Municipal bonds have long been a go-to corner of the bond market for advisors looking to serve the income needs of older clients looking to preserve capital while dialing back on risk.
Munis are also appealing to high-net-worth clients and investors, particularly those living in high-tax states, because these bonds offer tax breaks not found with other forms of debt. Yet for all the benefits associated with municipal bonds, big yields on the highest quality munis aren’t easy to come by. For example, the widely followed ICE AMT-Free US National Municipal Index sports a 30-day SEC yield of 3. 45%.
Even if the Federal Reserve lowers interest rates this rate as expected, it will likely still be possible, albeit temporarily, to find yields in excess of 3. 45% on some high-yield savings accounts. There ways to juice munis’ yield proposition, including various high-yield municipal bond exchange traded funds and mutual funds, but there’s a catch.
Actually, there’s two catches. First, as is usually the case in fixed income investing, higher yields require sacrificing credit quality. On that note, it should be pointed out that most high-yield munis aren’t as risky as junk-rated corporate debt. Second, advisors and investors looking for elevated yields on munis typically need to accept longer-dated fare, meaning they’re not only taking on credit risk, but they’re taking on rate risk, too. There’s an avenue for ameliorating those scenarios. Enter the VanEck Short High Yield Muni ETF (SHYD).
Sizing Up SHYD
For the uninitiated, SHYD is the short duration counterpart to the $3. 48 billion VanEck High Yield Muni ETF (HYD), which is one of the most popular ETFs in high-yield muni category. SHYD is no shrinking violet. It turns 12 years old in January and has nearly $357 million in assets under management, but its true appeal is access.
“High-yield municipal bonds with maturities under 10 years remain scarce. Issuers rarely bring such deals to market, as longer amortization schedules better align with project cash flows and provide greater flexibility for refinancing or restructuring,” according to VanEck.
As the asset manager points out, due to the scarcity associated with high-yield short duration munis, the associated secondary market isn’t particularly robust because investors owning those bonds often hold them to maturity. That’s another point about access and it highlights the allure of SHYD, which is home to 478 bonds.
SHYD, which sports a 30-day SEC yield of 3. 70% and an effective duration of 4. 30 years, is appealing here and now and not just because interest rates are poised to decline.
“On a tax-equivalent basis, they offer close to 290 basis points of incremental yield compared with short investment-grade munis, and they do so without meaningfully extending duration,” adds VanEck. “This makes them an efficient way to capture enhanced income while maintaining a conservative stance on interest-rate risk. ”
Ride the Demand Wave with SHYD
Advisors and other professional investors are awakening to the benefits of lower duration municipal bonds, including SHYD holdings.
“This development is important for investors, as increased buying interest could gradually lead to spread compression in the short HY segment,” concludes VanEck. “While this may reduce the current yield premium, it also highlights the advantage of positioning early to capture value before spreads tighten further. ”
Bottom line: Bonds such as those held by SHYD are the precipice of being in style and as noted above, it’s likely better to be early to the party than not arrive at all.
