Insights

SPDR® Nuveen Municipal Bond ESG ETF [MBNE] – Q3 2022 Commentary

For the quarter, MBNE returned -2.72%, outperforming its benchmark by 1 basis point (bps). Sector allocation was the largest positive contributor to performance, rating allocation and selection both slightly detracted from performance.



Performance

For the quarter, MBNE returned -2.72%, outperforming its benchmark by 1 basis point (bps). The yield curve flattened between 1- and 10-years during the third quarter as interest rates rose by 1.46% on bonds due in 1 year, and by 0.58% on bonds due in 10 years. The curve steepened between 10- and 30-years as yields rose by 0.72% on bonds due in 26 to 30 years, according to the Refinitiv MMD scale of yields of general obligation bonds rated triple-A. On maturities of 5- and 20-years, rates increased by 0.90%, and 0.69%, respectively.1 Despite duration shorter than the benchmark, positioning of the fund led this to detract from performance. Sector allocation was the largest positive contributor to performance, rating allocation and selection both slightly detracted from performance.

When MBNE launched earlier this year, interest rates had already moved considerably higher year to date, and as broader municipal market outflows accelerated. This allowed the fund to purchase quality bonds at attractive yields, aiding performance.  

Fund Performance

MBNE Performance Table Q3 2022

Quarter in Review

The third quarter began with another false start rally, but hawkish US Federal Reserve rhetoric and a disappointing inflation report stifled any comeback. Overall performance was much less negative, however, indicating this historic bond selloff may be slowing. Credit fundamentals are strong and municipal bond valuations are attractive, especially for Municipal-to-Treasury ratios beyond 10 years in maturity. The tax-exempt income compensation for investors willing to invest now and wait for a market shift is at the highest level in more than a decade.

Municipal-to-Treasury yield ratios fluctuated, but remained much higher than the beginning of the year and historical averages. The 10-year ratio started the year at 67%, rose to its high of 105% on May 20 and then fell to 86% to close the third quarter. The 30-year ratio, which is typically cheaper, rose from 78% to a high of 110%, then ended the quarter at 103%, compared to its long-term average of 93%.2

Supply declined by -14.6% from the same period last year to $309.1 billion, primarily because refundings dropped by 51%. The market selloff appears to have stalled the ability of many issuers to refund existing issues, at least temporarily.3

Portfolio Positioning and Outlook

The fund’s duration positioning relative to the benchmark hurt performance during the quarter, as an underweight to bonds with durations less than two years caused the majority of underperformance. The continued back up in rates has provided attractive relative value to the intermediate and longer end of the curve, although continued volatility in the fixed income market due to inflation prints and Fed uncertainty continue to present challenges to the market. We like the intermediate and longer parts of the yield curve, however, we are cognizant of the likelihood of continued volatility in the near term.

An overweight in bonds rated BBB and single-A hurt performance, as did an underweight to bonds rated AA.4 An underweight to bonds rated AAA and some cash helped offset most of this underperformance. The fund benefitted from an overweight to transportation bonds, as well as an underweight to hospital and industrial development bonds. An overweight to education bonds with durations greater than 12 years helped performance meaningfully. Overall, we saw some changes within the portfolio, however, the largest change was putting cash to work. An example of a purchase we made is bonds issued by O’Hare Airport, as the airport has made an effort at reducing negative environmental outcomes. This is partly evidenced by its participation in the FAA’s Voluntary Airport Low Emissions (VALE) program and its certification by the Leadership in Energy and Environmental Design (LEED) program. We continue to look for bonds that provide strong investment opportunities, coupled with ESG aligned purpose.


More on Fixed Income