FMHI's Dividend Boost: A Tax-Advantaged Gamble in the Rate War

The First Trust Municipal High Income ETF (FMHI) has just declared its May 2025 dividend of $0.1650 per share, marking a 1.2% increase from its July 2024 payout of $0.1630. This uptick raises a critical question: In an era of rising rates and fiscal uncertainty, can FMHI sustain its high-yield promise while shielding investors from taxable pain? Let's dissect the fund's portfolio strengths and vulnerabilities to answer it.

The Tax-Free Edge: Why FMHI Still Attracts Income Hunters

FMHI's core appeal lies in its tax-exempt status, which transforms its 3.42% SEC Yield (as of June 2024) into a 5.78% taxable equivalent yield for top-bracket investors. This math alone makes FMHI a compelling alternative to taxable bonds, especially as the 10-year Treasury yield nears 4.75% (as of May 2025).

But the real magic happens when comparing FMHI's yield to its risk profile. While its 7.08-year weighted average duration (vs. the 5.5-year average for high-yield muni funds) suggests sensitivity to rate hikes, the fund's $0.1650 dividend signals confidence in its ability to weather volatility. Here's why:

Portfolio Stress Test: Credit Quality & Rate Risks

FMHI's portfolio is a high-wire act. Over 38.89% of bonds are unrated, and nearly 35% carry BBB or BB ratings—a red flag in a stressed economy. Yet, this risk is offset by:
- Sector diversification: Top allocations to Florida (16.43%) and Texas (7.89%) shield it from regional defaults.
- Short Treasury hedges: The fund's -0.47% allocation to Treasury futures may buffer against rising yields.

The $0.165 dividend reflects FMHI's strategy of prioritizing income over principal stability—a gamble that works if defaults remain low and demand for tax-exempts stays strong.

Why Rising Rates Might Boost Demand for FMHI

While rising rates typically depress bond prices, municipals have a unique advantage: tax-free demand. Here's the twist:

1. Corporate bond crowding: As corporations face higher borrowing costs, investors flee taxable corporate debt for safer, tax-shielded alternatives like muni bonds.
2. Municipal supply shortages: States like Florida and Texas are issuing fewer bonds due to fiscal conservatism, tightening supply and propping up prices.

This dynamic could keep FMHI's yield attractive even as rates climb.

The Dividend's Hidden Message: FMHI is Bidding for Income Supremacy

The $0.165 dividend isn't just a payout—it's a confidence signal. Active managers at First Trust are likely rotating into higher-yielding issues (e.g., special assessment bonds at 17.4% of the portfolio) to offset duration risks. The fund's 1-year dividend growth rate of 4.3% since 2023 also suggests a pattern of incremental yield expansion.

But beware: A return of capital (ROC) warning lurks. If earnings shrink, part of the dividend could be a return of your own principal—a red flag for long-term investors.

Final Verdict: FMHI's Dividend is a Buy Signal—With Caveats

FMHI's May 2025 dividend increase is a clear win for income-focused investors, especially those in high tax brackets. Its tax shield and diversified muni exposure make it a rare bird in a rising-rate world.

Buy if:
- You prioritize tax-free income over capital preservation.
- You're comfortable with a 7-year duration and lower-rated bonds.
- You're under age 65 and in the 35%+ tax bracket.

Avoid if:
- You fear a recession-driven spike in defaults.
- You need capital growth or stability.
- You're in a low tax bracket (the taxable equivalent advantage fades).

Action Plan: Secure Your Tax Shield Before Rates Surge Further

The May dividend is a clear call to act. Pair FMHI with short-term Treasuries or inverse rate ETFs (e.g., TLTZ) to hedge against duration risk. With its 0.70% expense ratio and Morningstar 4-star rating, FMHI offers a competitive edge in this environment.

The next 12 months will test FMHI's resolve, but for income hunters who can stomach volatility, this is a buy at current prices.

Invest wisely—but invest decisively.