ETFs are becoming an essential investment vehicle for accessing the Munis market

OAs a major source of direct investment demand for municipal debt securities, retail investors are changing their ways and increasingly turning to the easy-to-use exchange-traded fund vehicle to tap into the $4 trillion market.

According to data from the Federal Reserve, the value of bonds held directly by households fell by $18 billion during the fourth quarter of 2021 to the lowest level since 2008, reports Bloomberg.

This does not mean that retail investors are giving up bond exposure. Instead, more buyers are buying mutual funds and ETFs, which have roughly doubled their holdings of munis over the past decade – the rise in muni bond holdings reflects the increase in cash inflows channeled into these funds.

“When individual investors were driving the market, every investor is different, and you had this incredible diversity for buyers and sellers,” Patrick Luby, city strategist at CreditSights, told Bloomberg. “Munis will maintain its appeal to individual investors, but I think how they access munis will continue to change.”

Luby argued that as interest rates have fallen over the past three decades, the risk-reward trade-off of individual debt securities has changed. The risk of losing their principal was no longer cushioned by high yields. In addition, it is also becoming more difficult for financial advisors to take advantage of investor education on individual transactions.

“Mutual funds are increasingly important, over the last decade their holdings have almost doubled,” Mikhail Foux, head of municipal strategy at Barclays Plc, told Bloomberg. “Right now, they are the most important institutional player in the municipal space.”

Looking ahead, Foux predicted the shift in retail municipal holdings would continue and believed there was a similar trajectory in the corporate market.

“There has been a lot of M&A activity in the mutual fund industry and acquisitions of separately managed account stores,” Sweta Singh, portfolio manager at City Different Holdings LP, told Bloomberg. “Our market is increasingly concentrated with bigger players because there is pressure on margins.”

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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