Van Eck Global plans to start an exchange-traded fund consisting largely of Puerto Rico municipal securities, a move that may broaden demand for the commonwealth's debt as it re-enters the market for the first time since a new administration took office.
The asset manager filed paperwork with the Securities and Exchange Commission earlier this month to launch the Market Vectors Puerto Rico Municipal Index ETF, consisting of munis issued by Puerto Rico and several other U.S. territories. The fund would try to replicate the price and yield performance of the Barclays Custom Puerto Rico Municipal Composite Index. Van Eck portfolio managers James Colby and Michael Mazier will steer the fund, which would be listed on the NYSE Arca exchange. Van Eck declined to comment during the SEC registration period.
The ETF may help investors with the appropriate risk tolerance gain exposure to Puerto Rico and the territories quickly, while providing a market benchmark for the debt just as Puerto Rico's government returns to the primary market after a series of rating downgrades that drove up its cost of borrowing.
"If you have an ETF heavily weighted to one issuer or region of issuers, it can help the marketplace gauge what the sentiment is for that specific issuer or region of issuers," said John Dillon, chief municipal bond strategist at Morgan Stanley Wealth Management.
Starting in mid-2012 yields on Puerto Rico's bonds started trading higher than similarly rated BBB rated credits in the secondary market. In a sign of investor concern about the territory's creditworthiness, by early April Puerto Rican 10-year general obligation bonds were trading roughly 160 basis points above Municipal Market Data's BBB GO scale. All three rating agencies rated and still rate the GO bonds at BBB-minus or the equivalent.
With the ratings agencies lowering many of Puerto Rico's ratings in the winter and spring and with investors concerned about its financial health, Puerto Rico stayed out of the long-term bond market from at least November 2012 to August.
After coming to power in January, Gov. Alejandro García Padilla passed a major pension overhaul, oversaw the adoption of a budget with a smaller deficit, contributed to an increase of water and sewer rates at the Puerto Rico Aqueduct and Sewer Authority, and provided additional revenues to a financially weak Puerto Rico Highways and Transportation Authority.
With these achievements behind it, the administration gave the go ahead for the Puerto Rico Electric Power Authority to sell $673 million in bonds on Aug. 7. In a sign of investor confidence, there were over $1 billion in orders for the bonds, according to Municipal Market Advisors. Yields were lowered as much as three basis points from preliminary pricing. However, PREPA had to pay 7.12% for its 30 year maturity.
Investment advisors were mixed in their opinions on the need and potential demand for the ETF.
At higher rates, stronger credits than Puerto Rico look more attractive to retail investors, which represent roughly 70% of muni bondholders, said Mark Tenenhaus, director of municipal research at RSW Investments, a separately managed account that invests in individual bonds.
"In a rising interest-rate environment, it doesn't really pay to chase yield when you can get reasonable yields at better credit points," Tenenhaus said. "For the retail investor in municipal bonds, who is seeking capital preservation and safety, this is not the vehicle for them. But if they're totally yield-oriented, then this could be the vehicle for them."
Still, by setting up the fund, Van Eck must think Puerto Rico is a good investment, said Richard Larkin, chief credit analyst at Howard J. Sims.
The fund should help Puerto Rico sell bonds because it will be another avenue to invest in the commonwealth, Larkin said. "It may broaden the market for Puerto Rican debt."
The prospectus defines the Barclays index as a "market size weighted total return index comprised of publicly traded" munis including investment-grade and high-yield tax-exempt bonds from issuers based in Puerto Rico, Guam, the U.S. Virgin Islands, American Samoa and the Northern Mariana Islands. By the end of June, 965 bonds filled out the index.
Revenue bonds comprise most of its constituents, along with some general obligation bonds. The revenue portion draws from sectors such as electric, health care, transportation, education, water & sewer, resource recovery, leasing and special tax.
There are other funds that hold large amounts of credits from Puerto Rico, but not as much as Van Eck's planned ETF would. Through June, Franklin Double Tax-Free Income A stands as the fund with the greatest weighting of Puerto Rico-based bonds, at 63.4%, according to numbers compiled by Morningstar, Inc.