With tax-equivalent yields for municipal bonds at levels not seen in over a decade, now may be a good time for investors to consider tax-efficient ways to add to their fixed income allocation. This is especially true for fixed income investors looking to focus on funds with shorter maturities.
When it comes to credit risk, municipal balance sheets are flush with cash after receiving pandemic-era stimulus money. So, for investors looking to benefit from strong yields over the short term as they wait out stock market volatility, the newly launched Vanguard Short-Term Tax-Exempt Bond ETF (VTES) may be worth looking into.
VTES, which seeks to track the S&P 0–7 Year National AMT-Free Municipal Bond Index, is designed to balance the need for tax efficiency with the need for tax-exempt yield. This balance can translate to potentially higher yields than those afforded by competing strategies, for an appropriate level of duration risk.
According to Vanguard, VTES provides investors “with a tool designed to optimize tax efficiency on the short end of the curve while maximizing potential yield overall.” And with an expense ratio of just seven basis points, VTES is markedly cheaper than most active muni mutual funds.
While the typical range for a short-term fund is from 1–5 years to maturity, VTES’s benchmark includes bonds on the shorter-end (0–1 years) as well as on the longer-end (5–7) years. The addition of bonds on both sides of the scale alludes to balance, and a shortening of maturity on average.
VTES may be best suited for investors with either an investment horizon of two to four years, a higher sensitivity to changes in interest rates, or both. It may also be particularly useful for high-net-worth clients seeking tax-exempt income.
“VTES is designed for tax-sensitive investors who have a preference for taking on less interest rate risk than the overall municipal market,” said Jeff Johnson, head of fixed income product at Vanguard, in an interview with VettaFi.
In the same interview, Janel Jackson, Vanguard’s head of ETF capital markets, added: “We saw an opportunity for investors who have an interest rate preference that’s on the shorter end of the curve.”
For more news, information, and analysis, visit the Fixed Income Channel.