MUB at Record-Long Discount Shows No Signs of Rally: Muni Credit

The largest exchange-traded fund tracking the $3.7 trillion municipal-bond market is selling for less than the value of its holdings for a record stretch as demand for local debt sinks to the lowest level in more than two years.

The $3.2 billion iShares S&P National AMT-Free Municipal Bond Fund, known as MUB, traded at a discount to its net asset value for 61 straight days through Aug. 21, data compiled by Bloomberg show. It’s the longest run since the 60-day period following bank analyst Meredith Whitney’s incorrect projection in December 2010 of “hundreds of billions of dollars” of local-government defaults within a year.

MUB, created in September 2007, traded at 98.8 percent of its net asset value in New York on Aug. 21, according to Bloomberg data. The current discount may persist for the next few weeks, reflecting concern that interest rates will rise further if the Federal Reserve cuts its bond purchases, said Bart Mosley, co-president of Trident Municipal Research in New York.

Yields on benchmark munis have soared to their highest levels in more than two years as investors wait for the next Federal Open Market Committee meeting beginning Sept. 17. Fear of more increases is “front and center as a worry,” Mosley said.

“Until we get some clarity on that, people are going to be nervous about recommitting assets to fixed income,” he said.

Fund Withdrawals

Investors have pulled $13.8 billion from U.S. muni mutual funds in the eight weeks through Aug. 14, the most since February 2011, Lipper US Fund Flows data show. The withdrawals have been reflected in the shares of MUB. The fund traded at $101.88 at 9:35 a.m. in New York today, near the lowest since April 2011, according to Bloomberg data.

It has lost $41 million of cash this year through Aug. 19, fueled by $252 million of outflows in the past two-and-a-half months, Melissa Garville, a spokeswoman for BlackRock, said in an e-mail. That exceeds the $240 million of withdrawals from MUB in the three months through January 2011.

While ETFs are similar to mutual funds that track an index of equities, bonds or commodities, they are bought and sold on stock exchanges and their prices may rise or fall more than the value of the assets they hold.

Two-Year High

Yields on benchmark 10-year municipals climbed to 3.09 percent Aug. 21, the highest since April 2011, Bloomberg data show. For investors in the highest tax bracket, 39.6 percent, the 3.09 percent benchmark yield for 10-year munis is equivalent to a taxable return of 5.12 percent, Bloomberg data show. The yield on 10-year U.S. Treasuries was 2.89 percent Aug. 21, the highest since July 2011.

“Although munis are getting interesting, there might be a better entry point down the road when there’s more clarity in the rate cycle,” said Matthew Tucker, head of iShares fixed-income strategy at BlackRock Inc. in San Francisco.

“If we keep getting higher rates, investors could enter at a more attractive yield level,” he said in a telephone interview.

State and city debt is less expensive than comparable federal securities. Since June 1, yields on top-rated munis maturing in 10 years have been higher than those for similarly-maturing Treasuries every day except for five. The ratio stood at 107 percent Aug. 21, higher than the five-year average of about 101 percent, Bloomberg data show.

While interest rates may increase in the next few weeks and the MUB may continue trading at a discount, the fund does offer investors a way to access the tax-exempt market, Mosley said.

‘More Attractive’

“Municipals as a whole are much more attractive than they’ve been in a while and the MUB is an attractive way to gain exposure to that,” Mosley said. “It’s one of the cheaper parts of a cheap asset class right now.”

Investors in search of tax-free debt to purchase in the near term should buy bonds directly through a broker rather than an exchange-traded fund or a mutual fund structured with a net-asset value, Matt Fabian, managing director at MMA, wrote in an Aug. 19 report.

It’s difficult, if not impossible to predict the full impact of the Fed reducing bond purchases, as well as “where levels will ultimately wind up and whether or not there will be a snap-back rally to follow,” Fabian said in the report. “Accounts unwilling to wait should be investing in individual bonds and not NAV-based instruments.”

$4.5 Billion

Dormitory Authority of the State of New York and Dallas’s water and sewer system are among issuers borrowing about $4.5 billion of long-term debt this week, Bloomberg data show.

At 4.67 percent, benchmark 30-year munis are near the highest since April 2011, Bloomberg data show. That compares with 3.92 percent for Treasuries with similar maturity.

The ratio of the two yields, a measure of relative value, is about 119 percent, higher than the five-year average of 112 percent.

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