Tuesday, June 25, 2013

Munis dumped below market levels via ETFs

Muni ETFs have taken tremendous hits in the last few days. SPDR New York and California municipal bond ETFs in particular have underperformed the overall muni market.

Source: Ycharts

Surprisingly these NY and CA ETFs now trade with a 4-5% discount to NAV (ETFs' value is lower than the value of the underlying portfolio). That discount explains a portion of the underperformance (the index ETF discount is about 1%). But these are not closed-end funds and over time the ETF discount should disappear. Given this is not driven by credit concerns (for now), one could make money going long these state ETFs and shorting the overall index or treasuries to "lock in" the discount.

It's just amazing to see investors dumping munis indiscriminately, even if they end up selling below market levels (via ETFs at discount to NAV). Many of the higher rated (particularly longer dated) munis yield more than the equivalent treasuries on a pre-tax basis. The fear of fixed income product is outweighing the attractiveness of post-tax yields.

From an economic perspective, this is bad news for municipal finance. Several muni bond issuances have already been delayed, given the nasty volatility. Just when some had hoped that employment at the state level may have stabilized, the increased cost of funding will now create additional headwinds.

Source: U.S. Bureau of Labor Statistics 

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