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Vanguard High-Yield Tax-Exempt: Don't Call It Junk

Ryan Ermey, Associate Editor, Kiplinger's Personal Finance

Names can be deceiving. French fries aren't really French, and Vanguard High-Yield Tax-Exempt fund (symbol VWAHX) isn't a high-yield bond mutual fund. In the bond investing world, the words high yield are interchangeable with junk--meaning bond issues rated below investment grade that pay high yields and come with an elevated risk of default. Vanguard High-Yield's peer group, however, is muni bond funds with long maturities. Though the fund's 15% stake in junk-rated or unrated muni debt is higher than the category average of roughly 4.5%, the typical fund in the actual high-yield muni category has 10 times that much--45%--in junk and unrated bonds.

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The remainder of the fund's assets are in investment-grade issues. Its yield is a generous 2.3%, which, because income from municipal bonds is exempt from federal taxes, is the equivalent of a 3.9% yield for investors in the highest federal tax bracket.

Should interest rates remain low, the muni market is a relatively safe place to hunt for yield, says Mathew Kiselak, who's helmed the fund since 2010. In the 10 years through 2016, muni bonds defaulted only 0.18% of the time, compared with a 1.74% default rate for corporate bonds. Even so, the fund's portfolio is built with a watchful eye toward risk.

Portfolio construction starts with a custom benchmark modeled on the Bloomberg Barclays Municipal index, with a tilt toward lower-quality, higher-yielding names. From there, Kiselak relies on input from Vanguard's extensive muni bond team. In 2019, the fund began shifting assets from single-A-rated bonds to higher-quality, double-A-rated debt. Within the fund's slug of triple-B-rated debt (one step above junk and 22% of assets), the team favors bonds backed by revenues from essential services, such as airports, hospitals and toll roads, all of which are unlikely to fare poorly even in a recession.

Low costs allow the fund to deliver nice returns without wading deep into junky waters. The 0.17% expense ratio is less than a third of the average for similar funds. Over the past decade, the fund's 5.3% annualized return bested 91% of peer funds. The fund has beaten the Bloomberg Barclays muni index in nine of the past 10 calendar years.

See Also: Stand By Your Bonds


Copyright 2019 The Kiplinger Washington Editors