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Get Active In The Middle With Municipal Bonds

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Municipal bonds, debt issued by cities, municipalities and states to fund day-to-day spending as well as major capital projects, such as airports, roads, highways and stadiums, are beloved by scores of income investors.

Investors’ affinity for municipal bonds stems from the often docile nature of this asset class, low-risk income streams and tax advantages. The current climate for riskier assets, such as equities and high-yield debt, is proving conducive for municipal bonds. As an actively managed fund, the JPMorgan Municipal ETF (JMUB) can help investors access some of the more compelling opportunities in the municipal market.

Traditional passive municipal bond strategies can subject investors to unwanted duration risk. Additionally, index-based municipal bonds often hold massive numbers of bonds. That is good from a diversification perspective, but it also means the strategy is not focusing on the best opportunities. The S&P National AMT-Free Municipal Bond Index is home to over 3,700 municipal bonds, none of which command weights of even 0.50 percent.

Conversely, the the JPMorgan Municipal ETF (JMUB) looks for intermediate-term exposure while identifying munis with the potential to perform well over a variety of market cycles.

Flight To Safety

While stocks rallied in the two trading sessions immediately following the Christmas holiday, one of December’s prominent themes has been investors’ renewed affection for less risky assets, a theme some market observers see benefiting municipal bonds.

On Thursday, Dec. 27th, “benchmark muni yields fell no more than one basis point in the six- to 30-year maturities. The remaining five maturities were higher by less than two basis points,” reports The Bond Buyer. “High-grade munis were also stronger, with yields calculated on MBIS’ AAA scale falling by as much as one basis point in the six- to 30-year maturities. The leftover five maturities saw yields rise by no more than four basis points.”

The JPMorgan Municipal ETF (JMUB) holds almost 310 bonds, 11.80 percent of which carry AAA ratings. Another 76.70 percent of JMUB’s holdings are rated AA and A.

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JMUB’s duration of 6.41 years is inline with that of the S&P National AMT-Free Municipal Bond Index, but JMUB’s managers have the flexibility to manage duration risk, an advantage not possessed by passive municipal bonds strategies. That is an important consideration in a rising rate environment.

“Rising interest rates also contributed to the muni market’s negative returns in the past several weeks,” said Morningstar in a note published in late November. “As investors sought insulation from those rising rates, short-term and floating-rate muni bonds became more popular, and the demand for long munis lagged. Recent tax reform also played a part here, because it disincentivized banks and insurance companies from using longer munis for tax shelter.”

Other Benefits

The JPMorgan Municipal ETF (JMUB) can help fixed income investors properly diversify their portfolios. While the size of the U.S. municipal bond market is staggering ($3.853 trillion at the end of the second quarter, according to the Federal Reserve), traditional bond benchmarks lack exposure to munis. Just look at the widely followed Bloomberg Barclays US Aggregate Bond Index, which features no muni exposure.

Looking ahead to 2019, strong fundamentals and a still robust U.S. economy underpin the thesis for the JPMorgan Municipal ETF (JMUB).

“And while munis have generally underperformed in 2018, the fundamental credit quality of many issuers has improved,” said Morningstar. “A strong U.S. economy has boosted the tax revenues of many state and local governments year to date, and that should ease some budget pressure moving forward.”

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