Many retail investors are turning toward mutual funds and, increasingly, exchange-traded funds (ETFs) for exposure, which offer more diversification and better liquidity than direct ownership. In addition, actively-managed funds can tailor strategies to reduce risk during specific economic cycles or capitalize on opportunities as they arise.
This article will look at how the rise of muni bond funds could impact the market and the most significant funds in the space.
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Over the past couple of years, ETFs have become a popular alternative, with significantly lower fees. In fact, Citigroup estimates ETF muni holdings will grow from $80 billion in 2021 to $125 billion by 2023. On average, ETFs also charge a full percentage point less than open-ended muni bond mutual funds, according to Morningstar Direct data.
While ETFs help reduce costs, they introduce some liquidity concerns. In particular, muni bonds are considerably less liquid than the ETFs that hold them, creating the potential for a liquidity mismatch and gap between the ETF’s net asset value (NAV) and share price. For instance, an ETF issuer may be forced to sell a bond at a discount or buy one at a premium.
These problems could become more severe during a crisis. For example, in March 2020, many ETF managers decided not to sell the underlying bonds, resulting in share prices that outperformed the estimated value of the underlying bond. In some cases, the gap lasted more than two months, although ETFs quickly recovered under pressure.
The largest mutual funds include:
|Vanguard Intermediate-Term Tax-Exempt Fund||VWITX||$85.5 Billion|
|Vanguard Limited-Term Tax-Exempt Fund||VMLTX||$38.0 Billion|
|American Funds Tax-Exempt Bond Fund||AFTEX||$26.5 Billion|
The biggest ETFs include:
|Franklin Dynamic Municipal Bond ETF||FLMI||$76.7 Million|
|Invesco VRDO Tax-Free ETF||PVI||$49.7 Million|
|SPDR Nuveen Municipal Bond ETF||MBND||$36.0 Million|
Investors should carefully consider each fund’s expense ratio and liquidity before investing. In addition, investors should keep in mind that muni bond ETFs may have significant premiums or discounts to their net asset value. As a result, investors may have an opportunity to acquire ETFs below net asset value.
Don’t forget to check our Muni Bond Screener.
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Data as of April 7, 2022