Invesco’s PowerShares Build America Bonds Portfolio ETF (BAB) will begin trading tomorrow (Tuesday). This ETF will track the Bank of America Merrill Lynch Build America Bond Index. The BAB ETF will consist of securities that are eligible to partcipate in the Build America Bond Program. BAB will be the first ETF to invest in taxable municipal bonds issued through the government’s American Recovery and Reinvestment Act of 2009.
The Build America Bond Program was created under the 2009 American Recovery and Reinvestment Act in order to decrease borrowing costs of local and state governments. BABs are taxable municipal bonds that are actually subsidized by the U.S. Treasury. There are two types of BABs – direct payment and tax credit bonds. Direct Payment BABs will pay the issuer 35% of the interest payments made to investors. Tax credit BABs will pass the 35% along as a tax credit. BABs were launched in April of 2009 and have been steadily increasing in popularaity with each passing day.
Issuance of Build America Bonds will cease on December 31, 2010 unless the relevant provisions of the Act are extended. The fund has built in a contingency plan to change the funds objectives should the program not be extended.
Principal Investment Strategies
The Fund will normally invest at least 80% of its total assets in taxable municipal securities eligible to participate in the Build America Bond program created under the American Recovery and Reinvestment Act of 2009 (the “Act”) or other legislation providing for the issuance of taxable municipal securities on which the issuer receives federal support of the interest paid (“Build America Bonds”). The Fund will normally invest at least 80% of its total assets in the securities that comprise the Underlying Index. The Underlying Index is designed to track the performance of U.S. dollar-denominated Build America Bonds publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. market. Unlike most other municipal obligations, interest received on Build America Bonds is subject to federal and state income tax. Under the terms of the Act, issuers of “direct pay” Build America Bonds (i.e., taxable municipal bonds issued to provide funds for qualified capital expenditures) are entitled to receive payments from the U.S. Treasury over the life of the bond equal to 35% (or 45% in the case of Recovery Zone Economic Development Bonds) of the interest paid. For example, if a Build America Bond is issued with a taxable coupon of 10%, the issuer would receive a payment from the U.S. Treasury equaling 3.5% or 4.5% in the case of Recovery Zone Economic Development Bonds. The federal interest subsidy continues for the life of the bonds. The Underlying Index does not include bonds that, under the Build America Bond program, are eligible for tax credits. Build America Bonds offer an alternative form of financing to state and local governments whose primary means for accessing the capital markets has been through the issuance of tax-free municipal bonds. The Fund’s policy to invest at least 80% of its total assets in Build America Bonds is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.
Issuance of Build America Bonds will cease on December 31, 2010 unless the relevant provisions of the Act are extended. In the event that the Build America Bond program is not extended, the Build America Bonds outstanding at such time will continue to be eligible for the federal interest rate subsidy, which continues for the life of the Build America Bonds; however, no bonds issued following expiration of the Build America Bond program will be eligible for the federal tax subsidy. If the Build America Bond program is not extended, the Board of Trustees of the Trust (the “Board”) will evaluate the Fund’s investment strategy and make appropriate changes that it believes are in the best interests of the Fund and its shareholders, including changing the Fund’s investment strategy to invest in an index composed of taxable municipal securities.
The Underlying Index is adjusted monthly and the Fund, using an “indexing” investment approach, attempts to replicate, before fees and expenses, the performance of the Underlying Index. The Adviser seeks correlation over time of 0.95 or better between the Fund’s performance and the performance of the Underlying Index. The Adviser uses a “sampling” methodology in seeking to achieve the Fund’s investment objective. Sampling involves the use of quantitative analysis to select securities from the Underlying Index to obtain a representative sample of securities that have in the aggregate investment characteristics similar to the Underlying Index based on such factors as duration, maturity, credit quality, yield and coupon. The Adviser generally expects the Fund to hold less than the total number of securities in the Underlying Index but reserves the right to hold as many securities as it believes necessary to achieve the Fund’s investment objective (currently, the Fund expects to hold approximately 25 securities out of the 1,405 securities in the Underlying Index as of September 30, 2009). The Fund may sell securities that are represented in the Underlying Index in anticipation of their removal from the Underlying Index, or purchase securities not represented in the Underlying Index in anticipation of their addition to the Underlying Index.
The Underlying Index is designed to track the performance of U.S. dollar-denominated investment grade taxable municipal debt publicly issued under the Build America Bond program by U.S. states and territories, and their political subdivisions, in the U.S. domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s, a division of The McGraw-Hill Company, Inc. (“S&P”), and Fitch Ratings, Inc. (“Fitch”)), at least one year remaining term to final maturity, a fixed coupon schedule and a minimum amount outstanding of $1 million. In addition, qualifying securities must be “direct pay” (i.e., a direct federal subsidy is paid to the issuer). The call date on which a pre-refunded bond will be redeemed is used for purposes of determining qualification with respect to final maturity requirements. Rule 144A securities and original issue zero coupon bonds qualify for inclusion in the Underlying Index. Securities in default are excluded from the Underlying Index.
Securities that are included in the Underlying Index are capitalization-weighted based on their current amount outstanding. Intra-month cash flows are reinvested daily, at the beginning-of-month SIFMA Municipal Swap Index yield, until the end of the month at which point all cash is removed from the Underlying Index. Accrued interest is calculated assuming next day settlement. The Underlying Index is rebalanced on the last calendar day of the month, based on information available up to and including the third business day before the last business day of the month. Issues that meet the qualifying criteria are included in the Underlying Index for the following month. Issues that no longer meet the criteria during the course of the month remain in the Underlying Index until the month-end rebalancing at which point they are removed from the Underlying Index.
The Underlying Index began operations on November 6, 2009. Valuation data regarding the Underlying Index is available via Bloomberg L.P.