A muni meme is born


T

Tad Borek

I was doing a write-up about the new Medicare tax on net investment
income, and one thing that struck me is that tax-exempt municipal bonds
are one of the few income sources that won't be hit by it. We've always
called those bonds triple-tax-free, because they aren't subject to
federal, state, or local income taxes for residents of the places that
issue them. Now that has to be updated to quadruple tax free, because
their interest won't get hit by the Medicare tax on net investment
income either.

A Google search for "quadruple tax free" turns up NO HITS vs over 100k
for "triple tax free." Well, OK, I get 10, but none have anything to do
with this. So, you heard it here first!

-Tad
 
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D

dumbstruck

income, and one thing that struck me is that tax-exempt municipal bonds
are one of the few income sources that won't be hit by it. We've always
Good find; I assume they don't have to be issued from your own state to
escape 0care tax? If so, whatdya think of HYD or other high yield muni funds?

HYD has almost double the yield and cap gain of generic national muni MUB
over the last 6 months and thru the life of HYD. 5% yield and 14% cap gain
last 12 months. Has a bit of Puerto Rican junk that is free of any state taxes,
yet doesn't seem volatile thru it's short lifespan. More attractive to me than
my state bond funds, which have absurd load fees... time to double up?
 
T

Tad Borek

Good find; I assume they don't have to be issued from your own state to
escape 0care tax? If so, whatdya think of HYD or other high yield muni funds?
I think ETFs in less-liquid asset classes add risks that aren't present
in the broad-market ones. The whole creation-redemption process is a bit
of a black box as it is and intuitively, must do better when the
underlying investments have readily-ascertainable values, and can be
traded at low cost. There seems potential for a lot of slop when you get
into something like an ETF holding high-yield municipal bonds, many of
which just don't trade all that often (relatively speaking).

I just pulled up a holdings list for one of the HY Muni ETFs and put a
CUSIP for one of the top holdings into EMMA. The recent trading history
is very light so it isn't much to go on, but there was a 350+ basis
point difference between a recent "customer sold" and "customer bought"
price - by recent I mean within three days. On a single trade the spread
looked to be about 35 bps. These are not small numbers.

A question I posed to one of the wholesalers who rang me up when these
came out was: how does your ETF structure and market-making process deal
with the peculiarities of this market - especially when munis get
rattled? Even just coming up with bond values to determine NAV has some
wiggle room in it. He didn't have an answer. I'd want to understand why
that isn't a risk factor before diving into something that is, at the
end of the day, yielding not really all that much - relative to a 350
basis point spread on trades executed just a couple days apart.

-Tad
 
D

David S Meyers CFP

I think ETFs in less-liquid asset classes add risks that aren't present
in the broad-market ones. The whole creation-redemption process is a
bit of a black box as it is and intuitively, must do better when the
underlying investments have readily-ascertainable values, and can be
traded at low cost. There seems potential for a lot of slop when you
get into something like an ETF holding high-yield municipal bonds, many
of which just don't trade all that often (relatively speaking).
Rick Ferri wrote an interesting post about this about a year ago,
entitled "Why we don't buy corporate bond ETFs". Mainly he's talking
about junk bonds (which he gives great examples for), and the example
for the more liquid investment-grade corporates don't show nearly the
problem that the junk bonds had. Presumably the even more thinly
traded HY munis would be even worse.

Here's a link:

I just pulled up a holdings list for one of the HY Muni ETFs and put a
CUSIP for one of the top holdings into EMMA. The recent trading history
is very light so it isn't much to go on, but there was a 350+ basis
point difference between a recent "customer sold" and "customer bought"
price - by recent I mean within three days. On a single trade the
spread looked to be about 35 bps. These are not small numbers.
The actively (or, perhaps semi-actively) managed ETFs may do better,
but they are pretty new, so we won't really know for a while. But this
kind of thing is one of the reasons, for example, why Pimco's junk bond
ETFs may be better than the pure index-driven ones -- they don't need
to worry about tracking error and can, theoretically, avoid some of
those spread issues. Whether that works in practice, we'll just have
to wait and see.
A question I posed to one of the wholesalers who rang me up when these
came out was: how does your ETF structure and market-making process
deal with the peculiarities of this market - especially when munis get
rattled? Even just coming up with bond values to determine NAV has some
wiggle room in it. He didn't have an answer.
One of the reasons that there may be some particularly great values in
CEFs when there are market rattles - when the NAV is that uncertain,
and the underlying securities are highly illiquid, the price mechanism
breaks down and therein may lie some great opportunities. That said, I
don't generally mess around with that - too much uncertainty and
liquidity risk -- if I can get a great deal on something because it's
trading absurdly cheaply, then I may be in trouble on the other side of
that trade when I need to get back out of it.

--
David S. Meyers, CFP®
http://www.MeyersMoney.com
disclaimer: discussions in misc.invest.financial-plan are for
educational purposes only and should not be construed as financial
advice. For personal financial advice, please consult directly with a
professional.
 
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D

dumbstruck

In reply to the concern that high yield muni etfs are poorly structured to follow the herd getting in or out... around now may be your opportunity to get in at a discount due to a bloodbath. I dont understand why they only now saw the possible loss of deductibility, or why these werent cushioned by their high rates even for nondeductible bonds, but...

P.S. below is a book authors amazing talk about financial crises of the 1800's which he shows are directly comparable to now rather than 1920/30 varieties. You may want to start around minute 44 to see the parallels and why he liquidated his ira at the perfect time in 2008.

He demonstrates this kind of interest rate crises cannot be diversified around, due to opacity between good and bad. Sounds like a timing approach is the only way to navigate, maybe like the "dufus" technique I suggested here early 2009. Anyway, when you get hooked, back up to video start to hear how wars of 1812, 1861, and the prewar rise of abe lincoln were all about such interest rate crises rather than stock market crises:
http://www.c-spanvideo.org/program/Deadbea
 
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