Published April 29, 2014

Municipal bonds have bounced back in a big way to start 2014 after experiencing tremendous volatility and outflows last year.

Rising interest rates and fiscal defaults in large cities such as Detroit weighed on the returns of muni-bond funds in 2013.

However, the same depressed prices and downtrodden sentiment that led to declines last year was the perfect recipe for attractive tax-free yields that lured high net worth investors back to this space.

The iShares National AMT-Free Muni Bond ETF (MUB ) is the largest aggregate national municipal bond ETF by asset size. The fund controls over $3 billion spread over 2,000 individual issues, with New York and California being the top holdings.

This ETF currently boasts an average duration of 5.56 years and a taxable equivalent yield of 3.62 percent.

While that yield may not sound all that attractive, when compared to the taxable iShares Core Total U.S. Bond Market ETF (AGG ) yield of 2.07 percent, it starts to become more significant.

So far this year, MUB has gained 4.81 percent and jumped nearly nine percent from its 2013 low. This performance bests treasuries, investment grade corporate bonds, high yield, and mortgage securities of a similar average duration.

The next top competitor is the iShares Emerging Markets USD Bond ETF (EMB ), which has gained nearly five percent in 2014 as well. Emerging market bonds were another heavily beaten down fixed-income sector that has come roaring back in spite of geopolitical tensions in Eastern Europe.

Currently EMB boasts a yield of 4.69 percent and is dominated by sovereign debt of emerging market nations such as Brazil, Turkey, Mexico, and Russia.

According to recent data from ETF.com, EMB has attracted $773 million in new asset flows year-to-date. These inflows may be the result of investors rotating out of domestic high yield bonds and into emerging market credits with similar income streams and more attractive fundamental valuations.

Further gains in both municipal and emerging market bonds will likely be driven by falling interest rates and additional repositioning from other fixed-income sectors .

On the flip side, these ETFs may find themselves giving up gains in the even that treasury yields rise or inflationary pressures become more pronounced.

Disclosure: The author owns EMB in his portfolio.

2014 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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