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Don't Forget About These Impressive Muni Bond ETFs

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Although there have been some concerns over the muni bond market as of late thanks to some high profile Californian bankruptcies, this important bond segment is still quite strong. Assets have flowed into muni bond ETFs at an incredible pace so far in 2012 as investors seek tax-exempt yield and relative stability in their fixed income holdings.

After all, it appears as though Meredith Whitney’s much discussed prediction regarding muni bond bankruptcies has—so far—proven to be inaccurate. “We have seen a return of sanity in the municipal bond market” said James Colby, Senior Municipal Strategist at Van Eck Global. “Bankruptcies have caused investors to pause, but they are looking beyond problem children to solid and stable choices”.

Thanks to this sentiment, the never-ending quest for yield, and a backlog of investor dollars, municipal bond ETFs have been on a tear in 2012, seeing inflows at an incredible pace. It also hasn’t hurt that institutional investors have also jumped in on the market, according to Colby, as these assets have pushed supply levels lower for the average investor, increasing muni bond prices in the process (read The Forgotten Municipal Bond ETFs).

However, despite these inflows into many of the most popular muni bond funds and ETFs, some haven’t seen the same level of interest as their more well-known counterparts. This is despite the fact that a few of these funds offer up truly novel or underappreciated ways to target the muni bond market.  

Below, we highlight two of these products which could be interesting picks for investors seeking to make a play on the muni bond market but are looking for a different approach than what is in funds like (MUB - Free Report) or (TFI - Free Report) . For these investors, either of the two funds highlighted below could be great alternatives that still offer well-diversified and safe, exposure to the municipal bond market:

Market Vectors CEF Municipal Income ETF (XMPT - Free Report)

For investors who like a closed end approach to the muni bond market, XMPT can potentially offer a more efficient way to play the space. That is because the fund offers basket exposure to more than 80 CEFs while still offering the intraday trading and flexibility that have become of the hallmarks of the ETF industry.

With this approach, exposure is spread out over hundreds, if not thousands, of individual securities, suggesting that the level of diversification is unmatched. Furthermore, since the product doesn’t put more than 6% in any one CEF, concentration risks from this perspective aren’t going to be much of a problem either (also see Inside The Closed-End Fund ETF).

Yet despite the intense diversification, yield hasn’t been sacrificed as the 30-Day SEC payout comes in at 5.4%. Furthermore, while the fund has seen some extreme volatility in months past, the trend has definitively been positive as the product has added over 7% this year in terms of price appreciation and roughly 16% over the trailing 52 week period.

Although both of these metrics are quite impressive, the volume and expenses are not exactly great for the fund. Fees come in at 1.43% per year—thanks to a 1.03% acquired fund fee—while volume is quite low at just 3,000 shares a day. These figures could increase the bid ask ratio for the fund and eat into the overall yield and performance of XMPT, something investors should be aware of (see the Guide to the 25 Cheapest ETFs).

Still, for investors seeking to make a truly diversified play on the muni market across a number of closed-end funds, XMPT remains the only choice. While its volume might leave something to be desired the solid performance of the fund—and the market beating yield—certainly should soothe some investor concerns over these metrics.

Market Vectors Pre Refunded Municipal ETF (PRB - Free Report)

If investors are looking for safety above all else, PRB is going to be extremely difficult, if not impossible, to beat. That is because the fund tracks an index of ‘pre-refunded’ bonds, which makes the fund, according to James Colby of Van Eck, “the highest credit quality you can get in the muni bond ETF space”.

This is largely due to the ultra-safe structure of the pre-refunded market, which is pretty much unparalleled in the municipal bond world. A ‘pre-re’ is created when a local government issues a bond and then once rates decline, it issues a ‘refunding bond’ at the lower rate (read Three Muni Bond ETFs to Weather the Coming Storm).

The proceeds from this are used to buy U.S. Treasury obligations, which are then placed in escrow to pay principal and coupon interest for the ‘pre-refunded’ original. The Pre-refunded bonds are relived from their original purpose but they continue to pay tax-free income to investors. Meanwhile, municipalities benefit from lower financing costs so both sides win in this scenario.

This technique, while somewhat complicated, brings the full faith and credit of the U.S. government—and its money printing capabilities—into the muni bond financing picture. Obviously, this is a pretty low risk way of doing things and it is arguably safer than using muni bond insurance, which relies on private companies and their ability to remain as going concerns, as the way to offer up investor protection.

However, investors should note that this ultra high level of safety comes with a price; extremely low yields. In fact, the 30 Day SEC tax equivalent yield is just 0.36%, although it should be noted that the 12-month yield is 1.42%. Yet, the product has been incredibly stable, as its standard deviation is below 5% for the past one year while it has been pretty much flat for the past one year period (see Forget About Low Rates with these Three Bond ETFs).

This trend suggests that this fund should probably be used as an ultra-safe place to stash cash while still receiving tax-free payouts. The low yield certainly hurts, but the relatively light expense ratio of 24 basis points per year and the unmatched safety undoubtedly help make a solid case for the fund for those who are looking to stay in the muni bond market in these uncertain times. 

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