery, U.S. municipal-bond issuance will decline each year through 2017 to as low as $175 billion. Investor’s appetite for munis pushed the yields to multi-month lows.

If this was not enough, the space is presently undervalued. A recent Bloomberg article stated that muni bonds almost reached the ‘cheapest’ valuation as compared to U.S. treasuries in 2014. The flight to safety mode led investors to grasp Treasuries quickly making munis an undervalued investment proposition.

A Bet for 2015 Too

With the deadline for income tax return filing coming closer, demand for municipal bonds should be on a roll in the New Year as well. Investors should note that munis are safer bets compared to corporate bonds and yield better than treasuries. With the Fed insisting to take a ‘patient’ stance on the rate hike issue, the higher yield nature of the munis should keep it in a straight up trajectory.

ETF Plays

Thanks to the muni boom, as much as $13.4 billion of assets were in muni ETFs’ as of September 30, an all-time high. Given the bright prospects of the muni space, let’s look at some of the top performing ETFs in the space. These could be a good way to target the best of the segment and these might be interesting selections for 2015 as well:

Market Vectors CEF Municipal Income ETF (XMPT)

This overlooked choice looks to track the S-Network Municipal Bond Closed-End Fund Index. The product is composed of shares of municipal closed-end funds listed in the U.S. that are principally engaged in asset management processes designed to produce a federally tax-exempted annual yield. Notably, closed-end products are best-suited for those who seek higher income.

The product charges165 bps in fees and has mustered an asset base of $39 million. The fund is up 17.8% year to date and 0.6% in the last one month (as of December 31, 2014). The fund has a dividend yield of 5.58% as of the same date.

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