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Build Something With This Bond ETF

September 7, 2016 1:16 pm
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Among the many corners of the bond market that yield-hungry investors are embracing this year are municipal bonds. The question savvy investors need to be considering right now is whether municipal bonds are inexpensive relative to other fixed income asset classes.

Although there has been some chatter regarding the impact of falling oil prices on municipal bonds, conservative fixed income investors have been embracing municipal bond ETFs, even longer duration funds, as the Federal Reserve has put off raising interest rates.

BABs And Barack

While standard municipal bond ETFs often get the most attention (and assets), investors can win with slightly different fare such as the PowerShares Build America Bond Portfolio (NYSE: BAB). As its name implies, the passively managed BAB holds Build America Bonds issued early during President Barack Obama's first term to fund infrastructure projects.

Related Link: Good Reasons To Love These Bond ETFs

Build America Bonds are no longer being issued, but that does not mean BAB is an ETF to be ignored. Rather, the opposite is true.

“Unlike most municipal bonds, income from ‘BABs’ are taxable to the bondholder. However they also came with tax credits or federal subsidies to the issuer enabling them to offer higher interest rates, which in turn made them competitive with other municipal debt after taxes are taken into consideration,” said AltaVista Research.

To be sure, BAB is benefiting from the Federal Reserve's refusal to raise interest rates to this point this year. The ETF's effective duration of nearly 9.4 years confirms as much as does its 30-day SEC yield of almost 3.1 percent, which is nearly double the yield on 10-year Treasurys.

BAB, which turns seven in November, holds nearly 300 issues and almost all of the ETF's holdings carry investment-grade ratings. In fact, a combined 71 percent of BAB's holdings are rated AAA or AA by Standard & Poor's. However, if investors insist on nitpicking, it must be noted BAB's credit quality is slightly lower than standard municipal bond ETFs.

No Such Thing As A Free Lunch

Of course, there’s no free lunch. One reason BAB offer higher yields is that profligate states such as California and Illinois are some of the biggest issuers, and they drag down the fund’s overall credit quality. So unlike most other muni ETFs with a median credit rating of Aa1 or Aa2, the Build America Bond fund has a median rating of Aa3,” added AltaVista.

Investors are not deterred as BAB has added over $330 million of its $1 billion in assets under management this year, a total exceeded by just 10 other PowerShares ETFs.

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