(PUB) Investing 2015

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12 • Fund Family Shareholder Association
LATE TO THE MUNICIPAL BOND
indexing game, Vanguard is looking for
another win with its ace-in-the-hole—
lower costs.
Four years ago, Vanguard gave the
market a head fake, first filing to launch
three municipal bond index funds and
ETFs in June 2010, only to withdraw
the filing six months later in January
2011. Now, Vanguard is back at it, hav-
ing filed a few days after 2015 began
to offer just one municipal bond index
fund—Tax-Exempt Bond Index.
The fund (and its ETF share class)
is expected to go live in the second
quarter of 2015 and will seek to track
the performance of the S&P National
AMT-Free Municipal Bond Index. The
index has an average maturity of 14
years or so and covers the investment-
grade muni-bond market.
Within Vanguard’s stable, the new
fund should look most similar to the
actively managed Long-Term Tax-
Exempt. Over the past decade, the
actively managed fund returned 4.7%
a year, just ahead of the 4.6% a year
gain recorded by the S&P index. Risk
was essentially the same as well, with
both the active fund and the index
experiencing drawdowns of 7.2% dur-
ing the “taper-tantrum” of 2013. Keep
in mind that the index numbers do not
include fees—making the performance
of Vanguard’s managers all the more
impressive.
The new fund’s most immediate com-
petitor, however, will be the iShares
National AMT-Free Muni Bond ETF
(MUB) which tracks the same index
and has over $4 billion in assets. The
price war continues in the ETF space
as Vanguard aims to come to market
with an expense ratio half as much as
the iShares ETF—0.12% versus 0.25%.
Vanguard has proven that it doesn’t
have to be the first to market to become
the largest player. The firm wasn’t the
first to the table in core taxable bonds
or the emerging stock index space, but
today Total Bond Market ETF and
Emerging Market Stock ETF are the
largest ETFs in those spaces, surpass-
ing iShares Core U.S. Aggregate Bond
(AGG) and iShares MSCI Emerging
Markets (EEM), as investors gravitated to
the lowest-fee option. Vanguard expects
the lure of lower costs to work again.
And yes, there’ll be regular, open-end
fund options available for minimums of
$3,000 (Investor shares, 0.20% operat-
ing expenses) and $10,000 (Admiral
shares, 0.12%), but these funds will
also be sold with a 0.50% front-end
load. As a consequence, I would expect
the bulk of the new index fund’s assets
to be held in the ETF shares. n
INDEXING
Another Stab at a Muni Index ETF
Watch Those Vanguard Calculations
THE INTRODUCTION OF A NEW, LOW-COST MUNICIPAL BOND FUND is a great time to crow
that yields are always higher when costs are lower. And most of the time they are. But there’s
higher yields, and then there’s Vanguard’s calculations of those yields—or rather, Vanguard’s cal-
culation of the taxable-equivalent yields that its tax-exempt bond funds offer.
No, they haven’t begun computing a taxable-equivalent yield or even an SEC yield for the new
Tax-Exempt Bond Index yet, since it’s not in operation. But hold onto your hats when you hear
that Vanguard thinks that the taxable yield on some of its longer-term muni funds are equivalent
to more than double their tax-free yields.
How’s that possible? Bad math.
If you received it in the mail, check out the opening page to the 2014 annual report for
Vanguard’s six tax-exempt bond funds, where a table lists those funds’ SEC yields at the end of
their October fiscal year, as well as Vanguard’s calculation of the fund’s taxable-equivalent yields,
or the yields you’d have to earn on a taxable fund to equal the tax-free yield of a muni fund. For
instance, Vanguard says that an investor in the highest federal tax bracket would need to earn a
taxable yield of 6.08% to equal the 2.64% tax-exempt yield on the Admiral shares of its High-
Yield Tax-Exempt fund. Zowee! That’s junk bond territory. Even the Admiral shares of High-
Yield Corporate were only good for a 4.87% yield at the end of October 2014.
Does this seem strange? You bet it is. Vanguard got the calculation wrong for all of its tax-
exempt bond funds, and the differences are pretty significant, as the table above shows. As of
Monday, January 12, Vanguard had finally posted a new annual report to its website with cor-
rected numbers, but of course there was no mention of the error in the prior iteration of the report.
So, when Vanguard begins promoting the taxable-equivalent yield on its new muni index fund, let’s
all give it a once-over and check the math. Or, you can simply turn to pages 9 and 10 in each issue of
this newsletter for the taxable-equivalent yields in a host of federal tax brackets for your data.
Tax-Equivalent Yields or Fantasy Yields?
Share SEC Actual Vanguard Vanguard
Fund Class Yield T-E Yield T-E Yield Error
Tax-Ex. Money Market Investor 0.01% 0.02% 0.02% —
Short-Term Tax-Ex. Investor 0.28% 0.49% 0.65% 0.16%
Admiral 0.36% 0.64% 0.83% 0.19%
Limited-Term Tax-Ex. Investor 0.70% 1.24% 1.61% 0.37%
Admiral 0.78% 1.38% 1.80% 0.42%
Intermediate-Term Tax-Ex. Investor 1.54% 2.72% 3.55% 0.83%
Admiral 1.62% 2.86% 3.73% 0.87%
Long-Term Tax-Ex. Investor 2.22% 3.92% 5.12% 1.20%
Admiral 2.30% 4.06% 5.30% 1.24%
High-Yield Tax-Ex. Investor 2.56% 4.52% 5.90% 1.38%
Admiral 2.64% 4.66% 6.08% 1.42%
Note: Taxable-equivalent yield is based on a 43.4% federal tax rate, as per Vanguard.