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.
The same point can be made for advisors who have built their practices on managing muni bond ladders. I often hear, “I prefer actively managed funds since indexing doesn’t work in less liquid markets.” Actually, Vanguard research shows that indexing has worked across all markets, as substantiated by S&P’s SPIVA report. A lot of the long-term performance shortfall of actively managed funds can be linked to higher management fees.
By spending too much of your valuable time on managing bond ladders, you may be missing out on other activities that produce client results and loyalty, such as asset location, rebalancing, spending strategies, and behavioral coaching (what we refer to as Vanguard Advisor’s Alpha®).
We believe this will change with the launch of our first muni bond index fund. Vanguard is taking a stand for more investors in one of the highest-cost segments on the markets.
So why the big deal about our new muni bond index fund/ETF? Simple: It’s provides a better solution for the majority of muni bond assets held by investors who are paying too much.
Ben Rost, CFP®, is a senior manager in Vanguard Portfolio Review Department, where he leads product management for Vanguard’s bond index funds and ETFs. Mr. Rost joined Vanguard in 2004 and has held a variety of financial sales and client service roles. He served as an investment analyst in Vanguard Portfolio Review Department and a project manager in Vanguard Corporate Strategy Group. Additionally, he was a manager in Vanguard’s fund and ETF research and development team for four years. Mr. Rost earned his B.A. from the University of Notre Dame and his M.B.A. from Villanova University. He holds FINRA Series 7 and 63 licenses.