ebook essays pieces of the puzzle
Tuesday, February 8th, 2011
stress test

With the debate over municipal bonds continuing apace, it’s time to look again at MUB, otherwise known as the iShares S&P National AMT-Free Bond Fund.

Top: In more than thirteen months there has only been a ten-percent range in the total return series.  Muni investors aren’t terribly used to volatility.

Middle: One of the selling points of ETFs is that you expect there to be little in the way of premiums or discounts to net asset value in comparison to that original group of funds traded on exchanges — the closed-ends.  But there are times when that’s not true.

Bottom: Not only did the NAV discount show up during a period of price weakness, but it was when shares were being redeemed.

Taken together, you can see that when money was flowing in, a slight premium was normally being paid.  On the way out, the discount showed up in earnest.  This is a hidden cost that can show up during times of stress for ETFs, even with relatively sizable ones like MUB.

As for the muni debate, it’s interesting that most asset managers and advisors are now vociferously defending the sector.  In a recent interview, the erudite Jim Grant takes the other side, but for a reason you might not expect.  Most of the muni talk is up front in the interview, but it is all worthwhile viewing, including Grant’s reminder how “memory conditions expectations” and how investors remain anchored to what they have seen and often don’t attempt to consider what they might see.

Postscript:  For those who wonder what has happened to closed-end muni funds since a recent chart of NIO — the other shoe hasn’t dropped.  In fact, the discount is completely gone and the fund is trading at its net asset value.  All in all, prices are down a bit, but the signs of panic appear to have left the municipal sphere for now.  (Chart:  Bloomberg terminal.)