Muni ETFs: Product Evolution and Innovation
JIM COLBY: Hello everyone and thank you for watching. I'm Jim Colby, senior strategist and portfolio manager for Van Eck Global's Municipal Bond ETFs. Six years ago this month, there were no municipal ETFs. Now with over $12 billion in assets for this class, it is one of the fastest-growing segments of the municipal industry and is the topic of today's session. After two strong performance years from munis and fixed income overall, municipal ETFs hope to gain and generate positive returns this year despite a swift recovery for the equity market, and against the backdrop of a steadily improving economy. Though in absolute terms investors are driving fewer dollars into municipal ETFs this calendar year, the vehicle continues to display the attractive characteristics that my guest and friend, Tom Doe of Municipal Market Advisors, is here to discuss in the context of the release of his white paper entitled "Municipal Exchange Traded: Funds, Product, Evolution and Innovation 2007-2012."
TOM DOE: Thanks Jim, always a pleasure to be with you.
COLBY: You came up with a with a white paper topic discussing this particular product. I'd love to get your views. You can share with us and our viewers about the process and your discoveries.
DOE: Well, when you all approached our firm Municipal Market Advisors to examine the growth of the ETF sector and municipals, it was an opportune time because we had the five year anniversary, as you noted, but in addition, that five-year period was marked by several periods of sharp volatility that truly tested Municipal investor's resolve, and also different products were in the sector. The opportunity to look back at the ETF products growth, who holds it, who is involved in the decision-making process with individual investors, the volatility and the comparison to mutual funds was a great opportunity-- so it was a pleasure to do so.
COLBY: Well in that context, perhaps you can share with me and share with our viewers what some of those fundamental findings were.
DOE: The first thing that I thought was really notable, was since 2010, you all remember, Meredith Whitney, the analyst who we love to use as our foil in the marketplace, who incorrectly predicted there would be a hundred billion in municipal GO defaults. Of course that didn't happen, but that scared municipal investors out of mutual funds. It created a lot of price volatility. But what we saw from 2010, since that event, to present, is we saw a shift in investors' behavior as it pertained to municipals. First of all, as we saw individual holdings decline by 10% since 2010, and we saw mutual funds increase their assets by roughly 20%. But the ETF sector -- relatively new and approaching its five-year anniversary -- growing 62% over that same time period. The other thing that was very fascinating about this is that, again, coinciding with Meredith Whitney, is that we lost bond insurance -- well, actually, that was two years before. So, most of the municipal market was no longer AAA-rated. As we know, individual investors love AAA ratings on a security. But with that gone, is that there was more volatility around credits, and that uncertainty drove individual investors to seek out professional advice. And so that's where we saw individual investors shifting to products such as the ETFs. But what we noticed when we looked at ETF holders is that most of the holding, or most of the direction that was given in the ETF was done through a financial advisor. And 97% of all ETF transactions were through the financial advisor. That was very important to us as we looked at some the different attributes associated with the ETF.
COLBY: One of the points that you're making and I think is really important in terms of our philosophy and how we look at ETFs, suggests that ETFs are given to a little bit of a different construct than their mutual fund counterparts, and at least to the extent that ETFs have gained $12 billion in assets under management -- still a small number compared to assets in the mutual fund side of the industry -- yet, six years ago, there were no assets in this particular category. Are there unique characteristics about what's being offered with ETFs that you found interesting?
DOE: Well, let's take an interesting step back to when mutual funds began. And when we looked at the absolute dollars that went into mutual funds in their first five years, it was only $5 billion worth of assets. ETFs over that same time period: $12 billion came in. Now, remember that we've had -- well, certainly, as you well know, interest rate have declined -- very favorable environment for the ETF introduction, albeit we had that volatility that we just mentioned, and in the late 1970s and early 80s, it was a very rough time for fixed-income. So that might be some of the disparity. But nonetheless, the interest of individual investors to seek out and work -- one, they want more transparency in their product, and that's what the ETF provides: being able to look intra-day at-- on a daily basis, not just intra-day but on a daily basis-- of what's in the index, or what's in the holding of their product. And again, with mutual funds, it can be-- it's a quarter by quarter, you know, discovery process. But the other thing, too, is that individuals along with that transparency-- they want liquidity. Now liquidity is an interesting word, it can be very philosophical, but what I like calling it is "On Demand Execution." It is that individual investors want to be able to move in an efficient manner, that was, of course, is provided through an exchange traded fund-- and be able to buy and sell as they see changes in their investment strategies-- again, done with the help of a financial advisor in most instances. So that on-demand execution is a tremendous attribute, but there is one downside to that-- which we all know, which is that that price volatility can be a real challenge to an investor. Volatility can challenge an investor to really understand why they're in an investment so that they don't get moved out an investment at an incorrect time simply because of a headline or volatility that they're unfamiliar with. So again, it comes back to that this great attribute of liquidity, or on demand execution, really needs to be done in concert, I think, with that financial advisor. And that was such a great discovery-- when we looked at how individuals pursue the ETF product.
COLBY: The traditional view, I think, is that investors have taken of municipal bonds over so many years and decades, is that this used to be traditionally a buy-and-hold product. Credit quality was not called into question in part because so much of the industry was insured until 4 or 5 years ago, and the default experience is so dramatically lower, so much more dramatically lower than other asset classes, that individuals had great comfort in holding bonds to maturity. The concept of liquidity, you know, the ability to buy and sell this product on an exchange-- see the price every single moment of the day—and this is a realm, this is an element of investing for muni investors that they haven’t had before. And does that also flow into the findings that you’ve had?
DOE: I think it's important to look at how the ETF products evolved, right. And how-- we really focused on four different investment platforms, or ETF providers, and two of them were provided by mutual funds-- Nuveen, Blackrock-- and then we have power sharers that introduced an array of products-- and then, of course, yourselves at Market Vectors. And what was noticeable was that the mutual funds simply try to mimic their strategies-- the mutual fund complexes or platforms-- their ETF's mirrored their mutual fund products. So they had a California or a New York state fund, and they had a long fund. You know, wonderful. But, and Powershares made an interesting decision that most of theirs, all theirs were insured. And of course we were just talking about now with insurance gone, that was probably not the best marketing strategy. But then we come to what you all did, which I, again, think is why we've had such a great dialogue, is you've rolled out these different products over the last five years. Because with that on demand execution and flexibility of a product array, both in terms of placement, or positioning, on the yield curve as well as making credit decisions-- either choosing to do the high-yield route or doing the pre-refunded safe route, you gave investors a way of participating in the interest rate sector while also just managing that risk. And I think that's really important, as we've seen the headlines here this year, you know, everyone's saying, you know, that there's a lot of risk with interest rates-- but that doesn't mean you leave that allocation. You don't go all in with equities, you maintain some portion with fixed income. So that balanced approach, the market vectors array of products became very appealing. I think the other thing that, you know, that really is probably one of the most important facets, and I think why the whole ETF product is also attained such interest from investors, of course has been the low fee structure. And I think again, with you and Market Vectors having the leading high-yield product and the, you know, .35 basis points, in terms of cost, is so far below not only the other high-yield products-- it may have more than 1% in terms of fees, just in management fees, let alone the other entries and fees that when you buy in or leave the fund, but also it is well below the municipal bond fund fee average of 0.97 basis points-- or nearly 1%. So that low-cost transparency and then on demand execution provide these wonderful attributes again from the product.
COLBY: And you detail all that in your in your white paper, and I think for viewers who might be interested in in seeing what the conclusions are in your product-- they'll see these different data points and these different comparisons, because I know you looked at the broad scope of the industry and other products being offered.
Thank you Tom for those insights. Once again, I'm Jim Colby from Van Eck Global. Thanks for watching and be sure to take a look at the white paper produced by Municipal Market Advisors, on the municipal bond ETF industry. Thank You.
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The views and opinions expressed are those of Municipal Market Advisors’s Founder, Tom Doe and are current as of the posting date.
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