SUB - MUNI: Outperforming Competitors But Still Unattractive

2023-12-28 10:04:43 ET

Summary

• PIMCO Intermediate Municipal Bond Active Exchange-Traded Fund ETF is an actively managed municipal bond fund with a flexible strategy and high turnover.
• The MUNI ETF has a higher risk in credit rating but a lower risk in maturity compared to iShares National Muni Bond ETF.
• It is more diversified geographically, with a lower allocation to New York and California.
• Despite being among the best performers in its category in the last 5 years, MUNI may not be attractive as a long-term investment due to losses in inflation-adjusted value and income stream.

Strategy

PIMCO Intermediate Municipal Bond Active Exchange-Traded Fund ETF (MUNI) is an actively managed municipal bond fund launched on 11/30/2009. It has 441 holdings, a trailing 12-month distribution yield of 2.80%, an estimated yield to maturity of 3.68% and an expense ratio of 0.35%. Distributions are paid monthly.

As described in the prospectus by PIMCO , the fund's objectives are current income and long-term capital appreciation. It seeks…

to maintain a fairly consistent level of dividend income, subject to market conditions, by investing in a broad array of fixed income sectors and utilizing income efficient implementation strategies. Long-term capital appreciation sought by the Fund generally arises from decreases in interest rates or improving credit fundamentals for a particular sector or security (…) PIMCO will utilize a bottom up approach to seek to identify asset classes and securities that are undervalued.

The fund invests primarily in investment grade bonds, but may also invest in:

• Derivative instruments, such as options, futures, swaps, mortgage- or asset-backed securities.
• High yield securities ("junk bonds"), up to 30% of assets.
• Securities denominated in foreign currencies, up to 15%.
• Instruments tied to emerging countries, up to 15%.
• Preferred and convertible securities, up to 10%.

In the most recent fiscal year, the portfolio turnover rate was 352%, which is very high. In this article, I will take as a benchmark the largest municipal bond ETF: iShares National Muni Bond ETF (MUB).

Portfolio

The next chart lists the states where MUNI has more than 1% of assets. They represent an aggregate weight of 82%, and 87% for MUB. Compared to the benchmark, MUNI underweights New York, California, and is more diversified geographically.

MUNI has 17.87% of assets invested in securities below investment grade (rated below BBB- or not rated), whereas MUB has less than 0.1% in this category.

About 84% of the fund's assets has a maturity of 10 years or less, vs. 39% for MUB.

Performance

Since its inception in November 2009, MUNI has underperformed MUB by 34 bps in annualized return (including distributions). However, it shows a marginally better risk-adjusted performance (Sharpe ratio in the next table) thanks to a lower volatility

For both funds, the capital appreciation has been about 5% in 14 years, as reported by the chart below (price return, excluding distributions). In the same time, the cumulative inflation has been about 42%, based on CPI. This represents a significant loss in inflation-adjusted value for shareholders.

The annual sum of distributions has gone slightly down in the last 10 years, from $1.23 to $1.10 per share (-10.6%). Once again, this represents a significant loss of income stream for shareholders relative to a cumulative inflation about 29%.

It is even worse for MUB, which has suffered a decrease in distributions of 30.3% (from $3.20 to $2.23 per share).

MUNI vs competitors

The next table compares characteristics of MUNI, MUB, and four of the most popular Muni bond ETFs:

• Vanguard Tax-Exempt Bond ETF (VTEB)
• iShares Short-Term National Muni Bond ETF (SUB)
• SPDR Nuveen Bloomberg Municipal Bond ETF (TFI)
• First Trust Managed Municipal ETF (FMB).

MUNI is the smallest fund in this group regarding assets under management, or AUM. It has the second most expensive fee behind another actively managed fund: FMB. In the last 5 years, MUNI has been the best performer by a short margin:

Takeaw ay

PIMCO Intermediate Municipal Bond Active Exchange-Traded Fund ETF is an actively managed fund in municipal bonds with a flexible strategy and a high turnover. Compared to iShares National Muni Bond ETF, it shows a higher risk in credit rating, but a lower risk regarding maturity. The strategy has resulted in a slightly lower historical volatility since inception and a better preservation of distributions in the last 10 years. Despite a high expense ratio, it has been among the best performers in its fund category in the last 5 years. Nevertheless, losses in inflation-adjusted value and income stream don't make MUNI really attractive as a long-term investment. The Muni bond asset class is more useful as a component of a tactical allocation strategy switching between bond categories, but in this case a more liquid ETF like MUB is preferable.

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