Feb. 4, 2008 (Investor's Business Daily delivered by Newstex) --
When the market corrects, it's better to pull out. But that doesn't mean your cash can't work for you.
Sometimes putting the money in an exchange traded fund that tracks municipal bonds can be a way to do that. That's because muni bonds tend to be less responsive to economic disruptions.
Several muni bond ETFs have been rolled out in the last several months, notably from State Street and Barclays. (NYSE:BCS)
Van Eck also has launched a set of muni bond ETFs in the past two months: Market Vectors-Lehman Bros. AMT-Free Long Municipal Index ETF MLN and Market Vectors-Lehman Bros. AMT-Free Long Municipal Index ETF ITM.
Muni bond ETFs offer tax-free income, though investors must still pay capital gains if they sell the share.
The income is sent to investors monthly, just as in bond mutual funds.
Returns
Muni bond funds also have done relatively well as an asset class, given their tax-free income.
Single-state short duration muni funds returned 5% over the past year, according to Morningstar. Investors would get the full 5% with no tax if they are residents of the state that issued the bond.
Meanwhile, national intermediate duration bonds returned 4.76%, a return that would come with federally tax-free income.
Van Eck's muni bond ETFs have expense ratios of 20 and 24 basis points, similar to iShares S&P National Municipal Bond Fund MUB at 25.
Muni bonds and other government-guaranteed investments, such as Treasuries, garnered more interest as the stock markets started to look shaky in the past quarter and the credit crunch pushed investors to higher-quality credit.
Single States
James Colby, senior municipal strategist at Van Eck, says the firm is working on single-state ETFs to take advantage of the in-state tax breaks for higher-tax states such as New York and California.
He says one advantage of muni ETFs over single muni bonds is their liquidity. Investors wanting muni bonds have to go through a broker, which can be expensive.
Because transactions usually must be through brokers, munis (or any other single bond) are harder to sell when an investor wants to get back into the market.
"It's better liquidity than a CD or if you don't like the money market rates," Colby said.
He said it is important to remember that bond markets have cycles just like equity markets do. Buying at the top of the market (when interest rates are low) is risky.
Interest rates are still trending downward, he says, with the possibility the Fed will cut further.
Colby notes the default rate for munis is historically at less than 1%.
Newstex ID: IBD-0001-22724218Originally published in the February 4, 2008 version of Investor's Business Daily.
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