Bloomberg News

Biggest Muni ETF Drops Most Since 2008 After Hitting Record Asset Premium

February 24, 2012

Protesters outside the courthouse as the county commissioners meet about the Jefferson County bankruptcy in Birmingham, Ala. on Aug. 12, 2011. Photographer: Butch Dill/AP

Protesters outside the courthouse as the county commissioners meet about the Jefferson County bankruptcy in Birmingham, Ala. on Aug. 12, 2011. Photographer: Butch Dill/AP

The biggest exchange-traded fund tracking the U.S. municipal debt market posted the largest two- day loss in more than three years, pulled down after rallying to a record and the highest premium ever to its underlying assets.

The iShares S&P National AMT-Free Bond Fund has fallen 3 percent since Feb. 22 to $110.40, the largest loss since October 2008. It has slumped six out of the eight days since the fund, known as the MUB, traded at a record 3.96 percent premium to the per-share value of the bonds it holds.

The security fell following reports this week by Matt Fabian of Municipal Market Advisors and Timothy Strauts of Morningstar Inc., who noted that MUB’s price had surged in relation to its holdings. Strauts recommended selling it.

“The ETF had outpaced the performance of the underlying index fairly significantly and even with the last two days’ move, you’re still slightly overvalued,” Bart Mosley, the New York-based co-president of Trident Municipal Research, said in a telephone interview. “That is an indication of how far out of balance it had gotten.”

Yesterday’s slump drove the premium to net asset value down to 1.67 percent, the lowest since Jan. 20, according to data compiled by Bloomberg. It has retreated 3.1 percent since climbing to a record high of $113.94 on Feb. 13.

“It’s more a technical move,” Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors, said by e-mail yesterday. The fund “appears extremely overvalued,” Fabian wrote in a Feb. 21 report.

$2.83 Billion Fund

The fund, with a market capitalization of $2.83 billion, had rallied 5.1 percent in 2012 through Feb. 22 amid declining bond sales by states and local governments that made the security one of the only ways to capture gains from the debt.

Standard & Poor’s announced adjustments to the holdings of the S&P National AMT-Free Municipal Bond Index, the gauge the iShares ETF tracks, as part of a monthly rebalancing. The changes will take effect at the end of the day on Feb. 29, according to a statement.

A net $218.5 million was invested in MUB this year, data compiled by XTF Inc. show. About $164.4 million was added in the past month, the eighth-highest inflow for U.S. fixed-income ETFs, data from the New York-based research firm show.

“It was at an unnatural premium,” Strauts, a Chicago- based analyst at Morningstar, said by phone yesterday. “All the other muni ETFs were pretty much flat. Nothing special happened in the market. It seems solely focused on MUB.”

Closer to NAV

Strauts said in his report that investors should buy the SPDR Nuveen Barclays Capital Municipal Bond ETF (TFI), known as TFI, which is trading closer to its net-asset value. TFI was unchanged at $24.17 yesterday and was at a discount of 0.06 percent on Feb. 22. The fund has seen inflows of about $72.3 million this year, of which $43.6 million was in the last month.

States and cities have reduced budgets as tax revenue stays below the peaks reached before December 2007, the start of the longest recession since the 1930s. Issuance dropped to $258.3 billion (YTDMTOT) in 2011, the least in eight years, according to data compiled by Bloomberg.

Illiquidity in the municipal market can raise costs for authorized agents and increase the price of the ETF.

Large orders of ETFs are made through so-called authorized agents of the sponsors, who purchase blocks of the underlying assets and trade them with the fund to create new shares. The mechanism helps an ETF’s share price stay close to its net-asset value as investors arbitrage discrepancies between the fund shares and underlying holdings.

To contact the reporters on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net; Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; William Glasgall at wglasgall@bloomberg.net


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