Municipal bonds — those dull dividend darlings income investors love — have gotten a bad rap in the past couple of months. Bankruptcy filings by three California cities and regulators’ concerns over the lack of transparency in the municipal debt market have rattled even Warren Buffett.
That said, munis still warrant a spot in income investors’ portfolios. And an easy, diversified way to gain exposure is through municipal bond exchange-traded funds (ETFs). In fact, U.S. municipal bond funds had $1.1 billion in inflows for the week ending Aug. 8, according to data from Thomson-Reuters unit Lipper. That’s the highest level in five months.
Not long ago, municipal bonds were considered a “go to” investment to hedge against volatile equities and low-yielding Treasuries, serving up safety, stable income and tax advantages for the conservative investor.
But regulators recently have voiced concerns over transparency in muni-bond markets. Securities & Exchange Commission Chairman Mary Schapiro told Congress last month that the nearly $4 trillion market needs mandatory disclosure rules and uniform accounting standards to better protect investors.
The recent bankruptcy filings of three California municipalities — San Bernadino, Stockton and Mammoth Lakes — also have called that value proposition into question. Buffett, whose Berkshire Hathaway (NYSE:BRK.A) recently dumped some $8 billion in municipal bonds, said the California cities’ filings could make future bankruptcies “more likely” because they reduced the “stigma.”
Still, Buffett’s BRK hasn’t completely cashed out of munis, and the Oracle of Omaha doesn’t believe the massive defaults predicted by banking analyst Meredith Whitney actually will come to pass. That’s good news for investors who cringe at low Treasury yields and whose stomachs churn over volatile equities.
A quick primer: Muni bonds come in two flavors — revenue bonds and general obligation bonds. Revenue bonds fund improvements in projects like airports or power plants that generate income. These bonds can repay investors only from that income. In a GO bond, municipalities can raise taxes to repay bondholders.
But it’s also prudent not to put all your eggs into one muni basket. And the easiest way to diversify is via muni ETFs, which often include both classes of debt. These funds offer greater diversification than individual bonds. And because ETFs trade like a stock over a major exchange, they also boast higher liquidity.
Here are four muni-bond ETFs to buy for their solid dividends:
Market Vectors High Yield Municipal Index ETF (NYSE:HYD). This national ETF tracks the Barclays Capital Municipal AMT-Free Continuous Municipal Index. Top holdings currently include GO and revenue bonds from Virginia, Puerto Rico, Illinois, Ohio and New Jersey. With over $781 million in assets, HYD focuses on lower credit quality (a lot of noninvestment grade and Baa/BBB issues), higher-yielding bonds. These riskier holdings help HYD boast a current dividend yield of 5.1%. It’s now trading around $32.50. HYD’s year-to-date return is nearly 12%, and it has an expense ratio of 0.35.
iShares S&P AMT-Free Municipal Bond Fund (NYSE:MUB). This also is a national fund, and it tracks the S&P National AMT-Free Municipal Bond Index. The alternative minimum tax–free aspect is a boon for investors who have a lot of tax-free income. Top holdings include bonds from California, Illinois, South Carolina and Texas. With more than $3 billion in assets, MUB has a current dividend yield of 3% and is trading around $111. Its year-to-date return is nearly 5%, and it has a tiny expense ratio of 0.25.
Invesco PowerShares Insured National Municipal Bond Portfolio (NYSE:PZA). PZA tracks the BofA Merrill Lynch National Insured Long-Term Core Plus Municipal Securities Index, which comprises primarily AAA-rated, insured, tax-exempt long bonds issued by states or local governments. Top holdings include revenue bonds for Puerto Rico, Florida, Texas and New Jersey. With nearly $815 million in assets, PZA has a current dividend yield of 4.2% and is trading around $25.50. Its year-to-date return is 7.5%, and it has an expense ratio of 0.28.
Market Vectors Long Municipal Index (NYSE:MLN). This ETF tracks the Barclays Capital AMT-Free Long Continuous Municipal Index, which focuses on bonds with maturities of 17+ years. Top holdings include revenue and GO bonds from Colorado, Massachusetts, Michigan, Colorado and Washington State. MLN is the smallest ETF in this group with assets of $102 million. It has a current dividend yield of 4% and is trading around $20. Its year-to-date return is 7.9%, and it has an expense ratio of 0.24.
As of this writing, Susan J. Aluise did not hold a position in any of the investments named here.