The Attractiveness of Tax-Exempt Municipal Bonds in a Rising Interest Rate Environment

The VanEck Vectors Intermediate Municipal Index ETF (ITM) has emerged as a compelling option for investors seeking tax-exempt income in a rising interest rate environment. Designed to track the ICE Intermediate AMT-Free Broad National Municipal Index, ITM offers exposure to a diversified portfolio of intermediate-term municipal bonds, balancing yield potential with interest rate risk [1]. With a net expense ratio of 0.18%, ITM is among the most cost-efficient muni ETFs in its category, a critical advantage for long-term income strategies [2].

Strategic Advantages of ITM in a Rising Rate Environment

1. Duration and Interest Rate Sensitivity
   ITM’s portfolio has an effective duration of 7.05 years and an average maturity of 10.48 years, placing it in the intermediate-term range [3]. This duration profile is notably shorter than many long-term muni ETFs, reducing its sensitivity to rate hikes compared to longer-duration alternatives. For example, a 1% increase in interest rates would theoretically reduce ITM’s price by approximately 7.05%, a manageable risk given its focus on intermediate-term bonds [3].

2. Credit Quality and Diversification
   As of August 2025, ITM’s portfolio is rated AA- on average, with 19% of holdings rated AAA and 32% rated AA [5]. This strong credit quality minimizes default risk, a critical factor in preserving capital during periods of economic uncertainty. The fund’s 1,262 holdings are spread across 375 issuers, with significant allocations to states like California, New York, and Massachusetts [2]. This geographic diversification mitigates regional-specific risks, such as those tied to a single state’s fiscal health.

3. Tax Efficiency and Yield Potential
   ITM’s focus on AMT-free municipal bonds ensures that investors in high-tax states can benefit from tax-exempt income without triggering the Alternative Minimum Tax [1]. With a 3.14% average annual total return since 2007 and a 0.91% return over the past year, ITM has consistently outperformed its benchmark index [2]. Its 20-day volatility of 2.79% further underscores its stability, making it a reliable income source in volatile markets [4].

Risks and Considerations

While ITM’s structure offers several advantages, investors must remain mindful of potential risks. Rising interest rates could still pressure bond prices, particularly for its longer-maturity holdings. Additionally, liquidity in the municipal bond market, though generally robust, may tighten during periods of economic stress. However, ITM’s high credit quality and intermediate duration position it to weather these challenges better than many peers [3].

Conclusion

In a rising rate environment, ITM’s combination of tax-exempt income, low expense ratio, and balanced duration makes it a strategic income play. Its strong credit quality and geographic diversification further enhance its appeal for investors prioritizing stability. While no investment is entirely immune to market shifts, ITM’s design aligns well with the dual goals of preserving capital and generating consistent, tax-advantaged returns.

Source:
[1] VanEck Intermediate Muni ETF - About ITM, https://www.vaneck.com/us/en/investments/intermediate-muni-etf-itm/
[2] ITM - VanEck Intermediate Muni ETF - Fact Sheet, https://www.vaneck.com/us/en/itm/fact-sheet/
[3] VanEck Intermediate Muni ETF ITM Portfolio, https://www.morningstar.com/etfs/bats/itm/portfolio
[4] ITM VanEck Intermediate Muni ETF, https://www.sumgrowth.com/etf-profile/invest-in-ITM-etf.html
[5] ITM Portfolio, https://www.schwab.wallst.com/Prospect/Research/etfs/portfolio.asp?symbol=ITM