Not Sure I Understand the Fuss About Munis

Recently, munis have received lots of press due to a perceived crisis.  However, from iShares description of iShares S&P National AMT-free Municipal Bond Fund (MUB), it appears that the press and investors just don’t understand one of the most important basics of fixed income—duration.

Fundamentals as of 1/24/2011

Weighted Average Maturity
11.81 yr

Weighted Average Coupon
4.77%

Effective Duration
7.61

Standard Deviation (3 year)
as of 12/31/2010
6.93%

Duration tells you the expected price change from a move in interest rates, so in the case of MUB with effective duration of 7.61, MUB should lose in price 7.61% for every 1% move up in interest rates.  7.61 duration (equivalent to a 7-10 Year Treasury) is what I would consider very interest rate sensitive and much more susceptible than the Barclays Aggregate at 4.98.

If we look on a graph (courtesy of Stockcharts), muni behavior has not been all that strange or unusual compared to the iShares 7-10 US Treasury (IEF).  So far, it just appears to be a bounded random blip that has already corrected itself.

via StockCharts.com

Now, of course if you have a leveraged closed-end fund, the pain is worse, but that is the danger of leverage.

Another way to look at it statistically would be to graph the rolling correlation (thanks R and PerformanceAnalytics).

This also does not look strange or unusual, especially if we compare to the 2008 panic.

The moral of the story is pay attention to duration if you invest in bonds.  The same thing is happening in the Investment Grade Corporate Index at a near-record duration (LQD is 7.01), so be very careful there too.

1.5 hours