A colleague recently asked me, “What’s the big deal about our new muni bond index fund/ETF?” It’s a fair question (it is an index fund, after all), and the answer has a lot to do with the $3.7 trillion municipal bond market and its accessibility to investors. But before I get to that point, let’s review why we launched this fund/ETF.

For a long time, advisors have asked Vanguard for a municipal bond index product that could serve as the core portfolio for the fixed income exposure of their high-net-worth clients with taxable accounts. Why? While Vanguard has a reputable actively managed municipal bond lineup,¹ many advisors are unable to access our lineup on their platforms. Furthermore, many of you seek an index approach or prefer to use ETFs or both. Indexing bonds, particularly municipal bonds, is challenging, and our Fixed Income Group wanted to be sure it could offer a high-quality fund before launching this product.

Vanguard’s 40-person active municipal bond team, in concert with our Risk Management Group, uses proprietary technology to analyze numerous risk factors for municipal bonds, which, in turn, influences the strategies employed in our actively managed funds. This team is now using the same rigorous risk management process to help minimize the Tax-Exempt Bond Index Fund and ETF’s differences versus the benchmark. Not something a dart-throwing monkey could handle.

But back to the main point of my story. The Tax-Exempt Bond Index Fund/ETF brings an index option to an area of the market that historically has been led by higher-cost, less diversified strategies such as separately managed accounts (SMAs) and individual bond portfolios. The customization of SMAs has its place with clients, but at what cost? Investors, especially those who directly hold $1.5 trillion in muni bonds continue to pay too much for tax-exempt income.²

The U.S. muni market has a market capitalization of $3.7 trillion, according the Federal Reserve as of March 2015. More than $1.5 trillion of that figure is directly held by households. An additional $500 billion is held at banks and invested in separate accounts. Only about 25% of the total is invested in pooled funds.

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