Conservative investors embrace municipal bonds for steady yields, tax advantages and reduced volatility. Munis also help diversify fixed-income portfolios. Investors who typically follow the Barclays U.S. Aggregate Bond Index will not have municipal bond exposure, so a muni bond ETF can complement core fixed-income positions.
Over the years, ETFs have become a favored avenue for accessing municipal bonds because many of the traditional funds in this group provide expansive coverage. For example, the Vanguard Tax-Exempt Bond ETF (NYSEArca: VTEB), Vanguard’s first muni bond ETF, holds nearly 4,200 bonds.
VTEB “tracks the S&P National AMT-Free Municipal Bond Index. The interest its holdings pay is not subject to federal income tax,” said Morningstar in a recent note. “As a result, these bonds typically offer lower pretax yields than taxable bonds and are attractive only to investors in the highest tax brackets. The managers use a statistical sampling approach to track this bogy as it isn’t practical to own every bond in the index.”
As is the case with so many other Vanguard ETFs, VTEB is cost effective. The fund charges just 0.09% per year, or $9 on a $10,000 investment, making it cheaper than 90% of competing strategies, according to Vanguard data.
Inside VTEB ETF
“The portfolio weights its constituents by market value, so its holdings skew toward the largest debt-issuing states,” according to Morningstar. “At the end of December 2018, the fund had greater exposure to California and New York than the category average. It collectively allocated one third of its assets to these states, while the average fund in the category had a 16% stake. Both these states have relatively high credit ratings, so higher-than-average exposure doesn’t hurt the fund’s overall credit risk.”