MUB: A Muni ETF Trading At A Rare Discount

ETFS

Main Thesis

The purpose of this article is to evaluate the iShares National Muni Bond ETF (MUB) as an investment option at its current market price. While MUB has come under selling pressure in the short-term, I believe this has opened up a buying opportunity. Muni bonds have a very low historic default rate, so concerns over mass defaults due to Covid-19 seem to be a bit overblown. While lower revenue and less consumer spending are certainly tailwinds, the recent Fed announcement that they will support the muni market should alleviate some concerns. Further, MUB is filled with investment grade munis, which means investors are taking on less credit risk than if they moved to the high yield space. While MUB’s income stream above 2.5% may not look too enticing on the surface, consider that this yield has seen a sharp uptick in the short-term (as the fund’s price has dropped), and that the income is tax-exempt for most U.S. citizens. Finally, the fund’s market price is actually at a discount to NAV, which is a development we don’t see often for passive ETFs.

Background

First, a little about MUB. The fund is managed by BlackRock, and its objective is to “track the investment results of an index composed of investment-grade U.S. municipal bonds”. MUB currently trades at $101.61/share and yields 2.68% annually. This is my first review of MUB, although I regularly cover the muni bond market and have often recommended it. While I typically prefer to invest in muni CEFs that are either trading at discounted prices or offering relative value (in my view), I believe it is an opportune time to discuss an ETF option for those looking to avoid a leveraged product. Given the sell-off over the past few weeks, in stocks and bonds, many investors may be looking for a less volatile product and MUB, which passively tracks an index without using leverage, could fit that bill. While the fund has been hit hard by the recent sell-off, along with the broader muni market, I believe this represents an opportunity to invest in high grade muni bonds at attractive prices, and I will explain why in detail below.

The Selloff Has Been Painful, But Yields Have Spiked

To begin, I want to touch on where the broader muni market stands. While munis have acted as relative hedge compared to equities, this has not stopped the sector from clocking in losses so far in 2020. In fact, performance of most of the muni funds I follow has been quite poor, and I would have expected them to be performing a bit better in this environment.

The real unfortunate point, in my view, has been how quickly losses have been accumulating. For example, consider the year-to-date return of a popular muni bond index, which had been positive through the middle of the March:

Source: Charles Schwab

While the size of the loss may not seem too concerning, the sharpness of the move in such a small amount of time raises eyebrows. In fact, selling has accelerated even in some of the safest asset classes, such as investment grade corporate bonds, as investors have been fearful of taking on any type of risk. While painful for current investors, the rapid sell-off has opened up an opportunity for those willing to stay invested. As bonds were sold off, yields for munis have spiked markedly, as shown below:

Source: Yahoo Finance

I personally view this as an opportunity to get in to a long-term investment in a tax-exempt asset class at a price not seen in months. Of course, I am not suggesting there is not any downside left from here. Yields have plenty of room to move higher and, even though I view investment grade munis as safe, that does not mean the rest of the market will. However, this is a sector that has a track record of delivering reasonable returns even in down markets, and I see the recent pullback as an opportunity to build to positions. Further, the increase in yield is a nice reward for doing so.

MUB Has Quality Holdings And A Discounted Price

I now want to shift my attention to MUB specifically, to explain why I feel this is a good option at the moment. As my readers are aware, I often recommend muni CEFs, which incorporate the use of leverage to compound returns. While this can quite profitable in good times, the downside of leverage has been playing out over the past few weeks. As a result, there has been a compounding of losses for many of these products, which is always an inherent risk to any leveraged fund. While my personal opinion is that buying leveraged CEFs at a discount will continue to be a good long-term strategy, I can absolutely understand why many investors will not want to take that risk right now. I personally am in that boat, as I have been only been adding small amounts to my leveraged funds. For a place to park higher amounts of cash, I wanted a safer play on muni bonds given how volatile the market has become.

With this mindset, I found MUB enticing. Aside from being an ETF that does not use leverage, it is also made up exclusively of investment grade bonds:

Source: iShares

While this is not inherent “good” or “bad”, it does mean the fund is a little bit safer than those with below investment grade debt. While high yield munis do have a history of few defaults, this market appears to be one that is avoiding any type of risk, no matter how minor. Therefore, I see investment grade bonds as the most prudent place to hide out for the time being.

Aside from the fund’s make-up, there is another very important reason why I like MUB right now. As I noted, I prefer to find CEFs at discounts, yet MUB is an ETF, which means it typically will trade at its NAV, or very close to it. This has been the case for MUB for a long time, but the recent sell-off has changed this dynamic. As I noted, investor redemptions are forcing some fund managers to sell off bonds below par in order to raise cash to meet those redemptions. This reality can cause funds like MUB, which typically trade within fractions of their NAV, to actually trade at marked discounts. In fact, as the selling intensified towards the end of the last trading week, MUB actually sits with a discounted market price of 5.45% to its NAV, as shown below:

Source: iShares

My takeaway here is this presents a fairly attractive value for investors right now. They are able to buy in to a passive ETF at a sizable discount, which is not a common occurrence. Looking ahead, I expect this discount to narrow back to being very close to par value, which means MUB has a very good chance of seeing some upside in the near term.

Munis Have Relative Value

Going back to the broader muni market, I want to expand on why I feel this is a relatively good place to park cash right now. While MUB holds investment grade debt, there are other places investors can go for similar credit quality. A notable example would be U.S. treasuries, and those are assets that had been yielding similar amounts to investment grade munis over the past few years. However, as munis have sold off, the relative spread between them and comparable treasuries has spiked, as shown below:

Source: Bloomberg

As you can see, investment grade munis are yielding considerably move than treasuries for the time being. In my view, the size of the spread is now attractive enough to favor munis over treasuries. Such large spikes in such a short period often present buying opportunities, and I believe this indeed one such opportunity.

Fed To The Rescue?

My final point concerns an announcement from the Federal Reserve on Friday (3/20). While I believe in my thesis up to this point regardless of any central bank action, the Fed stunned markets with a statement early in the trading day. Specifically, the Fed announced it was expanding its asset purchase program to include muni bonds. This is an action that was not even undertaken during the 2008-09 financial crisis, and underscores just how tight credit conditions are right now. Simply, the central bank will now be able to make loans available to eligible financial institutions secured by certain “high quality assets” purchased from tax-exempt municipal money market mutual funds. The ultimate goal of this program is that it should ease the credit burden on states and other local municipalities, as demand for muni bonds should see an uptick given their new status as acceptable collateral.

My takeaway here is modestly positive. This is by no means a “cure all”, and will not be enough if investors as a whole continue to flee the sector. However, I see the sell-off in munis as largely overdone, with relative value in prices and yields set to encourage demand. The Fed’s new support for this sector is simply another tailwind that I believe will help funds like MUB see a positive move going forward.

Bottom-line

This market is quite challenging, and I am surely not alone in my frustration. While I had hedged my equity positions in what I thought were the right places, my fixed-income positions are in the red for the year. This has me contemplating what a defensive position truly is, and how to better prepare myself for further volatility. With this in mind, I see a non-leveraged, investment grade muni fund as a smart play right now. MUB fits the bill as it exclusively holds investment grade bonds, which have a very low default history. Further, the fund currently trades at a discount to its NAV, which is a unique opportunity for an ETF. Finally, the Fed’s recent announcement that it will support the muni bond sector should put investor’s minds at ease. Therefore, I have opened up a position in MUB, and I would suggest investors give this investment some consideration at this time.

Disclosure: I am/we are long MUB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Products You May Like

Articles You May Like

Virtual, robot and solo home touring soar as social distancing hits the housing market amid coronavirus fear
Chief regulator says mortgage bailout is ‘on the honor system’, pleads with borrowers to be honest
Macy’s is the first of what could be a retail and energy purge from the S&P 500
Market casts a skeptical eye on Chicago mayor’s fiscal confidence
Bank of America says 85,000 small businesses have asked for $22.2 billion in loans since 9 a.m.

Leave a Reply

Your email address will not be published. Required fields are marked *