(PUB) Investing 2015

INDEXING A Muni Index Fund at Long Last?

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

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

Active Management Has Matched the Index

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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%

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.

14 • Fund Family Shareholder Association

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