Will investing in New York’s municipal bonds be the best way to build your investment portfolio in 2012, or will Golden State munis deliver more sparkle? As physicist Niels Bohr once said: “Prediction is difficult — particularly about the future.” That makes it all the more important for investors interested in municipal bonds to seek diversification. Exchange-traded funds (ETFs) are a good way to take advantage of healthy yields on both coasts while hedging against default or interest rate risk.
Last year, prophets of doom predicted massive municipal defaults in the range of hundreds of billions of dollars. Despite the bankruptcy of Jefferson County, Ala., last November — the largest filing by a municipality in U.S. history, at nearly $1 billion — actual defaults represented only a small fraction of that amount.
Nevertheless, default fears were enough to drive more than $35 billion out of muni-bond ETFs and mutual funds last year. That means investors likely left a lot of money on the table. And municipalities issued only about $295 billion in bonds last year — the lowest level in a decade and down from just over $430 billion in 2010.
When American Airlines parent AMR (PINK:AAMRQ) filed for bankruptcy last November, the nearly $3 billion in special-facilities bonds it sold through airports and municipalities for gate and hangar upgrades took a hit. But even including the AMR-backed bonds, only $6 billion of munis wound up in default last year, according to researchers at Municipal Market Advisors.
Most municipal bonds had a great year in 2011, in some cases delivering double-digit yields and even outperforming junk bonds. And as Europe continues to haunt investors with the prospect of inflation and emerging markets slow down, U.S. municipal debt is becoming an interesting investment opportunity.
One of the most intriguing plays in 2012 is likely to be municipal debt in New York and California, two states that in many ways are a microcosm of the nearly $3 trillion U.S. municipal bond market. While new bond issues were down sharply last year, New York led the pack with more than $39 billion, according to The Bond Buyer. California held onto the No. 2 two spot, with more than $37 billion, though that was a huge drop from 2010’s $61 billion. Financial challenges likely will continue to foster short supply in 2012.
Risks remain because governments at every level are unable (or unwilling) to embark on serious belt-tightening, so eventually, taxpayers will have to pay the piper. ETFs give fixed-income investors a more diversified play, offering the added benefits of higher liquidity since they trade over an exchange, as stocks do. Here are three New York and three California muni-bond ETFs to keep in mind for 2012:
SPDR Nuveen Barclays Capital New York Municipal Bond ETF (NYSEArca:INY). With a market cap of nearly $26 million, INY seeks to match the price and yield of the Barclays Capital Managed Money Municipal New York Index. At $23.41, INY is trading 15% above its 52-week low of last February. The ETF has a current dividend yield of 3.2%, a three-year return of 9.3% and a one-year return of 13.2%.
iShares S&P NY AMT-Free Municipal Bond ETF (NYSEArca:NYF). With a market cap of $97 million, NYF seeks to replicate the performance of the tax-exempt S&P New York Municipal Bond Index. At about $108, it’s trading nearly 10% above its 52-week low of last February. NYF has a current dividend yield of 3.4%, a three-year return of 7.5% and a one-year return of 11.2%.
PowerShares Insured New York Muni Bond (NYSEArca:PZT). With a market cap of $41 million, PZT seeks to match the performance of the New York Insured Long-Term Core Plus Municipal Securities Index. At about $24, the ETF is trading about 14% above its 52-week low of last February. PZT has a current dividend yield of 4.2%, a three-year return of 9.6% and a one-year return of 12.8%.
iShares S&P CA AMT-Free Municipal Bond (NYSEArca:CMF). With a market cap of $195 million, CMF seeks to match the performance of the S&P Municipal Bond Index, which tracks state and federal tax-exempt municipal bonds issued by California state and local municipalities. At $111, CMF is up about 17% from its 52-week low of last February. The ETF has a current dividend yield of 3.6%, a three-year return of 6.9% and a one-year return of 15.4%,
SPDR Nuveen Barclays Capital CA Muni Bond (NYSEArca:CXA). With a market cap of $75 million, CXA seeks to match the price and yield of the Barclays Capital Managed Money Municipal California Index. At $23.50, it’s trading 19% above its 52-week low of last February. CXA has a current dividend yield of 3.6%, a three-year return of nearly 9% and a one-year return of 16.7%.
PowerShares Insured California Muni Bond (NYSEArca:PWZ). With a market cap of $40 million, PWZ seeks to match the price and yield of the Merrill Lynch California Insured Long-Term Core Plus Municipal Securities Index. At $24.30, the ETF is trading 15% above its 52-week low of February. It has a current dividend yield of 4.3%, a three-year return of nearly 9% and a one-year return of 12.7%.
As of this writing, Susan J. Aluise did not hold a position in any of the investments named here.