I’m generally not a fan of high-yield corporate bond ETFs for retirees, and it has very little to do with credit risk. My bigger concern is taxes. Unless you hold them inside a tax-advantaged account such as a Roth IRA, the interest they generate is typically taxed as ordinary income at the federal level and, in many cases, at the state and local levels as well.
That’s one reason many retirees gravitate toward Treasury securities instead. Interest from Treasuries is exempt from state and local income taxes, making them especially attractive for investors living in high-tax states such as New York or California. The trade-off, however, is lower yields because Treasury bonds carry very little credit risk.
One overlooked corner of the bond market sits between those two extremes: high-yield municipal bonds. These funds generally retain the federal income tax exemption and are often exempt from the alternative minimum tax (AMT) as well. By investing in lower-rated general obligation and revenue bonds issued by municipal entities, they can generate substantially higher income.
Importantly, on a tax-equivalent basis, those yields can rival many taxable high-yield bond funds. Today we’re looking at two liquid and affordable ways to access that market: one actively managed ETF from iShares and one passive index fund from VanEck.
iShares High Yield Muni Active ETF (HIMU)
The iShares High Yield Muni Active ETF (HIMU) is an actively managed portfolio holding approximately 900 municipal bonds. Rather than concentrating heavily in California or New York, the largest allocation is Florida at 16.2%, followed by Texas at 9.14%.
Lower-rated municipal issuers often borrow at higher interest rates because they may have smaller tax bases, greater dependence on individual revenue sources, or higher exposure to economic and natural disaster risks that can affect their ability to service debt.
From an interest rate perspective, HIMU carries meaningful duration risk. Roughly 30% of the portfolio matures in the 7- to 10-year range, with another meaningful allocation extending beyond 20 years, producing an effective duration of 9.39 years. Rising interest rates can therefore pressure the fund’s price, while falling rates could provide a meaningful tailwind.
Approximately 56.4% of the portfolio consists of non-rated municipal bonds. In the municipal market, many smaller issuers simply choose not to obtain ratings because doing so can be expensive. While non-rated doesn’t automatically imply poor credit quality, investors generally should treat these holdings as carrying greater uncertainty than investment-grade municipal bonds.
After deducting its 0.39% expense ratio, HIMU currently offers a 5.12% 30-day SEC yield. That headline yield becomes much more compelling when viewed on a tax-equivalent basis. Tax-equivalent yield estimates how much a fully taxable bond investment would need to earn to match the after-tax income from a municipal bond.
Using the highest federal marginal tax bracket, iShares estimates HIMU’s tax-equivalent 30-day SEC yield at 8.64%. In other words, a taxable high-yield bond fund would need to yield roughly that amount just to match HIMU’s after-tax income before considering any additional state or local taxes.
VanEck High Yield Muni ETF (HYD)
Investors who prefer an index-based approach may find the VanEck High Yield Muni ETF (HYD) more appealing. HYD tracks the ICE Broad High Yield Crossover Municipal Index while charging a slightly lower 0.32% expense ratio.
The portfolio also maintains somewhat higher overall credit quality. Approximately 25% of holdings are rated BBB, with another 5% rated A, while non-rated securities are capped at roughly 30%. That construction helps improve liquidity while maintaining exposure to higher-yielding municipal issuers. Interest rate sensitivity is also lower than HIMU. HYD’s effective duration of 6.8 years means its price should fluctuate somewhat less as interest rates move.
The trade-off is income. HYD currently offers a 4.16% 30-day SEC yield, lower than HIMU because of its somewhat stronger credit profile and lower interest rate risk. VanEck helpfully publishes tax-equivalent SEC yields across various federal tax brackets:
- 12% bracket: 4.73%
- 22% bracket: 5.33%
- 24% bracket: 5.47%
- 32% bracket: 6.12%
- 35% bracket: 6.40%
- 37% bracket: 6.60%
For retirees in higher tax brackets, these tax-equivalent yields illustrate why high-yield municipal bond ETFs like HYD can remain competitive with many taxable corporate bond funds by avoiding federal income taxes on their distributions.
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