SPDR Nuveen High Yield ETF: Municipal Bond Index ETF, Growing 3.8% Yield (NYSEARCA:HYMB)

Author’s note: This article was released to CEF/ETF Income Laboratory members on December 5th.

In keeping with my coverage on bond funds, and due to reader interest, thought to write an article on the SPDR Nuveen Bloomberg High Yield Municipal Bond ETF (NYSEARCA:HYMB), a simple high-yield municipal bond index ETF.

HYMB offers investors a growing, tax-exempt 3.8% yield. Although the fund’s yield is a bit low, it is exempt from federal taxes. This is a significant benefit for investors, and one which should be particularly impactful for investors in higher tax brackets. HYMB is a buy, although the fund’s investment thesis and benefits are very dependent on the specific circumstances of each individual investor. Consider your tax liabilities before investing in HYMB, or in other municipal bond funds.

HYMB – Basics

• Investment Manager: State Street
• Underlying Index: Bloomberg Municipal Yield Index
• Dividend Yield: 3.75%
• Expense Ratio: 0.35%
• Total Returns CAGR 10Y: 1.97%

HYMB – Overview

HYMB is a high-yield municipal bond index ETF, tracking the Bloomberg Municipal Yield Index (go to ‘About this Benchmark’ for details). It is a relatively simple index, including all dollar-denominated, tax-exempt, municipal bonds in the market, subject to a basic set of inclusion criteria. Portfolio weights are as follows:

• 70% non-investment grade / unrated securities, so BB+ or lower
• 20% securities rated BBB
• 10% securities rated A

HYMB focuses on non-investment grade securities, but also invests heavily in HYMB, investment-grade securities. It is somewhat rare for a high-yield bond to do so, but there is nothing inherently wrong or negative with doing so. The above are index weights, actual fund portfolio weights are as follows.

As can be seen above, HYMB’s credit ratings weights are similar to those of its index, although the fund’s investment-grade holdings are currently a bit larger than expected. This is at least partly due to widening credit spreads, which have caused prices for most high-yield bonds to decline.

HYMB is an incredibly well-diversified fund, with investments in over 19,000 securities, and with exposure to most relevant industries and states. For reference, the average bond index ETF invests in a couple thousand bonds, actively-managed ones sometimes in a couple of hundred. State exposures seem reasonable, with the fund generally investing more heavily in the more populous states with larger economies. The exception is Puerto Rico, with the highest territorial allocation in the fund.

HYMB seems like a simple high-yield municipal bond index ETF, with the characteristics and holdings one would expect from such a fund. With this in mind, let’s have a look at the fund’s positives and negatives, starting with the positives.

HYMB – Positives

Tax-Advantaged Dividend Yield

HYMB’s most significant benefit is its tax-advantaged dividend yield. Bond interest rate payments are (generally) taxable income, so investors must pay federal income tax on said payments. Said taxes are a burden for all investors, and particularly significant for those in higher tax brackets. There are, however, ways to reduce, minimize, and even completely sidestep these taxes. Investing in municipal bonds, including municipal bond ETFs, is one such way, as the income from these securities and funds is exempt from federal taxes. Said tax exemption is a significant benefit for all investors, and particularly impactful for those in higher tax brackets, for obvious reasons.

On a more negative note, HYMB only yields 3.8% right now. It is not a particularly strong yield, with most bond sub-asset classes yielding more. Still, the fund’s tax advantages might more than make up for its low yield. The easiest way to know is through calculating a taxable equivalent yield to HYMB’s 3.8% dividend yield, for the different tax brackets. Said metric seems pretty self-explanatory, and can be used as a break-even point. If a fund’s dividend yield is higher than its taxable equivalent yield, then it yields more than HYMB after accounting for the latter’s tax advantages. For the fund, taxable equivalent yields are as follows.

Consider your federal tax rate and attendant taxable equivalent yield before choosing to invest in HYMB: the fund might make sense for tax-payers in the higher tax brackets, less so for those in the lower ones.

As a final point, even though HYMB’s dividend yield is quite low on an absolute basis, it is higher than average for a municipal bond fund. Would not describe this is a positive per se, the yield remains quite low, but it is definitely an advantage vis-à-vis its closest peers.

Strong Expected and Realized Dividend Growth

HYMB’s dividend yield is quite low, but it is growing very fast, due to interest rate hikes. Growth has been strong in the past, with the fund’s dividends growing 9.2% YTD.

Growth will likely remain strong moving forward, as further interest rate hikes are exceedingly likely, and as the impact from previous hikes continues to be felt across the economy and financial markets. HYMB’s dividends should grow until the fund yields around 4.7%, equivalent to its SEC yield, a standardized measure of a fund’s short-term generation of income.

Low Credit Risk

Even though HYMB focuses on high-yield bonds with weak credit ratings, default rates and credit risk is incredibly low, as municipal bankruptcies / defaults are extremely rare. As per Moody’s, annual default rates for municipal bonds rated BB, average for the fund, have averaged 0.07% for the past decade. HYMB’s underlying holdings should experience marginally higher default rates, due to the fund’s riskier holdings (securities rated B or lower), but risks remain extremely low regardless.

Low credit risks decreases risk, volatility, and potential losses during downturns, all important benefits for HYMD and its shareholders.

HYMB – Negatives

Low Yield

As previously mentioned, HYMB sports a relatively low yield of 3.8%. It is not a particularly attractive yield right now, with most bond sub-asset classes yielding more. These include T-bills, investment-grade corporate bonds, high-yield corporate bonds, and bonds as a general asset class. HYMB’s yield should see some growth in the coming months, but fund yields would almost certainly remain low regardless.

HYMB’s low dividend yield is a significant negative for the fund and its shareholders. As previously mentioned, the fund’s tax advantages might more than outweigh its low yield, but much will depend on the specific circumstances of each individual investors. For those in lower tax brackets, or for those investing in tax-advantaged investment vehicles, HYMB’s low yield might prove to be a deal-breaker.

Volatile Holdings

HYMB’s underlying holdings have extremely low default rates. This should lead to stable capital levels and share prices, as well as significantly reduce losses during downturns and recessions. This has not been the case in the past, with the fund suffering from above-average volatility / losses. As an example, the fund suffered losses of 6.7% during 1Q2020, the onset of the coronavirus pandemic. Although these were not significant losses, they were definitely higher than expected, and important for investors to consider.

Notwithstanding the above, HYMB’s underlying holdings remain relatively safe securities with low default rates. Short-term volatility is quite high, but as long as defaults remain low, then investors will (mostly) be made whole long-term.

Above-Average Interest Rate Risk

HYMB’s holdings have relatively low credit risk, but relatively high interest rate risk, with an average maturity of 16.9 years, and an average duration of 7.8 years.

HYMB’s duration is relatively high on an absolute basis, and slightly higher than that of most of its peers. Expect moderate, above-average losses when interest rates increase, as has been the case YTD.

HYMB’s above-average interest rate risk is a negative for the fund and its shareholders, although not a significant one.

In my opinion, although HYMB is not an incredibly risky fund, it is also not a particularly safe, stable one either. Funds focusing on T-Bills or short-term investment-grade bonds are less risky than HYMB, and might be more appropriate choices for the most conservative investors.

Conclusion

HYMB’s tax-advantaged, growing 3.8% yield and low credit risk makes the fund a buy.