Municipal bonds and the related exchange traded funds have been under pressure this year due to rising interest rates. However, there are examples of muni bond ETFs outperforming aggregate bond funds.
With that in mind, some market observers are constructive on municipal debt as a 2023 rebound idea, noting that investors can currently use munis and the corresponding ETFs to access above-average yields without taking on undue risk.
That setup could be encouraging for ETFs such as the SPDR Nuveen Municipal Bond ESG ETF (MBNE ). MBNE debuted earlier this year as one of the few ETFs offering the coveted combination of municipal bonds with an environmental, social, and governance (ESG) overlay. Adding ESG to the equation could make MBNE all the more attractive in 2023.
“For the first time in a long time, yields are attractive. At the beginning of the year, the yield on the Bloomberg Municipal Bond Index was close to 1%, near the lowest level in the history of the index. That’s no longer the case,” according to Charles Schwab research. “The yield on the index has risen to roughly 3.4%. While this isn’t as high as other fixed income options, municipal bonds are one of the few investment options that are often exempt from federal and potentially state income taxes if the issuer is located in your home state, so after adjusting for this, they are attractive relative to alternatives.”
Further bolstering the allure of MBNE as a muni rebound idea is the point that the ETF is actively managed, meaning the fund’s managers can work to mitigate credit and interest rate risk. Likewise, they can also scour the landscape of municipal bonds with strong ESG credentials to identify potential value opportunities.
Speaking of credit, the muni-to-Treasury ratio, which evaluates AAA-rated munis against U.S. government debt, indicates there are opportunities with intermediate-term munis. That’s relevant to investors considering MBNE because the ETF’s option-adjusted duration is 5.16 years, which is firmly in the intermediate-term territory.
“The ratio is below its five-year average for most maturities on the curve. It’s especially below its longer-term average for short-term bonds. Tactically, this can be translated to mean that intermediate-term bonds offer more attractive relative yields than shorter-term bonds. This isn’t to say that we don’t suggest holding some short-term bonds, but we think investors should consider extending duration in 2023 to take advantage of the move up in longer-term yields,” concluded Schwab.
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