What To Expect From Municipal Bond ETFs On Detroit’s Bankruptcy

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July 25, 2013 4:57pm NYSE:MUB NYSE:PZA

detroitRecently, Detroit, with its $18 billion in debt, became the largest municipality to file for bankruptcy in the nation’s history. The city has struggled for decades with a shrinking population (and tax base), crime, and jobs troubles, all of which

came to a head in this historic filing.

While the bankruptcy was initially halted by a State Court—due to a Michigan law that protects pensions—a Federal Bankruptcy judge has ruled that it could go forward, basing the ruling on the idea that the city and its residents would suffer irreparable harm if restructuring efforts were stalled. “In the context of a Chapter 9 case, and especially this Chapter 9 case, that is probably the most important factor of all” said Judge Steven Rhodes, allowing the case to continue.


If this holds up, it looks to allow Detroit to shed some of its costs and get back to some semblance of sustainability. However, the move will likely be closely watched by a number of other highly-indebted municipalities, which are probably not too far off from bankruptcy themselves either (read 3 Oversold Bond ETFs to Buy on the Rebound).

The bankruptcy proceedings have also thrown a bit of risk back into the municipal bond market, at a time when most are skittish about bonds anyway. Given this, investors who have muni bond holdings may want to consider keeping a watchful eye on the space, as it could be a harbinger of things to come across the nation in a number of municipalities.

An easy way to do that is by looking at broad muni bond ETFs, of which there are many in the market. These funds have all been under a little pressure lately, in light of both the bankruptcy issues and rising Treasury rates, and could face rocky trading in the next few months too.

In particular though, the following muni bond ETFs could be ones to watch in order to ascertain how the broad muni market is dealing with the uncertain economic environment:

Broad Market

There are a number of popular broad muni bond market ETFs out there which could be impacted by increased worries over municipal bond finances. These are investment grade-focused funds though, so hopefully they will not be as impacted by the growing concerns. Some of the top options include:

(MUB)- Arguably this multi-billion dollar ETF is the best for broad exposure to the market. The fund holds over 2,000 securities in its basket, focusing on mid and long term securities from a number of states. MUB is down about 1.7% in the past 10 days.

(TFI)- This SPDR ETF is also a popular choice for muni bond investing, as it has over one billion dollars in assets and sees more than 350,000 shares in volume a day. The ETF does hold far fewer securities in its basket though, with just under 500 companies in the fund. TFI is down roughly 1.2% in the past 10 days.

Insured/Low Risk

For a low risk way to target the market, investors have a few options. In particular, either the insured or short-duration segments could be solid choices for this type of exposure.

These funds should be better positioned than most in this type of environment, especially if rates continue to rise. Furthermore, if the pain starts to hit these products, then that could signal some serious trouble for the broad muni bond space. Choices in this market include:

(SHM)- This SPDR ETF is a very popular muni bond fund that has a decided focus on the short end of the curve, holding about 500 bonds in its basket. The fund also sees solid volume on a good AUM, suggesting decent bid ask spreads as well. Over the past 10 days, this ETF has actually added about 0.3%, bucking the trend in the space (see Are Short Term Bond ETFs the New Safe Haven?).

(PZA)- This ETF doesn’t focus on short term bonds but it does look to offer a lower risk level thanks to the ‘insured’ nature of its securities. This looks to give a lower credit default risk profile, though duration risk will be quite high here. Thanks to this, PZA has actually lost about 2% in the past ten day period.

(SUB)- Another short-term option for muni bond investors is PZA, an ETF that holds securities that have a maturity between one month and five years. In total, the ETF has about 700 bonds in its portfolio, with exposure stretching across a variety of states. This fund has also had a decent performance in the past ten days, losing about 0.2% in the time frame.

High Yield

High yield muni bond ETFs could be especially impacted by the recent trends in the market. These types of securities already hold high risk securities, and more big bankruptcies—or a possible trend towards that end—could be disastrous for the space.

Still, payouts in this space are elevated, so lower duration securities may be less impacted by a rising rate environment. Plus, if Detroit turns out to be an isolated event, these could rebound in the months ahead. Options here include:

(HYD)- This is the most popular high yield muni bond fund on the market, with just under $900 million in assets. The product holds about 300 securities in its portfolio, and interestingly, has a very small allocation to City of Detroit bonds (less than 0.1%) in the product. The fund has declindeb y 1.5% over the past 10 days.

(HYMB)- This ETF is also a solid option for broad exposure to the high yield muni bond market, giving access to about 260 companies in the space. Exposure is well spread out across a number of local bonds, while City of Detroit Sewage Disposal System Revenue Bonds account for 0.4% of the total. The fund has been one of the worst performers on the list in the past ten days, losing roughly 2.9% in the time frame.

This article is brought to you courtesy of Eric Dutram.

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