A Favorite ETF for Munis

11/25/2013 9:00 am EST

Focus: STRATEGIES

Jim Powell

Principal Analyst, Global Changes & Opportunities

I've often warned investors to steer clear of municipal bonds; but a select handful are starting to look attractive—especially if, as I expect, interest rates remain low for an extended period, says Jim Powell, editor of Global Changes & Opportunities Report.

Unlike munis, that are often issued by cities and states with shaky credit, the muni bonds that I think you should consider are fully insured by one of several large financial guarantee agencies.

Even if the governments that issued them are forced to default, bondholders will be paid.

Having insurance against a default doesn't mean that municipal bond prices can't decline in the marketplace. They can, and sometimes do, particularly if interest rates start to rise. If rates remain relatively stable, as I expect, I think the downside for munis is low.

In addition to the obvious advantage of being insured, the safer muni bonds offer tax-advantaged returns that leave other fixed income yields far behind. Real returns can be 8% (and more when tax considerations are factored in). Rising tax rates next year can only sweeten the appeal of muni bonds.

For most investors, it is smarter to buy a diversified insured muni bond ETF rather than individual bonds. There are no minimum purchases with a fund—you can buy one share or a million.

You can also trade an ETF as easily as a stock. Dividends are reinvested immediately instead of quarterly or biannually. Best of all, muni bond funds provide a steady, tax-free income stream.

I think the best of the insured muni bond ETFs is the PowerShares Insured National Municipal Bond Portfolio (PZA). The fund tracks the performance of AAA-rated, insured, tax-exempt, long-term debt publicly issued by US states or their political subdivisions.

This should be a good time to invest in the PowerShares fund. Two months ago, when interest rates were rising—in the expectation that Mr. Bernanke would taper QE3—many bond funds dropped sharply in price, including PZA.

The decline boosted the yield on the fund to an attractive 4.22%, and that's before the tax advantages are added. I think PZA will perform well for investors who need above average income.

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