First Trust Municipal High Income ETF’s experienced managers and researchers execute a straightforward process, and the strategy’s higher-than-peers non-investment-grade stakes differentiate it from rivals.

Municipal veterans Johnathan Wilhelm and Tom Byron comanage the exchange-traded fund and bring more than three decades of average industry experience. First Trust named Wilhelm a comanager in November 2017, while Byron only joined about two years ago from BMO Global Asset Management to take over for the retiring Tom Futrell. The supporting cast is small but experienced. Six credit analysts, who average more than 25 years’ average industry experience, and a dedicated trader support the managers. When a veteran analyst left in 2022, the team worked quickly to backfill the role with an equally experienced researcher. They aren’t standing pat, though, and First Trust is looking to grow the analyst team. More research resources will help here, especially given the higher credit risk in the ETF compared with its typical peers and index.

The strategy employs an industry-standard methodology, blending top-down views with bottom-up fundamental analysis. Beginning with a proprietary total return scenario analysis tool to gauge bond performance amid rising interest rates, collaboration is central to the approach. Regular engagement between comanagers Wilhelm and Byron, analysts, and traders via weekly meetings fosters effective security selection and credit surveillance. This process emphasizes higher-yielding securities, which contributes to the strategy’s elevated risk profile versus peers. The ETF must hold at least 50% below-investment-grade debt (including nonrated), which is normally between 53% and 65% of assets; as of December 2023, the ETF held 57.1% (37.1% nonrated) of assets in BB rated and below paper. Healthcare issuers make up the ETF’s largest sector weighting at 20% of assets, primarily consisting of hospitals; however, the managers recently reduced exposure to continuing care retirement communities because of credit concerns about maintaining capacity at these facilities after the pandemic.

These non-investment-grade tilts have helped the ETF’s top-decile performance versus its high-yield muni Morningstar Category peers since its inception. The ETF’s 2.8% annualized return through March 2024 was about 40 basis points better than its peer median, surpassing two thirds of rivals. However, investors should expect a bumpier than usual ride versus peers during credit-driven selloffs and outperformance in normal periods.

Analyst Rating

Experienced managers lead this active high-yield tax-exempt ETF.

The portfolio’s higher risk profile differentiates it from its index and peers, driven by solid fundamental credit research; however, the approach does not stand out from rivals and earns an Average Process rating. 

This sensible process incorporates industry analysis, credit surveillance, and performance attribution analysis. First Trust’s proprietary total return analysis tool that reviews each bond’s characteristics and how it may perform in various scenarios makes up the process’ backbone. 

The team first screens the universe of bonds that often identifies higher-yielding issuers with income cushions that can provide insulation during rate-driven selloffs. Analysts then conduct due diligence on obligors that meet their criteria and assign internal credit and momentum ratings, indicating potential upgrades and downgrades. The team then gathers to debate an issuer’s merits. Finally, comanagers Johnathan Wilhelm and Tom Byron select bonds that offer appealing risk/reward characteristics. It is rare for the managers to purchase a bond if they don’t agree. 

The portfolio must hold at least 50% of assets in below-investment-grade bonds, including nonrated debt, and currently maintains approximately 57% of assets exposure to high-yield munis. In contrast, the blended benchmark, 50/50 Bloomberg High Yield 10-Year Muni (8-12 Years) Index/Bloomberg Revenue 10-Year Muni (8-12 Years) Index features 43% below-investment-grade debt. The team is selective when adding positions, emphasizing areas of analytical strength such as healthcare, education, and special assessment districts. The managers aren’t active duration managers, but the ETF’s duration, a measure of interest-rate sensitivity, is typically up to three years longer than its benchmark. The ETF’s 7.7-year duration as of December 2023 was 2.6 years longer than its blended benchmark.

Average

Process

Experienced municipal managers and a seasoned analyst team make up a solid foundation, but a larger analyst team is appropriate given ETF’s higher than normal non-investment-grade stakes; it earns an Average People rating.

Municipal-bond veterans Johnathan Wilhelm and Tom Byron lead this effort. Wilhelm, named comanager in November 2017, brings more than three decades of industry experience while the relative newcomer to the firm in March 2022, Byron, has more than four decades. 

Alongside the comanagers is a small, but experienced supporting cast. This includes a team of six credit analysts, who provide fundamental research on each of the ETF’s issuers and bring more than 25 years of average industry experience, and a dedicated municipal-bond trader. When former analyst Allison Keller departed in 2023, the team hired a more experienced analyst in Andrea McKeague, a 30-year muni credit veteran; she will primarily focus on general-obligation bonds, higher-quality utilities, and airports. The team is committed to expanding resources, yet remains relatively small compared with industry peers, especially given the significant credit risk inherent in its portfolios. 

Fund ownership, which demonstrates alignment with investors, could be better here; Wilhem has between $100,001 and $500,000, while Byron has between $10,001 and $50,000.

People

First Trust meets the industry standard for stewardship, but it could do more to align itself with investors. It earns an Average Parent rating.

This is a team-oriented organization that eschews star managers. While exchange-traded funds represent the bulk of the firm's assets, First Trust bypasses the competitive market for low-cost beta funds, instead opting for complex strategies with higher management fees. However, the firm's focus on ETFs for future product development underpins its commitment to tax efficiency and transparency. Some of its thematic strategies appear trendy, but it stands behind them and rarely liquidates funds. 

The firm is a private partnership, controlled by Jim Bowen, the CEO. Many senior managers are limited partners. This ownership structure helps the firm stay focused on the long term and promotes retention, which has been strong for the investment team. The firm has grown considerably over the past decade and is among the largest providers of actively managed ETFs, as well as unit investment trusts. As it has grown, the firm has expanded its investment team and beefed up its technology infrastructure.

First Trust's focus is on educating advisors and providing them solutions. This may benefit investors indirectly, but First Trust could do more to directly align with investors by cutting fees and limiting trendy strategies.

Parent

First Trust Municipal High Income ETF

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WHEATON, Ill.--(BUSINESS WIRE)--First Trust Advisors L.P. ("FTA") announces the declaration of the monthly distributions for certain exchange-traded funds advised by FTA. The following dates apply to today's distribution declarations: Expected Ex-Dividend Date: April 23, 2024 Record Date: April 24, 2024 Payable Date: April 30, 2024 Ticker   Exchange   Fund Name   Frequency   Ordinary Income Per Share Amount   ACTIVELY MANAGED EXCHANGE-TRADED FUNDS   First Trust Exchange-Traded Fund III FCAL   N.

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