Pick your municipal fund carefully

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Rick Ferri
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Pick your municipal fund carefully

Post by Rick Ferri »

The following article is the first on a 4 part series. This article comapres the Vanguard Intermediare-termTax-exempt Bond fund Admiral share (VWIUX) performance to it's competition over the past 5-years ending June 30.

Pick your municipal fund carefully

The next two articles are similar and will compare the Vanguard Total Stocks Market fund to broad actively managed US equity funds, the Vanguard International Index Fund to diversified foreign equity funds. The 4th article will combine the three funds together in a 3-fund portfolio and compare the results to 3-fund actively managed portfolios using the same asset classes and allocations.

Rick Ferri

PS. The minimum initial purchase for VWIUX is $50,000. The article states $10,000. It's being fixed.
Last edited by Rick Ferri on Mon Jul 30, 2012 8:19 pm, edited 1 time in total.
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am
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Re: Pick your minicipal fund carefully

Post by am »

Nice article. I would also add that I remember reading somewhere that Vanguard does their own research on each bond without regards to what the credit agencies say. I am not sure that having 3000 bonds versus 100 makes much of a difference when you are dealing with investment grade bonds since they have such a low default rate.
optimpessim
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Re: Pick your municipal fund carefully

Post by optimpessim »

Rick--
I am ready to invest in a Municipal Bond Fund and would prefer to stay with Vanguard but I am concerned that WVITX has only 17.14 AAA bonds. I don't know about the other funds you use in your comparison. I wonder why you are not considering the percentage of AAA bonds in your comparison.

I am considering Baird Intermediate Municipal Fund which I see is not included in your comparison. I find it has 67.4 AAA bonds. It does have a higher ER (.55) but I'm wondering if the fact that it has a much higher percentage of AAA bonds would mean much lower risk.

--Sally
optimpessim
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Re: Pick your municipal fund carefully

Post by optimpessim »

Of course I meant 17.14% AAA bonds in the Vanguard Fund versus 67.4 % AAA bonds in the Baird Fund.
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Re: Pick your municipal fund carefully

Post by Rick Ferri »

optimpessim wrote:Of course I meant 17.14% AAA bonds in the Vanguard Fund versus 67.4 % AAA bonds in the Baird Fund.
Most AAA ratings are not natural. They're from Insuance. Personally, I don't count insurance when I value a muni bond. The underlying has to be solid on its own.

Rick Ferri
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Grt2bOutdoors
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Re: Pick your municipal fund carefully

Post by Grt2bOutdoors »

Rick Ferri wrote:
optimpessim wrote:Of course I meant 17.14% AAA bonds in the Vanguard Fund versus 67.4 % AAA bonds in the Baird Fund.
Most AAA ratings are not natural. They're from Insuance. Personally, I don't count insurance when I value a muni bond. The underlying has to be solid on its own.

Rick Ferri

Excellent point. Imagine if all municipalities that were insured suddenly stopped paying, do you think for a second insurance companies have enough money to make good on the insurance they sold?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
larryswedroe
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Re: Pick your municipal fund carefully

Post by larryswedroe »

Few points
First, many municipals used to get their rating from the insurers, but there are very few left insuring any longer with any rating worthwhile.

Second, one should never have relied on the insurance anyway, because while if one or a few municipalities defaulted the insurance could pay, but not if there was systemic risk--there was simply not enough capital in the whole mono line industry. Which is why we never relied on insurance but only looked at the underlying rating

Third, one should also care about the sector. Not all AAs are created equal. Bonds from certain sectors (like multifamily residential, health care, private activity) have lower PERSISTENCE of ratings. So a AA GO or AA essential service revenue bond is more likely to remain AA 10 years down the road than a AA health care sector bond.

Fourth, because the ratings agencies are always behind the curve, one should also look at how the bond trades. In other words, if a AA bond is trading with the yield of a BBB then while many would buy it thinking they had a bargain we would avoid assuming the market price is the right price and the ratings agency is just late.


Fifth funds do provide the benefits of diversification, but if stick with the highest investment grades in munis there is much less need for diversification. And with national fund you end up buying bonds that don't make sense for you (the price of that diversification). For example, why would a Florida resident want to own NY and Cal bonds of the same credit rating when those state's bonds have much lower yields due to demand from high bracket investors in those high tax states. That investor should likely be buying bonds from places like Texas, Washington, Nevada and other zero tax rate states. This is an added cost if you will of owning a fund. Another issue is that along the yield curve often taxables might provide higher returns than munis, even to the highest bracket investors at times. Obviously a muni fund is not going to buy CDs or government agencies when they are the best yielding (and no credit risk). But when building an individual bond portfolio you can do that. Clearly investors with relatively small portfolios should either buy funds to diversify the risks or stick with prefunded bonds (with the prefunding done with Treasuries) which have no risk. But investors with larger portfolios (say $1mm or more) should consider building individual portfolios.

I hope that is helpful

Best wishes
Larry
Last edited by larryswedroe on Mon Jul 30, 2012 10:11 pm, edited 1 time in total.
etarini
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Re: Pick your municipal fund carefully

Post by etarini »

optimpessim wrote: It does have a higher ER (.55) but I'm wondering if the fact that it has a much higher percentage of AAA bonds would mean much lower risk.
It's definitely lower risk, but it is also likely to be slightly lower return. Check out the amount of AAA and pre-refunded bonds they hold.

If you buy Baird Intermediate Municipal Institutional (BMBIX) instead of the Baird Intermediate Municipal Investor (BMBSX)through Vanguard Brokerage Services, the minimum *is* $10,000 (I know, I did it) and you get the lower ER of .30 instead of .55. There's a $20 purchase fee, but no front-end load.

As I've posted before, I have a lot of VWIUX, and I haven't sold any of it, but all my new muni acquisitions over the past two years have been the higher-quality Baird Intermediate Institutional muni fund.

Eric
claimui
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Re: Pick your municipal fund carefully

Post by claimui »

Just want to clarify something: Nationally diversified muni bond funds are exempt from federal tax, but not state tax, correct? Are these funds marketed specifically to folks that are not subject to state income tax? Or is there a diversification benefit or some other rationale for why an investor might get a better risk-adjusted return from investing outside his home state, even after state taxes?
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Re: Pick your municipal fund carefully

Post by dkturner »

Rick Ferri wrote:
optimpessim wrote:Of course I meant 17.14% AAA bonds in the Vanguard Fund versus 67.4 % AAA bonds in the Baird Fund.
Most AAA ratings are not natural. They're from Insuance. Personally, I don't count insurance when I value a muni bond. The underlying has to be solid on its own.

Rick Ferri
Rick,

I believe municipal bond insurance now only raises the rating of municipal bonds to AA. Because of this lowered ratings for insured bonds most bond funds hold far fewer AAA bonds than they did pre 2008. Vanguard discontinued its insured tax-exempt fund by merging it with its long-term tax-exempt fund because insurance now adds very little additional security to a high quality (AA or better) muni fund.
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Re: Pick your municipal fund carefully

Post by Rick Ferri »

A municipal one that is pre-refunded in US Treasuries is also rated AAA. This occurs when an issuer refinances debt, but can't pay off the old bonds until the first call date. So the money for refinancing sits in Treasuries until that time, which gives the old bonds an AAA rating. Pre-refunded bonds are as good as Treasuries.

Rick Ferri
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retiredjg
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Re: Pick your municipal fund carefully

Post by retiredjg »

claimui wrote:Just want to clarify something: Nationally diversified muni bond funds are exempt from federal tax, but not state tax, correct? Are these funds marketed specifically to folks that are not subject to state income tax? Or is there a diversification benefit or some other rationale for why an investor might get a better risk-adjusted return from investing outside his home state, even after state taxes?
I'll take a guess, since no one else has answered.

I don't think a national tax exempt fund is specifically marketed to folks with no state income tax. Instead, I think the state tax-exempt funds are specifically marketed to people with the higher state taxes and the other folks (lower state taxes) are just not included in the party.

A second issue is whether people even want their own state tax-exempt fund. Some people in states that are struggling are concerned about higher default rates. Some people don't like the longer durations that state funds seem to have. Individuals in both groups may choose a national fund over their own state fund.
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Re: Pick your municipal fund carefully

Post by optimpessim »

larryswedroe wrote:----Another issue is that along the yield curve often taxables might provide higher returns than munis, even to the highest bracket investors at times. Obviously a muni fund is not going to buy CDs or government agencies when they are the best yielding (and no credit risk). But when building an individual bond portfolio you can do that. Clearly investors with relatively small portfolios should either buy funds to diversify the risks or stick with prefunded bonds (with the prefunding done with Treasuries) which have no risk. I hope that is helpful
OK. These are the issues I am struggling with. 1. At my 25% tax rate. Municipal bond funds are fine at this time but I remember when I considered them and they were only a good deal for those in higher tax brackets. I don't want to buy into a municipal bond fund and then soon regret it because it turned out that I would have been better off investing in Total Bond even in a taxable account. (I actually doubt that would happen because the difference probably would not be extreme.)
2. If I am understanding Larry, as I have quoted him, it would seem that the Baird fund would have minimal (?) risk as such bond funds go. I quote from Baird fact sheet. "Investment Strategy: ------Focusing in the five- to fifteen-year maturing range, the Fund purchases emphasis pre-refunded issues, as well as general obligation bonds or revenue bonds funding essential services such as water, sewer and electricity."

Why am I writing all this? Because my basic knowledge of this stuff is admittedly limited. I am looking for confirmation that I am thinking relatively clearly.

If I do go with Baird I will do it through my Vanguard Brokerage Account so it will show up in my Vanguard reports.
---Sally
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Re: Pick your municipal fund carefully

Post by larryswedroe »

Sally
My book The Only Guide You'll Ever Need to a Winning Bond Strategy should help you with the answers.

Whether munis or taxables are better depends not only on your tax bracket, but the slope of the yield curves. that means that even for high bracket investors you might find that CDs are better on the shorter end of the curve but munis better on the longer end (muni curve typically steeper for variety of reasons). Obviously a muni bond fund or a taxable bond fund is not going to play in the other sandbox, so you get inefficient investing at times. Unfortunately for someone that wants to keep it simple these things can shift. So simplicity comes at a price, you will keep in one investment that will not always be the best, and in fact may never be the best.

The Baird fund is very conservative, personally like their credit profile.

I hope that is helpful

Larry
optimpessim
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Re: Pick your municipal fund carefully

Post by optimpessim »

I found The Only Guide to a Winning Bond Strategy You'll Ever Need on my book shelf! I will now read the chapter on municipal bonds. I was not considering them at the time that I purchased the book nor did I have the knowledge base I needed to understand what I was reading. I am glad to be referred back to it. It has at least more meaning for me now.

In an earlier post I said the ER for the Baird fund was .55 which seems awfully high. That was Investor Shares (BMBSX) but as etarini pointed out in his post, I can get Institutional Shares(BMBX) with ER .30 through Vanguard Brokerage.

I have not fully decided yet but at least I feel I am well on the road to picking my municipal bond fund carefully!
Rozdg
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Re: Pick your municipal fund carefully

Post by Rozdg »

Just wanted to add....while muni funds are tax free, they are not with regards to Medicare Part B. If your AGI is over 85K (for singles, a bit higher for marrieds) you would have to pay a surcharge for Medicare Premiums according to how high your AGI. The entry level for surcharges begins with the 85K AGI.....and they include any monies earned from Muni dividends. I'm sure this is redundant info for many, but thought in case anyone was unaware I'd post it.
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