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Inside Vanguard's New Muni Bond ETF

Zacks Equity Research

Vanguard Group, known for its low cost offerings, has been making great strides in recent times in launching products on varied themes. At present, it is offering around 70 U.S. listed ETFs and managed to secure the second position (with about $457.1 billion market cap) among the top 10 fund sponsors list following BlackRock.


Most recently, the issuer stepped into the muni bond market. The fund trades under the name of Vanguard Tax-Exempt Bond Index Fund (VTEB). Let’s look into the fund.


The Proposed Fund in Focus


As per the prospectus, the fund looks to track the performance of the investment-grade U.S. municipal bond market. The goal will be achieved by tracking the S&P’s National AMT-Free Municipal Bond Index. The basket is long-duration in nature. The fund charges 12 bps in fees and the expense ratio is 86% less than the average expense ratio charged by the funds with similar constituents.


How Does it Fit in a Portfolio?


Municipal bonds are great picks for investors seeking a steady stream of tax-free income. Usually the interest income from munis is exempt from federal tax and sometimes even state taxes, making these especially attractive to investors in the high tax bracket looking to reduce their tax liability.


The proposed fund also looks to follow munis that have their interests excused by U.S. federal income taxes and the federal alternative minimum tax (AMT). However, investors should note that tax-free bonds yield lower than taxable bonds. With the increase in the U.S. taxes, demand for municipal bonds has grown by leaps and bounds among high earners.


The best part of the fund is that it includes high quality muni bonds. Recently, the sentiment about the creditworthiness of some munis like Puerto Rico soured. Also, a gradually improving U.S. economy will provide relief to investors as the credit quality of the municipal bonds could improve, thereby reducing default rates (read:Municipal Bond ETFs to Watch After Detroit Bankruptcy).


Though yields will likely rise in the coming days as the Fed is set to hike rates sometime in 2015, the tax benefit will look more promising with rising yield. For example, a 10% yield translates into 18% (for high tax payers) after considering the tax exemption as noted by Bloomberg. Probably this is why Vanguard has endorsed the idea of tax-exemption the most (read: Is 2015 The Year for Municipal Bond ETFs).


ETF Competition

 

The fund has managed to amass about $50 million in assets within just 10 days of launch which can be considered as a benchmark of success. After all, Vanguard is known as a low-cost producer. VTEB is the lowest cost product in the Muni-bond ETF space (see all muni bond ETFs here).


Still this new fund has big competition in the form of iShares S&P National Municipal Bond Fund (MUB). MUB is the highest grossing muni ETF with about $5.2 billion assets. Plus this fund also tracks the same index, i.e.; S&P National AMT-Free Municipal Bond Index to provide exposure to a basket of 2,782 investment grade securities. The average maturity for MUB stands at 5.54 years, while duration is 4.74 years. The fund has a 30-day SEC yield of 1.73% and charges 25 basis points as expenses per year.


In a nutshell, though Vanguard made a late entry to this thriving space, it was off to a strong start. Going forward, it should not face hurdles in garnering investors’ money despite iShares’ presence with an ultra-popular product.

 

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VANGD-TAX EX BD (VTEB): ETF Research Reports
 
ISHARS-NAMTF (MUB): ETF Research Reports
 
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