Muni bonds haven’t been spared in what’s shaping up to be another year of weakness for the broader bond market. For example, the widely followed ICE AMT-Free US National Municipal Index is down 1.07% year-to-date as of Nov. 3.
That’s not a staggering loss. But with Treasury yields still elevated and no clear sign regarding when the Federal Reserve will begin lowering interest rates, high yield municipal debt may not be the first fixed income segment on investors’ minds. However, fixed income investors shouldn’t be hasty in glossing over funds such as the VanEck High Yield Muni ETF (HYD).
The ETF, which tracks the ICE Broad High Yield Crossover Municipal Index, catches investors’ attention with a 30-day SEC yield of 5.11% — unusually high among muni bond ETFs, even those with a high-yield mandate. Fortunately for market participants considering HYD, the fund is supported by sources of allure beyond that yield.
High Yield Muni Fundamentals Are Sturdy
While there’s ample chatter this year regarding the health of the U.S. economy, state-level tax collections in some states with large amounts of outstanding municipal debt, such as New York and New Jersey, remains strong. Those two states combine for over 13% of HYD’s roster.
“Strong revenue growth, record-high cash reserves and billions in pandemic stimulus strengthened the credit quality of US states, just as a muni market selloff has driven yields to their highest levels since the financial crisis more than a decade ago,” reported Nic Querolo for Bloomberg. “In New York, for instance, yields on 30-year debt are 4.8%. On a tax-equivalent basis, which accounts for tax savings, that translates to roughly 9.8% for buyers in the state’s top tax bracket.”
Municipal bond investors often focus on debt issued in states with high local and state taxes, such as California and New York, as avenues for offsetting personal tax burdens if they live in those states. However, that doesn’t mean there aren’t opportunities with munis in lower-tax states.
For example, neither Texas nor Florida, the second- and third-largest states, respectively, have personal income taxes. However, those are two of the fastest-growing states in the U.S. This indicates tax bases there are increasing, providing ballast to municipal debt obligations. Texas and Florida combine for about 11% of the HYD roster.
Additionally, from a fee perspective, ETFs are the superior vehicle through which to access municipal bonds.
“The fees of an investment vehicle are important; they affect an investor’s ultimate return. As of December 31, 2022 the average net expense ratio of municipal bond ETFs was 43 bps lower as compared to municipal bond mutual funds, and was 131 bps lower as compared to municipal bond closed-end funds. Many investors may prefer municipal bond ETFs for this reason,” according to VanEck.