VMATX Maturity/Duration Question

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SavageAmusement
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VMATX Maturity/Duration Question

Post by SavageAmusement » Sat Jan 06, 2018 4:58 pm

I’m interested in Vanguard’s Massachusetts Tax-Exempt Fund (VMATX) and I have a question for the gang.

The fund has an average stated maturity of 16.7 years and an average duration of 7.1 years. This appears to me to be an unusually large difference between maturity and duration. Can anyone explain what causes such large differentials? I’m thinking it has something to do with variable coupons that reset prior to maturity, but I’m not sure. Any help would be appreciated. Thanks.

lack_ey
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Re: VMATX Maturity/Duration Question

Post by lack_ey » Sat Jan 06, 2018 5:05 pm

That should mostly reflect call options.

Usually when average duration is calculated for a fund, there are reasonable assumptions made about bonds being called early, prior to maturity. Also, the fund's sensitivity to interest rate changes reflects the fact that many of the bonds will be called and not mature on the stated date, as the bond market anticipates those actions and prices bonds accordingly.

If there's a 20-year muni bond with 5 years left until the first potential call date, and it's trading at a significant premium (i.e. paying a high coupon, having unfavorable terms for the borrower, where they're very likely to call it), you can pretty much treat this as a 5-year bond, and its pricing and sensitivity to interest rate changes will reflect that.

Keep in mind that for such a fund, the behavior is not symmetrical and linear with respect to rate changes. If rates go up significantly, the duration may increase (as fewer issuers will want to call early) and you may lose more than implied by the average duration measure now.

SavageAmusement
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Re: VMATX Maturity/Duration Question

Post by SavageAmusement » Sat Jan 06, 2018 5:21 pm

Thanks lack_ey. That explanation makes sense.

Edited. You answered my question.

SavageAmusement
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Re: VMATX Maturity/Duration Question

Post by SavageAmusement » Wed Jun 13, 2018 1:00 pm

I have a follow-up question for the group regarding Vanguard's duration numbers.

Which duration number does Vanguard provide for its fixed income funds ... Modified Duration or Effective Duration?

Thanks to anyone who might know the answer.

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grabiner
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Re: VMATX Maturity/Duration Question

Post by grabiner » Wed Jun 13, 2018 9:44 pm

lack_ey wrote:
Sat Jan 06, 2018 5:05 pm
Keep in mind that for such a fund, the behavior is not symmetrical and linear with respect to rate changes. If rates go up significantly, the duration may increase (as fewer issuers will want to call early) and you may lose more than implied by the average duration measure now.
In particular, this makes long-term muni funds somewhat riskier than the reported duration. If rates rise by 2%, a muni fund with a 7-year duration might lose 18% rather than 14% as its duration rises from 7 to 11 years.
Wiki David Grabiner

alex_686
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Re: VMATX Maturity/Duration Question

Post by alex_686 » Wed Jun 13, 2018 9:52 pm

SavageAmusement wrote:
Wed Jun 13, 2018 1:00 pm
I have a follow-up question for the group regarding Vanguard's duration numbers.

Which duration number does Vanguard provide for its fixed income funds ... Modified Duration or Effective Duration?

Thanks to anyone who might know the answer.
Neither. Mutual funds use Macaulay duration.So average cash flow in years. The least useful duration value in my opinion. But it is easiest to calculate and easy to save all of the inputs and models per SEC regulations.

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