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The Independent Adviser for Vanguard Investors
•
October 2015
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13
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above Short-Term Treasury, 0.98% vs.
0.62%, this fund has appeal even before
considering the tax-exempt benefits. Why
do you think Vanguard founder Jack
Bogle has, in the past, stashed more than
$3 million of his own money here?
Intermediate-TermTax-Exempt
Buy.
Intermediate-term bond funds
often give fixed-income investors the
biggest bang for their bucks while taking
moderate risk. This fund has stacked up
well against its intermediate-term tax-
able brethren, delivering an average of
70% to 90% of the returns of Vanguard’s
taxable intermediate funds over rolling
one-year, three-year and five-year peri-
ods. Before taxes,
Intermediate-Term
Investment-Grade
offers a higher yield
and should be your fund of choice in
retirement accounts. But investors in
the 33% tax bracket and above will find
Intermediate-Term Tax-Exempt’s tax-
equivalent yield more attractive.
Intermediate-Term Tax-Exempt
also holds its own against Long-Term
Tax-Exempt. Over the past decade,
Intermediate-Term Tax-Exempt’s aver-
age return of 4.8% over rolling five-
year periods is not far behind Long-
Term Tax-Exempt’s 5.2% average five-
year return. However, the intermediate
muni fund’s worst five-year return of
3.4% is better than its long-term sib-
ling’s 3.2% gain.
Given this history of balancing
risk and reward, it is no surprise that
Intermediate-Term Tax-Exempt has
been a go-to fund for Vanguard inves-
tors. At times it has become too popular
and too big, leading Vanguard to close
the fund to advisers and institutions to
slow inflows. With nearly $44 billion in
assets, it is the largest muni bond fund
in the U.S. and is currently open to any
and all investors.
For taxable investors, Intermediate-
Term Tax-Exempt remains a good com-
promise for those who want higher
levels of current income and are willing
to take a modicum of risk with their
principal.
Tax-Exempt Bond Index
Hold.
See last month’s issue for an
in-depth review of this new index fund.
It took Vanguard years to open a muni
index fund and ETF for investors, but
we now have a horse race between this
fund and its actively managed Long-
Term Tax-Exempt sibling. My money
would be on Vanguard’s active manage-
ment to win that race in the long run, but
I’m not eager to buy either fund today
due to the long-maturity bonds domi-
nating their portfolios.
Long-TermTax-Exempt
Hold.
Though you might expect a
sell rating here given my disdain for
long-maturity bonds, this fund is not
nearly as long as Vanguard’s taxable
long funds. A duration of 6.3 years is
pretty long, but it falls well short of
Long-Term Investment-Grade
(13.0
years),
Long-Term Bond Index
(14.7
years) and
Long-Term Treasury
(16.5
years). In fact, it’s much closer to Total
Bond Market’s 5.7-year duration. I
ing when they continue adding layers and layers of managers to their
actively managed funds. More managers on a fund leads the fund to look
more and more like the market or an index. At that point, Vanguard’s cost
advantage all but guarantees that the fund will outperform its average,
more costly peer, but probably won’t outperform its index benchmark—
though it should come close to matching the index.
But so what? I don’t buy or own the average active manager, and nei-
ther do you. In fact, we only own a handful of active managers, like Don
Kilbride, the PRIMECAP team, Jim Barrow and Mark Giambrone, and yes,
Vanguard’s fixed-income group, which runs funds for us at low costs and
at an index-beating pace.
And as for the multitude of efficient-market fanatics who spout off
about being “passive” investors, claiming you can’t beat the market so
you might as well own the market, well, they aren’t walking their own
talk. Not even Vanguard walks its talk, and it can’t stop talking!
If you own just
500 Index
(or say
Total Stock Market Index
), you
might consider yourself a passive investor, but relative to the global oppor-
tunity set, you are actually very active. By holding just U.S. stocks, you are
ignoring foreign stocks and other financial assets like bonds or real estate.
You’d actually be taking the same active bet as someone who owned an
actively managed U.S. stock fund, or someone who bought just one U.S.
stock. Jack Bogle is the ultimate active investor in that he says he doesn’t
want to own foreign stock funds—indexed or otherwise. He thinks he’ll
be just fine, thank you very much, sticking with a domestic index fund.
Jack is no indexer, by any means. He also owns actively managed funds
as well as shares in his son’s hedge fund, the epitome of active funds.
The benefits of indexing—low costs, low turnover and relatively good
tax-efficiency—can be found in funds run by active managers as well.
Consider that
Capital Opportunity
’s 6.7% turnover is lower than the 10.6%
turnover at
MidCap Index
and the 9.7% turnover at
SmallCap Index
,
and it isn’t much greater than 500 Index’s 2.7% turnover. Warren Buffett is
extremely low-cost and tax-efficient—actually buying Berkshire Hathaway
has been lower cost (there’s no annual management fee) and more tax-
efficient (it hasn’t paid out a dividend) than buying 500 Index—but he’s
the poster child for active management. (By the way, why do you think he
encouraged his heirs to buy an index fund when he dies? He doesn’t think
they’ll be able to repeat his own successes buying stocks, nor does he think
they’ll be able to pick good managers, though Buffett himself chose two.
Their records running Berkshire money are too short to be judged just yet.)
The truth is, I fully expect a low-cost index fund to outperform the aver-
age actively managed fund over time and after fees. Bogle’s math wasn’t
wrong. That said, as you know, my money is invested in actively managed
funds. Why? I don’t think I’m buying an “average” manager, but rather,
I’m partnering with top-notch managers I’ve spent a lot of time vetting.
Over the past 20 years, there has been only one five-year stretch (out
of 240 periods) when the original
PRIMECAP
failed to outperform 500
Index. And by the way, it underperformed by 0.04% per annum over that
period—a laughable difference. If I own PRIMECAP, what do I care about
how the average fund has done versus 500 Index? I don’t. It’s a distraction.
Trying to predict whether 2015 is the year the average active manager
beats the indexes is just another form of market timing, and one that
isn’t all that fruitful in the first place. Find what works for you—index or
actively managed—tune out the noise, and stick with it. But don’t for a
second believe that great active managers can’t be found, and that those
“indexers” aren’t making active bets with their investments—they are.
They just don’t know it. Who said “ignorance is bliss”?
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