What is FMHI? (Pros, Cons, and Strategies)

Investors seeking stable income with tax-exempt benefits often turn their attention to municipal bonds. One popular way to invest in municipal bonds is through ETFs, and the First Trust Municipal High Income ETF (FMHI) is worth considering. With a focus on high-yield municipal bonds, FMHI provides attractive income opportunities. In this blog post, we'll explore what FMHI is along with its advantages, disadvantages, and investment strategies.

What is FMHI?

FMHI stands for First Trust Municipal High Income ETF. It is an exchange-traded fund that invests primarily in U.S. municipal bonds. These bonds are issued by states, municipalities, and other governmental entities to fund public projects like schools, highways, and infrastructure.

FMHI aims to provide high current income that is exempt from regular federal income taxes. Unlike typical municipal bond ETFs, FMHI focuses on high-yield municipal bonds, which offer higher income at the cost of increased risk.

Key Features of FMHI

• Primarily invests in municipal bonds rated below investment grade or unrated.
• Seeks to provide income that is exempt from regular federal income taxes.
• Actively managed to select bonds based on their credit quality, yield, and potential for price appreciation.

FMHI targets high-yield municipal bonds and aims to balance the benefits of tax-exempt income with the risks associated with lower credit quality issuers.

FMHI Composition

FMHI consists of bonds from a variety of issuers such as states, cities, and other local authorities across the United States. It includes bonds from a range of sectors, including healthcare, education, transportation, and utilities. Because FMHI focuses on high-yield, it predominantly includes bonds that are rated below investment grade, also known as "junk" bonds, or unrated bonds.

Pros of FMHI

Tax-Exempt Income

One significant advantage of FMHI is the tax-exempt income it provides. The interest income from municipal bonds is usually exempt from federal income tax and, in some cases, state and local taxes as well. This makes FMHI an attractive investment for individuals in higher tax brackets seeking to minimize their tax liability.

Higher Yields

FMHI offers higher yields compared to traditional municipal bond ETFs due to its focus on high-yield bonds. Investors seeking higher income levels may find FMHI appealing for this reason. While higher yields come with greater risk, they also provide the opportunity for enhanced income.

Professional Management

As an actively managed ETF, FMHI benefits from professional management. The fund managers select bonds based on their credit quality, yield potential, and price appreciation prospects. This active approach allows managers to respond to changes in the market and make adjustments as necessary.

Cons of FMHI

Credit Risk

The focus on high-yield bonds means that FMHI is exposed to higher credit risk. These bonds are more likely to default compared to investment-grade municipal bonds. Investors should be aware that while high yields are attractive, they come with the increased potential for loss.

Interest Rate Risk

Like most bond investments, FMHI is subject to interest rate risk. When interest rates rise, the prices of existing bonds typically fall. Given the potential for rising interest rates, investors in FMHI should be prepared for the possibility of bond price declines.

Market Liquidity

High-yield municipal bonds can sometimes be less liquid than investment-grade bonds. This can make it more challenging to buy or sell bonds at favorable prices during periods of market stress. Investors should consider the liquidity risk when investing in FMHI.

FMHI Investment Strategies

FMHI is suitable for investors looking for higher income levels with the benefits of tax-exempt interest. Given its higher risk profile, FMHI is best suited for investors with a higher risk tolerance and a longer investment horizon.

Diversification Strategy

To mitigate risks, investors should consider diversifying their portfolios by including a mix of high-yield and investment-grade municipal bonds. Blending FMHI with other less risky investments can help balance the risk-reward profile of a portfolio.

Long-term Investment Strategy

FMHI is most appropriate for long-term investors willing to withstand potential price volatility in exchange for higher income. A long-term investment horizon allows investors to benefit from the compound effect of reinvested income while weathering any short-term market fluctuations.

Risk Management

Investors should employ risk management strategies, such as regularly reviewing the credit quality of the holdings and staying informed about market conditions that could impact municipal bonds. Active risk monitoring can help investors maintain a balanced and well-performing portfolio.

Conclusion

FMHI offers an attractive option for investors seeking high-yield, tax-exempt income through municipal bonds. While the higher yields come with increased risk, the benefits of professional management and tax advantages can make FMHI a worthwhile addition to a diversified portfolio. By understanding the pros and cons and adopting effective investment strategies, investors can make informed decisions about incorporating FMHI into their investment plans.