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Add municipal bonds to the growing empire of assets tracked by exchange-traded funds. These index followers, which trade like stocks, come at an opportune time, as income investors worried about choppy credit markets scramble to safer havens. But is a muni-bond ETF right for you?
Rock-bottom cost is the main attraction. SPDR Lehman Municipal Bond (symbol TFI) charges a 0.20% annual fee; iShares S&P National Municipal Bond (MUB) has a 0.25% expense ratio. Those fees compare favorably with an average expense ratio of 1.02% for all national tax-free bond funds, which invest in local- and state-government debt. Yet the best muni-bond mutual funds are almost as economical. For example, Fidelity Intermediate Municipal Income fund (FLTMX), a member of the Kiplinger 25, charges 0.34% annually.
Expect decent yields. The SPDR and iShares ETFs, which launched in mid September, haven't been out long enough to calculate an exact yield. But the underlying indexes the funds mimic give you a fair guess. The SPDR fund's index recently yielded 4.3%, and the iShares fund's index, which includes a riskier mix of bonds than the SPDR index, posted 4.9%. For investors in the 28% federal tax bracket, that works out to tax-equivalent yields of 6.0% and 6.8%, respectively. By comparison, Fidelity Intermediate Municipal Income yields 3.9% and has a 5.4% tax-equivalent yield for investors in the 28% bracket.
More muni-bond ETFs are on the way. State-specific SPDR and iShares ETFs are set to launch for New York and California, which have high state income taxes. PowerShares and Van Eck have an array of muni-bond ETFs in the works. Besides a broad muni-bond ETF, PowerShares wants to start a fund consisting entirely of muni bonds insured against default. Van Eck's ETFs will chase indexes that slice the market into short-term, intermediate-term, long-term and high-yield segments as well as indexes that target New York and California.
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