More than four months after the Build America Bonds program ended, many financial advisers are still touting the merits of these high-yielding bonds -- at least for now.
It's an odd trend: These bonds are essentially subsidized municipal bonds, which have been under pressure since late last year. But Build America Bonds have flourished, with yields higher than almost every other domestic bond. The average Build America Bond currently yields 6.5%, about 1.6 percentage points more than comparable Treasurys and 0.3 percentage points more than long-dated corporate bonds, according to Citi Investment Research and Analysis. Year-to-date, the bonds have returned 7.5%, says Mikhail Foux, credit and municipal strategist for Citigroup triple the return of the Barclays Capital US Aggregate Bond Index.
So should you buy now? Many advisers and analysts say the outlook for these bonds remains strong for at least the rest of the year. "We continue to have a pretty favorable view on them," says Foux. "The valuations are still there and they provide nice diversification." And if demand for these bonds remains strong, the fact that there is a limited universe of bonds to choose from may push prices up, says Ed McRedmond, senior vice president of institutional and portfolio strategies for Invesco PowerShares, which offers the $683 million PowerShares Build America Bond exchange traded fund (BAB)
The catch: Many of these bonds have higher yields because of their longer maturities, which makes them especially sensitive to interest rate changes. If rates rise sharply, prices on these bonds will fall and investors could see losses, says Timothy Strauts, an ETF analyst for Morningstar. In fact under the Build America Bonds program, which was created as part of President Obama's stimulus plan to reduce borrowing costs for states and cities, many municipalities issued bonds with maturities as long as 50 years in order to maximize the government subsidy, which covers 35% of interest payments, said Strauts. "You're buying these bonds because the yields are attractive, but there is a lot of interest rate risk to get those yields," he adds.
In addition, some municipalities are still struggling with budget issues that could impact their abilities to keep up with payments. "The muni market is not out of the woods yet," says Foux. "You can expect some volatility."
For regular investors still interested in buying Build America Bonds, advisers recommend buying an exchange-traded fund or mutual fund that specializes in these investments. The PowerShares Build America Bond ETF is the largest of three ETFs that invest primarily in Build America Bonds, according to Morningstar. The fund has returned 5.4% year to date, compared to a 1.7% gain by the Barclays Capital US Aggregate Bond Index. It charges .29%, or $29 for every $10,000 invested. Todd Rosenbluth, mutual fund analyst for Standard & Poors, likes the $44 million Eaton Vance Build America Bonds fund,