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Unexpected Impact Of The Biden Administration? A Muni Bond Boom

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Unexpected Impact Of The Biden Administration? A Muni Bond Boom

All things considered, the municipal bond market had an exceptional 2020. 

In a year in which municipalities were faced with an economic crisis that had some investors concerned about defaults, the VanEck Vectors CEF Municipal Income ETF (NYSE: XMPT) rose 3.44% in 20201, a stunning turnaround given its sharp decline during March (click here, to view the fund’s standardized performance).

Muni bond investors have several tailwinds to thank for that rebound, according to VanEck Senior ETF Product Manager Michael Cohick: a supply-demand imbalance driven by fewer bond issuances, the realization that municipalities are in a better position than the financial crisis of 2008, and the Federal Reserve, whose municipal liquidity facility acted as a lender of last resort.

“Although only used by two issuers, simply the fact that the municipal lending facility was put in place brought tremendous calm and reassurance to the market,” he said. “We also saw that municipalities, state and local governments, were in a much better position in terms of fiscal health and reserve funds than they were in 2008 to allow them to weather the storm. So I think these provided a backstop to the market.”

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Source: St. Louis Fed2

The 2021 Outlook

Going forward, Cohick believes demand for muni bonds will continue to rise as investors search for yield in light of historically low U.S. Treasury rates, a falling dollar, and increased fears of rising inflation. 

There’s also the political environment to consider. A Biden administration and Democrat-controlled Congress are likely to unwind some Trump tax cuts. Anticipation of this is already creating investor demand for muni bonds for their tax-exempt qualities. 

Unlike other fixed income assets, municipal bonds have one key tax advantage: the interest generated from the bonds is exempt from federal income taxes. As a result, some investors may seek out municipal bond exposure to shield themselves from higher tax rates. 

“There's anticipation for higher taxes, which is going to potentially lead to very strong demand for tax-exempt paper from investors across the board,” Cohick said. “Broadly speaking, the yield environment that we find ourselves in is making investors search for attractive pockets of the market to add income to their portfolios.”

Gaining Exposure To Muni Bonds

Many investors looking for municipal bond exposure will do so via a mutual fund or ETF, such as XMPT, which allows them to broadly diversify across states, sectors, quality, and asset class. 

Unlike most typical broad-based muni bond funds however, XMPT is structured as an ETF that holds municipal bond closed-end funds, or “CEFs." 

The closed-end structure of XMPT’s underlying holdings allows those fund managers to effectively use leverage, meaning they borrow at low rates in the short end of the marketplace and buy long-dated municipal bonds with higher yields. 

Also, because CEFs have a set number of shares, they cannot rely on the creation-redemption mechanism of ETFs that generally acts to keep a fund’s share price close to its net asset value (NAV). As a result, closed end funds have a tendency to trade with wide discounts to their net asset value. 

In other words, the closed-end fund nature of XMPT gives it the potential to offer investors attractive income from a high-quality portfolio. 

“Both leverage and systematic approach to buying assets at a discount create a yield advantage,” Cohick said. “The rules governing XMPT’s index provide a systematic way to invest in CEFs exactly how professionals do: buying municipal closed-end funds trading at wider discounts and selling funds trading at higher premiums.” 

The chart below shows the taxable-equivalent yield of XMPT, against the 7-year, 10-year, 20-year, and 30-year U.S. treasury nominal or pre-tax yields. You can see how the yield from XMPT is greater than the benchmarks. This is due to the underlying holdings being closed-end funds. 

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Source: U.S. Department of Treasury, VanEck. As of 12/31/2020

 

1. VanEck data
2. https://www.stlouisfed.org/publications/regional-economist/fourth-quarter-2020/how-covid-affected-municipal-bond-market

Important Disclosures:  

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.

The Fund's performance, because it is a fund of funds, is dependent on the performance of the Underlying Funds. The Fund is subject to the risks of the Underlying Funds' investments, and the Fund's shareholders will indirectly bear the expenses of the Underlying Funds. In addition, at times certain segments of the market represented by the Underlying Funds may be out of favor and underperform other segments. The shares of a closed-end fund may trade at a discount or premium to its net asset value ("NAV"). Additionally, the securities of closed-end investment companies in which the Fund will invest may be leveraged. As a result, the Fund may be indirectly exposed to leverage through an investment in such securities. An investment in securities of closed-end investment companies that use leverage may expose the Fund to higher volatility in the market value of such securities and the possibility that the Fund's long-term returns on such securities (and, indirectly, the long-term returns of the Shares) will be diminished. An investment in the Fund may be subject to risks which include, among others, market, municipal securities, high yield securities, credit, interest rate, call, tax, liquidity, leverage, anti-takeover measures, non-diversified, investment restrictions, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Fund. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that Fund's income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value.

S-Network Municipal Bond Closed-End Fund IndexSMis calculated and maintained by S-Network Global Indexes, Inc. S-Network does not sponsor, endorse, or promote the Fund and bears no liability with respect to the Fund or any security.

Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus , which contains this and other information, call 800.826.2333 or visit  vaneck.com/etfs. Please read the prospectus and summary prospectus carefully before investing

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