HYMB - HYMB: An After Tax Yield Worthy Of A Second Look

2023-04-19 11:10:34 ET

Summary

• The tax advantages of municipal bonds are undisputed.
• HYMB boosts this yield by venturing outside of investment grade.
• This hence offers one of the highest after-tax yields from a bond fund.

Issued by the non-sovereign or local governing authorities, municipal bonds lack the guarantee of the federal government. However, since it is not common place to hear about defaults by city, county or state governments, these debt instruments are considered a relatively safer bet compared to their corporate counterparts. Municipal bonds can be issued to fund the day to day operations of the respective locality and public works projects such as roads, schools, libraries, etc. Those that are issued to fund daily operations are repaid at maturity with the ongoing revenue sources such as taxes. On the other hand, if the funds were raised for a specific infrastructure, the principal repayment is funded by the revenues generated on fruition of the project. Generally, the municipal bonds are exempt from federal taxes. Exemption from state or local taxes is also likely if the debt holder resides within the geographical boundaries of the issuer. Just like corporate bonds, municipal bonds can be rated investment or high yield depending on factors such as financial strength of the issuer, riskiness of the underlying project, etc.

We have written about a couple of funds that focused on this brand of debt. BNY Mellon Municipal Bond Infrastructure Fund, Inc. (DMB) is a closed end fund that invests primarily in municipal bonds that fund infrastructure projects. It aims to have at least half of the portfolio in investment grade bonds. With the exit of ZIRP (Zero Interest Rate Policy), DMB's leverage turned foe and predictably its investors felt the impact in terms of a distribution cut and poor returns. We explained why we were taking a hard pass on this one despite our outlook on fixed income being on the brighter side lately. The distributions have kept the fund afloat since that call.

The second fund we covered is a newer offering from a well-known name. The Vanguard Short-Term Tax-Exempt Bond ETF Shares ( VTES ) opened its doors in March of this year and most of our coverage was based on information from its prospectus. Today, we will talk about another municipal bond fund. This one, like DMB, invests in both investment and high yield securities.

The Fund

Started in 2011, SPDR Nuveen Bloomberg High Yield Municipal Bond ETF ( HYMB ) tracks the Bloomberg Municipal Yield Index and aims to provide income that is exempt from federal income taxes. This almost $2 billion ETF aims to have at least 80% of its net assets engaged in pursuit of tracking the index with rebalancing occurring at the end of the month. The remaining can be allocated in other securities, cash and cash equivalents or money market instruments. Management has the leeway to invest in a sample of the index securities that have the same risk and return features as that of the index or invest in all of the index securities on a proportionate basis.

The most recent data reflects the sampling methodology with the index comprising almost 19,000 securities.

While the average maturity of the portfolio is close to 16 years, the option adjusted duration is closer to seven years suggesting that the ETF holds quite a few securities where the issuer has an option to redeem prior to maturity. The yield to worst is not that much lower than the yield to maturity, with both over 5%. HYMB's distributions have been trending down in recent times with the most recent payment yielding just over 4% on an annualized basis [based on current price of $24.78].

While generally the yield to maturity of a portfolio is a precursor to what the fund will distribute over the next year to its investors, we have to also consider the expenses. The 30-Day SEC Yield represents the net income earned by the fund in the most recent 30-day period. Another metric we look at is the yield to maturity minus the fund expenses. This also comes in in the ballpark of the 30-Day SEC yield. Ultimately these are all estimates and don't account for defaults or the fund switching to other securities at a loss or profit.

Composition

As per recent data, around a third of the portfolio is made up of investment grade securities, which is about the same as the index.

The average portfolio maturity of 15.83 years noted earlier in this piece makes sense with the majority of the holdings having more than 10 years left to repayment.

Puerto Rico leads the charge in terms of issuers with California a close second.

Performance

One of the handicaps a fund has versus an index is the lack of expenses for the latter. However, HYMB's performance shows a bigger lag to the index than what would be suggested by its annual expense ratio of 0.35%.

This is where sampling worked against the investors. Of course the alternative is to own all the bonds in the index, and that might be also close to impossible considering the size of the fund. Many of these issues will only trade in large size and the fund cannot pick up each and every issue. That 0.35% expense ratio may also seem high relative to some of the funds that we cover, but considering how vast this high yield arena is, it seems acceptable to us.

Verdict

The fund's current yield is just over 4%, and the potential increase as reflected by the 30-Day SEC Yield is a few basis points over that. Investors might quibble that they can currently get more than that just on a 1-year Treasury.

That is of course true but on an after-tax basis, HYMB wins hands down, especially for those in the higher tax brackets.

So in this comparison you have to account for other nuances like where this security is held and how much you pay in taxes. But the bigger consideration is your total return. At this stage of the cycle we think the risks of owning junk (municipal or otherwise) is just too great. Alongside that, the fund's duration risk is also higher than what we want. We would keep this on our radar and look to pick this up in a market panic where some serious default risk is priced into junk of all colors. Until then we are neutral on it.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

For further details see: