State Street Global Advisors (SSgA) launched the SPDR S&P VRDO Municipal Bond ETF (VRD) yesterday (September 24, 2009). The underlying S&P National AMT-Free Municipal VRDO Index tracks investment grade variable rate demand obligations (“VRDOs”) issued by municipalities.
A VRDO is a short-term tax-exempt fixed income security whose yield is reset on a periodic basis (typically weekly or monthly). VRDOs tend to be issued with very long maturities (often 30-40 years). However, since they include a “put” feature that coincides with the periodic yield reset, VRDOs are considered short-term securities.
If you think these sound suspiciously like the auction rate securities (“ARS”) that damaged so many investors in the last year, you are not alone. There are differences, however. Auction rate securities were an attempt to improve on the VRDO concept, but according to Wikipedia, the “collapse of the [ARS] market in February 2008 revealed that these benefits [over VRDOs] were largely illusory. When market participants lost confidence, the auction mechanism failed. As a result, the ARS market has effectively ceased to exist.”
The main difference between ARS and VRDOs is the “put” feature available on VRDOs. If you would like to better understand the differences, I suggest reading an article by Stan Provus for the Council of Development Finance Agencies, or the report by Douglas Skarr for the State of California.
The index used by VRD has 377 holdings with the five largest states being California 19.6%, New York 15.1%, Illinois 7.0%, Massachusetts 5.2%, and Pennsylvania 5.0%. By sector the breakdown is health care 19.6%, general obligation 17.9%, water 7.2%, transportation 5.7%, and education 5.0%. The index average yield comes in at 0.5% and the fund’s gross expense ratio is 0.2%. Additional information can be found in the VRD fact sheet.
VRDO securities trade in an over-the-counter negotiated market, making it all but impossible for the average retail investor to gain access to this market directly. Additional background on investing in municipal securities can be found in a white paper by SSgA titled Muni Bond ETFs: A Match Made in Tax-exempt Heaven.
VRD will compete with PowerShares VRDO Tax-Free Weekly Portfolio (PVI), which was launched 11/15/07. Except for hiccups resulting in a -0.7% decline in late February 2008 and a -0.9% drawdown during the height of the financial crisis a year ago, the gains have been small but rock steady. Adjusted for monthly dividends, PVI gained +3.4% in 2008 and is up 0.9% so far in 2009. PVI has a 0.25% expense ratio.