Why Actively Managed Municipal ETFs?

by: , Product Management, New York Life Investments

Investing in municipal bonds by way of a packaged product has been around since the 1970s, but with the advent of ETFs a couple of decades later, municipal bonds soon became one of many asset classes available in the ETF wrapper. Since that time, municipal bond ETFs have grown significantly and continue to be an attractive solution for tax-aware investors looking for portfolio diversification and income.

When investors think of ETFs they naturally think of passively managed funds that track a broad index or benchmark. While passive funds can provide cost-efficient access to an asset class and can be a valuable addition to a portfolio, investors should consider the asset class they want exposure to when deciding on the investment vehicle and how it is managed. Another option available to investors are actively managed ETFs, which are managed similarly to most mutual funds, but have the added benefit of greater liquidity and tax efficiency.

When should investors consider actively managed ETFs? Typically, inefficient markets lend themselves well to active management – one such market is U.S. municipal bonds. As MacKay Municipal Managers notes in their paper, Municipal Bonds: The Case for Active Management, the fragmented nature of the municipal bond market, in addition to its high proportion of ownership by individuals contribute to the market’s inefficiency. Regardless of the investment vehicle, professional, active management can help investors navigate these inefficiencies while leveraging deep credit research, which has the potential to lead to meaningful outperformance over a benchmark. This portfolio management expertise, in addition to certain fund operating expenses, can contribute to the overall higher fees of actively managed funds compared to passive funds.

On the other hand, a passively managed fund will aim to track an index representative of a specific asset class. Besides the management fee, there are other embedded costs associated with tracking an index that should be considered, especially in the case of municipal bonds, that in aggregate would be referred to as tracking difference. These fees are all passed down to the investor and include:

  • Management fee: The explicit cost to manage the fund
  • Transaction & rebalancing costs: Fees associated with trading in the portfolio in an effort to replicate the index as closely as possible – these can be relatively high for municipal bonds given the inefficiencies of the market
  • Sampling: Many indexes cannot be fully replicated given the high number of constituents, so a passive manager will create a portfolio representative of the index, which can create a potential drag to performance

Some of the key differences between of actively managed ETFs, passively managed ETFs, and mutual funds are described below:

Feature

 

Actively Managed ETF

 

Passively Managed ETF

 

Mutual Fund

 

Portfolio Objective Seeks to outperform the performance of a benchmark Seeks to track the performance of an index Seeks to outperform the performance of a benchmark
Management Typically managed by a seasoned team with specialized expertise in the asset class Managed to replicate the holdings of a specific index representing the asset class Typically managed by a seasoned team with specialized expertise in the asset class
Liquidity Intraday Intraday Once a day
Trading Trades on an exchange; able to trade intraday and enter specific orders and trading instructions Trades on an exchange; able to trade intraday and enter specific orders and trading instructions Trades executed at the end of day NAV
Transparency Daily transparency of holdings Daily transparency of holdings Holdings typically disclosed on a quarterly basis
Tax Efficiency Creation/redemption process may significantly reduce or eliminate capital gains Creation/redemption process may significantly reduce or eliminate capital gains Redemptions are fulfilled by selling securities, which creates capital gains for shareholders
Minimum Investment None None May be high, depends on share class
Cost Bid/ask spread + management fee + possible brokerage fee Bid/ask spread + management fee + tracking difference + possible brokerage fee Management fee + possible distribution/ service fee + possible sales charge

Actively managed municipal bond ETFs combine the best features of ETFs and mutual funds into one solution: they offer investors access to professional management of an inefficient asset class within a cost effective, liquid investment vehicle.

Tracking difference is the discrepancy between ETF performance and index performance.

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

MacKay Shields is an affiliate of New York Life. New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, located at 51 Madison Avenue, New York, New York 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs, and NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC.

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Maria Rahni, CFA

Product Management, New York Life Investments

Maria Rahni is a Senior Associate in the Product Management group at New York Life Investments, covering multiple asset classes for MainStay and IndexIQ…

Full Bio

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