State Street Nuveen Municipal Bond ETF (MBND)

The State Street Nuveen Municipal Bond ETF (MBND) holds bonds issued by US state and local governments — states, cities, counties, school districts, and public authorities. These bonds typically pay interest that is exempt from federal income tax, and often from state tax too if the bondholder lives in the issuing state. MBND gives investors exposure to the municipal bond market in a single, diversified, liquid fund.

What exactly is a municipal bond?

A municipal bond is a debt instrument issued by a state, city, school district, or other local government. When a city needs to build a bridge or school, it can issue bonds to raise money upfront, then repay the borrowed money over time through tax revenue. Investors who buy the bond receive periodic interest payments (coupons) and the return of principal at maturity. The crucial feature is that the interest is exempt from federal income tax — and often from state and local tax too. This tax exemption is a federal subsidy designed to make borrowing cheaper for states and cities. It is also why a municipal bond can offer a lower yield than a corporate bond of the same quality; the tax exemption is valuable to taxable investors.

Why would I hold municipal bonds?

The tax exemption makes municipal bonds especially attractive to investors in high tax brackets. An investor who pays 40 percent combined federal and state income tax experiences very different returns from a muni bond and a corporate bond that both offer the same nominal yield. If a corporate bond yields 5 percent, the investor nets 3 percent after taxes. If a municipal bond yields 3.5 percent but is tax-exempt, the investor keeps all 3.5 percent. The after-tax return of the muni is superior. For investors in lower tax brackets, the advantage is smaller or nonexistent.

MBND is most valuable for investors in high tax brackets, retirees living in low-income states, and anyone wanting to diversify a portfolio into bonds while keeping the income stream efficient. It also appeals to investors with a particular interest in supporting state and local government finance — by buying munis, you are directly funding infrastructure and services in your community or state.

What types of bonds does MBND hold?

Municipal bonds fall into two broad categories. General obligation bonds are backed by the full taxing power of the issuer — the state or city pledges its ability to collect taxes to repay. Revenue bonds are backed only by the cash flow from a specific project, such as toll bridge, a water system, or an airport. Revenue bonds carry more risk because if the project underperforms, the revenue stream may be insufficient to pay interest. MBND holds both types, diversified across issuers and projects.

The fund’s holdings span dozens of states and hundreds of local governments. The portfolio includes bonds maturing in the near term, medium term, and long term — a ladder that ensures the fund is always receiving principal repayment while also maintaining interest-rate exposure. This diversification across geography, time, and project type is the main reason to hold MBND rather than buying a handful of individual bonds; a single bad outcome — a poorly managed project, a local economic shock — affects the fund’s value far less than it would your personal holdings.

Is there credit risk in munis?

Yes. Municipal bonds issued by stable, well-managed governments backed by strong tax bases are very safe. Bonds issued by struggling cities or by projects that have turned out worse than expected carry real credit risk. A few local governments have defaulted on their bonds — Detroit’s bankruptcy in 2013 wiped out investors in certain Detroit bonds, for instance. Most municipal bonds are paid in full, but the assumption that “all munis are safe” is false. MBND’s index is diversified enough that the failure of even a few issuers has a small impact on the fund, but defaults do happen and do matter.

The municipal bond market has also experienced periods of stress. In 2008, during the financial crisis, even highly-rated municipal bonds fell sharply in value as investors fled risk. The credit quality of individual bonds is rated by agencies like Moody’s or Standard & Poor’s, and MBND’s index includes bonds across the investment-grade spectrum. Investors should understand that a muni bond ETF, while diversified, is not riskless.

What about interest rates and duration?

Like all bonds, municipal bonds move inversely with interest rates. If rates rise, existing bonds (paying fixed coupons) become less attractive, and their market price falls. If rates fall, bonds appreciate. The longer the maturity, the more sensitive the bond is to rate changes. MBND likely includes bonds across the maturity spectrum, so its interest-rate sensitivity (or duration) is moderate. In a falling-rate environment, MBND will appreciate; in a rising-rate environment, it will depreciate. This is a structural risk that no diversification can eliminate.

How do I evaluate MBND?

Start with the fund’s prospectus and fact sheet. Review the index it tracks — the number of holdings, the average credit quality (the percentage that are AAA-rated, AA-rated, etc.), the weighted-average maturity and duration, and the geographic distribution. Compare MBND’s current yield and expense ratio to other municipal bond ETFs and to a ladder of individual bonds you might buy directly. Be aware of your own tax situation; the higher your tax bracket, the more valuable the tax exemption is to you. Monitor your state and local economic conditions if you are considering holding municipal bonds specifically from your home state (which offer triple tax exemption in some cases). As with all bond funds, watch the broader interest-rate environment and remember that rising rates will depress the fund’s net asset value, at least temporarily.