Biggest ETF Alluring at Deepest Discount Since ’11: Muni Credit

The largest exchange-traded fund tracking the U.S. municipal market is selling at its biggest discount to its underlying assets in almost two years. If history is any guide, that signals a buying opportunity.

The $3.6 billion iShares S&P National AMT-Free Municipal Bond Fund fell to $107.60 in New York yesterday, the lowest since March 2012, before rising today by the most since April 5. It sold yesterday at about 1.4 percent below its net asset value, the most since August 2011, data compiled by Bloomberg show.

The municipal market still earned 1.5 percent that month, Bank of America Merrill Lynch data show. At the same time, yields on benchmark 10-year munis fell about 0.49 percentage point, the biggest rally since January 2009. This time around, yields are close to a 15-month high and investors are set to receive $128 billion in June, July and August from principal and interest payments, $16 billion more than in 2012, according to Bank of America.

“Munis could benefit from even a little bit of strength on the demand side, whether it’s from reinvestment flows or just the appeal of slightly higher rates,” said Bart Mosley, co-president at Trident Municipal Research in New York.

Debt Weakness

Investors speculating that the Federal Reserve will reduce its debt purchases pushed yields on benchmark 30-year munis to 3.33 percent yesterday, the highest since May 2012, data compiled by Bloomberg show. Economic reports this week are forecast to show employers sped up hiring, bolstering bets the economy is gaining strength.

Some investors see a discount as a signal to buy the muni ETF, which typically has traded at a premium since it was created in 2007. ETFs usually track an index while trading on an exchange like stocks.

With an average maturity of 14 years, the ETF is declining in price as investors spurn longer-dated bonds, which are the most vulnerable to rising interest rates, said George Friedlander, chief muni strategist at Citigroup Inc. in New York. The municipal market has lost money since April, after nine straight quarterly gains.

Yields on 10-year Treasuries will climb about 0.4 percentage point to 2.53 percent in a year, according to the median forecast of 64 analysts in a Bloomberg survey.

Funds Reliance

Investors are “much more cautious about putting cash to work on the long end,” Friedlander said. “That is particularly important for munis because the long end of the muni market is very reliant on fund flows.”

Assets of U.S. municipal mutual funds with securities maturing in 10 or more years have dropped for 13 straight weeks, Lipper US Fund flows data show. That’s the longest period since June 2011, according to Matthew Lemieux, a senior research analyst at Lipper in New York.

“We haven’t yet really seen investors moving out of the fund in response to rate concerns, though it does seem like they have slowed down their purchases,” Matthew Tucker, head of iShares fixed-income strategy at BlackRock Inc. in San Francisco, said of the muni ETF.

Investors have added about $212 million to the fund this year, half the amount for the same period of 2012, Christine Hudacko, a spokeswoman, said in an e-mail.

The declines of the past month have pushed the interest rate on 30-year munis above the one-year average of about 2.96 percent, Bloomberg data show. That sets the stage for a rebound given the wave of cash set to flow back to bondholders.

The amount of cash returning to investors is “massive,” Friedlander said. “You could get something of a snap back here over the next several weeks” or months.

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