Amid fears of the Federal Reserve's imminent rate hiking regime, the first month or so of 2022 was unkind to myriad fixed income assets with municipal bonds ensnared in that weakness.
Weakness in muni land is a vexing proposition for advisors because many clients are nearing or are in retirement and they need low-risk sources of income. Fortunately, there are signs professional investors are matriculating back to municipal bonds and that the darkest clouds for the asset class have passed.
“Bank of America Corp. says the worst of this year’s selloff in the municipal bond market might already be over, though there may be some additional pain in March after the Federal Reserve’s rate decision,” reports Skylar Woodhouse for Bloomberg.
Expanding on the notion of a muni rebound are emerging opportunities in this space that mesh with clients' desire to add more sustainability to their fixed income portfolios. Said another way, owing to the evolution of sustainable and environmental, social and governance (ESG) investing, the fixed income space is increasingly green and that includes municipal bonds.
Sizing Up SMI
Broadly speaking, the greenification of the fixed income fund universe is a slow-moving process, but it's gaining momentum. When it comes to municipal debt, the newly minted VanEck HIP Sustainable Muni ETF (SMI) is a pioneer. That actively managed exchange traded fund debuted last September.
SMI, which is managed by HIP Investor, focuses on investment-grade municipal debt issued to “fund operations or projects that support or advance sustainable development, as well as promote positive social and environmental outcomes,” according to VanEck.
SMI holds just 44 bonds – confirmation that there's stringent criteria for entry into the fund and that the greenification of munis has much more growth ahead.
“HIP Investor Ratings are data-driven, evidence-based, and research-linked. Specifically, HIP Ratings incorporate research that shows which variables are key to improving outcomes. Then, HIP tracks data and metrics related to evidence-based targets and goal,” said HIP Investors founder and CEO Paul Herman in a recent note.
In addition to being a pioneer in the green muni fund space, SMI is a potentially interesting income idea for advisors to discuss with clients because it's actually additive to the ESG equation – perhaps ahead of its time.
“HIP Investor’s methodology, which precedes the term ‘ESG’ by several years, uses five pillars based on Maslow’s hierarchy of needs. These five pillars — Health, Wealth, Earth, Equality, and Trust – can be mapped to ESG as well,” adds Herman.
As noted above, SMI focuses on investment-grade bonds. To that end, the fund allocates almost three-quarters of its weight to municipal debt rated AAA, AA or A. That is to say credit risk is relatively benign with SMI.
On a related note, California and New York combine for 60.6% of the issues in the ETF. It's not political commentary, but the reality is those states are notorious for finding more ways of increasing taxes. That's not great for residents, but it's a positive characteristic for muni investors.
SMI's effective duration is 5.77 years, putting the fund firmly in intermediate-term territory. As advisors know, that's a plus for clients that want fixed income exposure to offset equity market volatility because intermediate-term bonds are the least correlated to stocks.