Traditional Municipal Bond Indices Limit Broader Investment Opportunities

September 17, 2018 |Author: Edward Kerschner, CFA, and Catherine Stienstra | Category: Chart of the Week

 
  • The municipal bond market is difficult to track broadly. Indices exist in large part to measure the value of a given market. While stock market indices are very familiar and offer widely accepted benchmarks, several unique intricacies make the municipal market far more difficult to define and track:
    • The municipal bond market is comprised of $3.9 trillion in market value, which is spread across over 80,000 issuers and roughly one million individual bonds.1 The high degree of fragmentation makes it nearly impossible for index providers to replicate the full market opportunity.
    • Municipal bonds trade over-the-counter rather than on a central exchange. Dealers act as market makers by quoting transaction prices for buyers and sellers. Pricing is often influenced by trading frequency or transaction size, both of which can affect transparency and liquidity.
    • Unlike the corporate or government bond markets, households own over 41% of all municipal bonds outstanding.2 Many investors purchase municipal bonds with the intention of holding them to maturity. As a result, many municipal bonds trade infrequently, which makes daily pricing more difficult to calculate.
  • A flawed approach provides an opportunity for investors. Unfortunately, many of the indices that prevailing municipal bond exchange-traded funds (ETFs) seek to replicate are constructed based on flawed methodologies that may leave investors exposed to less desirable characteristics. However, these flaws present opportunities for investors who approach the municipal market with a more strategic approach, informed by insights, to manage the complexities of the changed market.
 
1 Source: Wall Street Journal, Muni Bonds May Not Be the Reliable Bet They Once Were, January 7, 2018.
2 Source: Bank of America Merrill Lynch, “Primer on Municipal Bonds,” January 2018.

Definitions:
Bloomberg Barclays Municipal Managed Money Index is an unmanaged index that is rules-based, market-value weighted engineered for the tax exempt bond market. All bonds in the National Municipal Bond Index must be rated Aa3/AA- or higher by at least two of the following statistical ratings agencies: Moody’s, S&P and Fitch.
Bloomberg Barclays AMT-Free Intermediate Continuous Municipal Index is intended to track the overall performance of the U.S. dollar denominated intermediate-term tax-exempt bond market.
S&P National AMT-Free Municipal Bond Index is a broad, comprehensive, market value-weighted index designed to measure the performance of the investment-grade tax-exempt US municipal bond market. Bonds issued by US territories, including Puerto Rico, are excluded from this index.
The ICE BofAML National Long-Term Core Plus Municipal Securities Index is composed of US dollar-denominated, investment grade, tax-exempt debt publicly issued by US. states and territories, or their political subdivisions, in the US domestic market with a term of at least 15 years remaining to final maturity.

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