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Adding Diversification to Your Muni Bond Ladder

Scott Burns

Scott Burns: Adding diversification to your muni bond ladder. Hi there, I'm Scott Burns, director of ETF research. Joining me today is Dodd Kittsley, who's a director in the iShares Internal Analytics Group. Dodd, thanks for joining me.

Dodd Kittsley: Thanks very much for having me.

Burns: iShares recently launched some pretty unique and interesting products in the municipal bond ETF space. These funds are basically ETFs with kind of a maturity date. Let's talk about this a little bit.

Kittsley: Yeah. It's a product that we're very excited about. We heard in the marketplace that there was significant demand from folks who traditionally ladder bonds, and they were looking for a diversified, cost effective, efficient way of complementing their ladders. So our product team put together a series of six products, six muni ETFs with termination dates starting in 2012, going to 2017. They mature each year in August. It really helps folks meet specific liabilities, be able to access specific parts of the municipal curve that they find attractive, or lack of inventory.

So we're starting to see folks use them as complements to ladders or to meet specific liability needs.

Burns: I think that lack of liquidity or even availability right now of municipal bonds is becoming a very key issue. A lot of that being driven by the new issuance of Build America bonds and things like that. Investors, what kind of liquidity can the expect from these targeted dated, I guess target date's not the right word, but these end date municipal bonds?

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Kittsley: A liquidity very similar to other exchange-traded funds. Essentially they're structured identically to our perpetual municipal exchange-traded funds that are out there. There's a natural arbitrage mechanism in place to keep the market price relatively in line with the net asset value. We have seen volumes increase in the products and expect them to continue going forward. But certainly, looking at spreads are important as a consideration, but one that we've seen pretty tight spreads for the products from the get-go.

Burns: One last thing, the mechanics. If an investor were to buy this fund, come the maturity date, what should they do? Do they sell it at the maturity date, or should they hold the fund and wait for the cash to show up in their accounts? What are you counseling owners to do right now.

Kittsley: It was something that we thought a lot about when developing the products. Do we want to have options to roll them to other funds? Does it go into sort of a cash equivalent? And we thought, look, investors want this to perform very similar to a bond. So at maturity which, again, is August of each one of the years, they'll get their cash back. Then it's their decision in terms of where they want to redeploy assets. So from that standpoint it works just like a bond.

Burns: These products sound great. I know that often criticisms, and you have one of the largest municipal bond open ended ETFs, perpetual ETFs, out there. That's always been one of the classic criticisms of that, is it has kind of that wavering, unknown termination. It's really hard to do liability-matching investing, even, with a product like that. And this sounds like they really fit in and help with that strategy a little bit.

Kittsley: Very much so. I think a lot of times people will want to buy fixed income to meet a specific liability, and the risk and the duration continues to scale down as it reaches its maturity date. Which is something we're all familiar with, for those of us who invest in fixed income. So it's an attractive feature, it's different. But we still see a tremendous amount of demand for people who want strategic exposure to municipals as an asset class to go with the perpetual, whether it's our long term MUB or the shorter part of the curve, the one to three year with SUB.

Burns: Got you. Well, Dodd, thanks for joining me. We'll have to check back in later to see both how the funds have performed in terms of their investor experience, and also in terms of investor appetite.

Kittsley: Yep, look forward to it.

Burns: I'm Scott Burns, director of ETF research with Morningstar. For this and other ETF news, please check out Morningstar.com's ETF Center, and Morningstar's ETFInvestor Newsletter.