Muni Bond ETFs offer transparency and lower fees than bond mutual funds
By Palash R. Ghosh, S&P Global Editorial Operations, and Alec Young, S&P International Equity Strategist
August 31, 2007
In the current climate of high volatility in the equity markets and possible credit loosening by the Federal Reserve, consider ETFs that focus on municipal bonds.
PowerShares Capital Management LLC is planning to launch two new exchange-traded funds (ETFs) that will invest in municipal bonds, representing the firm's first foray into the fixed income sector.
The two new offerings -- the PowerShares Insured Municipal Bond and the PowerShares National Municipal Bond Portfolio—are expected to start trading in October. Both bond portfolios—each will track the performances of rules-based indexes to be provided by Merrill Lynch—will exclude single- and multi-family housing bonds, tobacco bonds, and all securities subject to the Alternative Minimum Tax.
The PowerShares Insured National Municipal Bond Portfolio will be based on the upcoming Merrill Lynch US Insured Core Municipal Securities index, which is designed to track the performance of U.S. dollar-denominated, AAA-rated, insured, tax-exempt long-term debt publicly issued by U.S. municipalities in the U.S. domestic market.
The PowerShares National Municipal Bond Portfolio will be based on the upcoming Merrill Lynch US Core Municipal Securities index, which will be designed to track the performance of U.S. dollar-denominated investment grade tax-exempt long-term debt publicly issued by a U.S. municipality in the U.S. domestic market.
Three of the biggest players in the ETF industry, Barclays Global Investors, State Street Global Advisors, and Van Eck Global are also planning to introduce muni bond ETFs. Among the vehicles in registration, Barclay's iShares S&P National Municipal Bond index, designed to track a comprehensive index of state and local municipal bonds with an investment grade rating of BBB- or better from at least one of the three major bond rating agencies. Barclay's also filed two state-specific muni bond ETFs, for California and New York.
Bond ETFs can be bought and sold like stocks on the open market and provide intra-day liquidity. Moreover, interest is generated through monthly dividends and any capital gains are paid out through an annual dividend. However, bond ETFs do not mature, although they can be shorted, traded on margin, and hedged with options. In addition, bond ETFs provide pricing transparency and typically carry lower fees than bond mutual funds.
Standard & Poor's Investment Policy Committee believes equities remain the asset class of choice and are likely to continue outperforming bonds and cash through year-end. We believe current equity volatility will likely be limited to a correction and is not the beginning of a new global bear market.
While global credit spreads have widened and increased the cost of capital, we do not think this is sufficient to spark either a global recession or a cyclical profit peak. S&P expects global GDP growth to remain strong, driven by robust expansions in developing countries like China and India, coupled with continued above-trend growth in Europe and Japan. This should offset a housing-driven U.S. economic slowdown in 2007.
As for profits, 2008 consensus earnings growth projections remain positive. In addition to continued profit momentum, attractive valuations justify a continued 65% global equity allocation, in our view. Lastly, while private equity M&A activity will likely slow significantly as a result of recent credit market risk aversion, corporate M&A, which comprised 75% of global M&A activity in the first half, will likely continue in light of underleveraged balance sheets, by our analysis.
