(PUB) Investing 2015

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14 • Fund Family Shareholder Association
WELL, THAT TOOK LONG ENOUGH!
For all the indexing expertise at
Vanguard, actually bringing a municipal
bond index fund (or ETF) to market has
been a trying ordeal for the bond giant.
Five years ago, in June 2010,
Vanguard gave investors a head fake
when it filed to launch three municipal
bond index funds and ETFs, only to
scuttle its plans in January 2011.
Then, at the outset of 2015,Vanguard
filed to offer a new, single municipal
bond index fund, but pushed its offer-
ing date back six times before finally
launching the new fund and ETF, Tax-
Exempt Bond Index, on August 18.
The fund comes in several forms,
including an Investor share class (ticker
symbol: VTEBX) charging 0.20% in
operating expenses with a minimum
investment hurdle of $3,000. If you
have $10,000 to invest, the Admiral
shares (VTEAX) charge only 0.12%
in expenses. As both shares currently
carry a 0.25% front-end load, I expect
the bulk of investor cash will be flow-
ing to the ETF shares (VTEB), with
their 0.12% expense ratio.
The fund’s objective is 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 (see the sidebar to the left for more on
average maturity) and covers the invest-
ment-grade muni-bond market with a
portfolio of more than 10,000 bonds.
So what return and risk profile should
investors expect from the new fund?
Performance of the index it tracks over
the past 15-plus years, as seen in the
chart above, suggests that Tax-Exempt
Bond Index should look most similar to
the actively managed Long-Term Tax-
Exempt . The actively managed fund has
the performance edge, though—even
before considering that the index num-
bers do not include fees.
Tax-Exempt Bond Index’smost imme-
diate competitor is the iShares National
AMT-Free Muni Bond ETF (MUB),
which seeks to track the same index and
has nearly $5 billion in assets. iShares has
a nice head-start over Vanguard. Vanguard
has been consistently late to the ETF game
but has been able to gain market share
through the lure of lower costs. With an
expense ratio half as much as the iShares
ETF—0.12% versus 0.25%—Vanguard
is looking for a repeat performance with
its new muni index fund.
If you are in a high tax bracket and
looking for tax-exempt income, Tax-
Exempt Bond Index is a solid, low-cost
route to take. However, with its long
maturity, the index fund’s price will
be quite sensitive to changes in inter-
est rates. I’d look to pair it with either
Short-Term Tax-Exempt or Limited-
Term Tax-Exempt to dampen the hit
this fund will inevitably take when
interest rates rise. I also wouldn’t count
out the actively managed Long-Term
Tax-Exempt, which has outpaced the
index over the long run. n
INDEXING
A Muni Index Fund at Long Last?
6/99 6/01 6/03 6/05 6/07 6/09 6/11 6/13 6/15
S&P National Index
Vanguard Int.-Term Tax-Ex.
Vanguard Long-Term Tax-Ex.
75
100
125
150
175
200
225
Active Management Has
Matched the Index
Which Maturity Date?
A QUICK ASIDE AND WORD OF CAUTION: When it comes to comparing maturities for bond
funds, you have to know what maturity you are looking at—e.g., a portfolio’s average stated
maturity or its average effective maturity.
Average stated maturity considers the actual maturity date written into the contract of each
bond in the portfolio. Average effective maturity takes into account call features any bonds in
the portfolio may have—i.e., the option of the bond issuer to pay back the loan, or to “call” the
bond in, before its scheduled maturity date.
For example, a bond with a maturity date of June 30, 2045, might be callable starting on June
30, 2025. The bond’s stated maturity is 30 years, but its effective maturity would be 10 years.
Unfortunately, there isn’t much consistency across the industry on which method to follow.
The average maturity you’ll find on page 9 of our Performance Review is the average effective
maturity for all the bonds in each fund.
Neither the effective nor the stated maturity is the right or wrong way to measure a portfo-
lio’s interest-rate sensitivity. In fact, on Vanguard’s website, you’ll find effective maturities for
taxable bond funds, while tax-exempt bond funds show stated maturity. (Yet Vanguard reports
an effective maturity calculation for its muni funds to Morningstar—go figure!) But investors
do need to be sure they are comparing apples to apples.
The iShares website reports an average maturity of around 5.5 years for the iShares National
AMT-Free Muni Bond ETF. That is closer to the average maturity of 8.7 years that Vanguard reports
on its site for Intermediate-Term Tax-Exempt than the 16.5 year average maturity of Long-Term
Tax-Exempt. This would seem to suggest that the iShares ETF and the new Tax-Exempt Bond Index
should be considered more of an intermediate-term muni fund than a long-term muni fund.
However, in this situation, we aren’t comparing apples to apples, as iShares reports aver-
age effective maturity, while Vanguard shows average stated maturity. For a more consistent
comparison, S&P reports the underlying index’s average stated maturity was 13.5 years as of
the end of July. Don’t be fooled by the average maturity reported by iShares. Both Tax-Exempt
Bond Index and the iShares ETF are long-term muni funds, and will be sensitive to changes in
interest rates, just like Long-Term Tax-Exempt.