(PUB) Investing 2015

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12 • Fund Family Shareholder Association
With all of that as prologue, here’s
a look at Vanguard’s municipal bond
options:
Short-TermTax-Exempt
Buy. As I said, compare this fund
with its new taxable sibling Ultra-Short-
Term Bond. However, as Ultra-Short-
Term Bond is only eight months old,
whereas Short-Term Tax-Exempt will
be celebrating its 40th anniversary in
two years, we can learn a lot more about
the taxable bond fund by looking at the
tax-free fund’s history. And the history
says Short-Term Tax-Exempt has done
its job very well—it just has a very spe-
cific role to play in a portfolio.
Short-Term Tax-Exempt isn’t a
money market fund, as its share price
does fluctuate. It’s more of a money
market on steroids. The fund maintains
some yield by pushing its portfolio’s
average maturity and duration to a bit
more than one year. Short-Term Tax-
Exempt’s yield of 0.48% isn’t any-
thing to get excited about, but it has
allowed the fund to deliver some gains
over the past five years when Tax-
Exempt Money Market has essentially
shot a blank—just see the Performance
Review on page 9. The fund has never
had a 12-month stretch where it lost
money and has outpaced Tax-Exempt
Money Market in about 85% of the roll-
ing 12-month periods since the money
market fund’s 1980 inception.
However, I don’t consider Short-
Term Tax-Exempt a bond fund substi-
tute either. The fund’s 0.8% annualized
gain over the past five years is only half
that of Limited-Term Tax-Exempt’s
1.6% per year return. And given that
Limited-Term Tax-Exempt’s 0.98%
yield is about double Short-Term Tax-
Exempt’s yield, I wouldn’t expect that
pattern to change.
So how should one use Short-Term
Tax-Exempt? It’s a good place to park
money that you don’t need today or
tomorrow if you’re willing to accept
a small amount of price devaluation,
which, over time, should be more than
recouped through higher monthly distri-
butions. If you have more than a year’s
worth of spending money sitting in a
money market, you might want to take
some of that excess and invest it here.
One note: If you choose to put the
bulk of your cash here, you should still
keep a money market fund for your
check-writing needs. Every check writ-
ten on Short-Term Tax-Exempt results
in a taxable transaction—something
that will drive you and your accountant
over the edge every April 15.
Limited-TermTax-Exempt
Buy. This is the fund to compare to
the short-term taxables like Short-Term
Treasury or Short-Term Investment-
Grade. Duration, at 2.6 years, is right in
line with its short-term taxable siblings.
Risk is very limited here—there have
only been two 12-month periods since the
fund’s 1987 inception where it failed to
deliver positive returns. With a yield well
ACTIVE-PASSIVE
An Actively Passive Distraction
FOR YEARS NOW, money has flowed out of actively managed funds and
into index funds, with active management pronounced as good as dead
at the end of 2014 and regular post-mortems a fixture of most invest-
ment publications.
This active versus passive debate is a favorite of the media, but over
the years, the efficient-market theory upon which much of the debate
has been built has morphed into something bigger, broader and much
more ill-defined. And the sweeping generalizations that characterize this
debate make it, to my mind, rather useless.
In reality, the difference between a passive index investor and an
active investor has never been as black-and-white as the media and
marketing gurus would have you believe. Consider that Vanguard, widely
considered the king of indexing, also oversees about $1.0 trillion in
actively managed funds. So how can we make sense of it all?
First, let’s be clear: The S&P 500 index, upon which so much historical
data on indexing is based, is an actively managed index. Yes, that’s right.
A committee, or what you and I might rightly call a team of portfolio
managers, guided by some self-imposed restrictions on their investment
“style,” decides which companies’ stocks to add to and which to drop
from the venerable benchmark.
Vanguard built its entire house of indexing—through the birth of
500 Index in August 1976—on an actively managed index. How’s that
any different from an actively managed fund? The big difference is that
S&P sells its “management” for a lower price (but much more broadly)
than the typical portfolio manager, by licensing the index to firms like
Vanguard who wish to use it as the basis for an index product.
Second, there’s nothing less active than an investor jumping from index
fund to index fund (or ETF to ETF) looking for the next hot sector, region,
or slice of the stock or bond markets. You don’t think this happens? Jack
Bogle loves to recite statistics on the turnover of ETFs, which he likens to
a beautiful shotgun with which you can shoot yourself. While ETFs may
be considered “passive” investments, many investors who use them are
more active than the active mutual fund managers they claim to abhor.
And finally, the whole argument about the “average active manager”
either outperforming or underperforming some benchmark is simply an
easy-to-say but useless bit of data mining. The analysts at Morningstar,
who really should know better, now produce what they call an Active/
Passive Barometer measuring active funds against index funds. But even
this “barometer” is based on the average performance or asset-weighted
performance of a host of different funds run by a small city’s worth of
portfolio managers.
Who cares about the average manager? The math tells you that the
average manager, over time, will underperform, since every manager that
outpaces the index is matched to a manager that falls behind. Add in the
sometimes obscene operating expenses that some companies charge
for their funds or their services (hedge funds being the worst), and the
numbers will always fall, on average, in the index fund’s favor, assuming
the index fund isn’t one of the price-gouging types you sometimes find
labelled with a brokerage firm’s moniker.
In many ways, the game of averages is the game Vanguard is play-
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