FCAL: A Tax-Smart Play in California's Municipal Market Amid Rising Rates

The First Trust California Municipal High Income ETF (FCAL) has emerged as a compelling option for California investors seeking tax-advantaged income, even as interest rates rise. A recent dividend hike and favorable tax treatment underscore its appeal, while its credit quality and strategic portfolio construction offer resilience in volatile markets. Here's why now could be the time to act.

The Dividend Boost Signals Stability

On May 30, 2025, FCAL declared a monthly distribution of $0.1320 per share, marking a 2.3% increase from the previous month's $0.1290 payout. This consistency in dividend growth reflects the fund's robust portfolio of California municipal securities, which generate steady tax-exempt income. While the exact payout date for May 2025 remains unspecified, the fund's monthly distribution schedule provides reliable cash flow—a rarity in today's volatile bond market. Investors should note that the SEC Yield stood at 3.23% as of March 31, 2025, with a taxable equivalent yield of 7.22% for high-income California residents. This compares favorably to taxable bond alternatives, offering a 35% yield premium when accounting for state and federal tax breaks.

Tax Efficiency: FCAL's Core Advantage

California's top marginal tax rate (federal + state) exceeds 50% for high earners, making tax-exempt municipal bonds a critical portfolio tool. FCAL's focus on California-specific municipal securities ensures investors avoid both federal and state income taxes on distributions. For instance, the fund's 3.29% distribution rate (as of April 2025) translates to a taxable equivalent yield of 7.34%, outpacing taxable intermediate-term bond funds like iShares Core U.S. Aggregate Bond ETF (AGG), which yields around 4.5%.

Valuation and Duration: Navigating Rate Risks

FCAL's weighted average effective duration of 7.49 years indicates moderate sensitivity to interest rate hikes. While this poses some risk in a rising rate environment, the fund mitigates exposure by focusing on shorter-maturity bonds (average maturity of 15.46 years) and emphasizing credit quality. Notably, 80% of its holdings are rated AA or higher, with only 17.7% classified as non-rated—a cautious approach that balances yield and safety.

Credit Quality: A Conservative Edge

The fund's portfolio prioritizes investment-grade securities, with 42.57% allocated to AA-rated bonds as of April 2025. This contrasts sharply with riskier high-yield muni funds, which often include more speculative credits. Even its non-rated portion is scrutinized for underlying strength, reducing default risk. Morningstar's 4-star rating (out of 100 California muni funds) reinforces this disciplined strategy, citing FCAL's superior risk-adjusted returns over the past five years.

The Bottom Line: A Prudent Tax Shelter

FCAL's blend of tax efficiency, consistent dividends, and robust credit profile positions it as a must-own holding for California investors. While its duration demands caution in a rising rate environment, its yield advantage and Morningstar endorsement suggest it's well-equipped to navigate 2025's economic uncertainties.

Act now to lock in tax-free income before yields compress further. FCAL's 0.65% expense ratio and tight bid/ask spread (0.25% as of May 2025) ensure minimal friction costs, making it an efficient way to capitalize on California's muni market. For those prioritizing income and tax savings, this ETF is a no-brainer.