Which Vanguard California Muni fund?

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bluquark
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Which Vanguard California Muni fund?

Post by bluquark » Tue Dec 11, 2018 8:52 pm

I'm trying to decide whether to use VCLAX ("Long-Term California tax exempt") or VCADX ("Intermediate-Term California tax exempt"). I see they have the following properties:

VCLAX: Average maturity 17.1 years, average duration 7.3 years
VCADX: Average maturity 9.1 years, average duration 5.5 years

I read in a few places that "duration" is the only one that matters and stated maturity is basically just an irrelevant factoid. So aren't these two funds extremely similar, with only a 30% difference in duration, basically making the "long-term" name of VCLAX a misnomer? I'm confused why Vanguard even bothered to offer two different funds in this niche category and I'm wondering if I'm missing any important difference.

Steadfast
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Re: Which Vanguard California Muni fund?

Post by Steadfast » Wed Dec 12, 2018 4:38 pm

I don't think you're missing anything important. The durations of these funds will vary a bit from time to time, and right now, they're a bit closer.

The general advice here is to hold intermediate-term bond funds, which nicely balance interest rate (duration) risk and return. If you look at yield curves these days, you're not being compensated very well for taking increased duration risk. 2.92% 30 day yield on VCLAX vs 2.49% for VCADX.

30% longer duration for 0.43% more yield, doesn't sound like a screaming bargain to me, with interest rates where they are.

We use VCADX as our core bond holding.
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bluquark
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Re: Which Vanguard California Muni fund?

Post by bluquark » Wed Dec 12, 2018 4:53 pm

Steadfast wrote:
Wed Dec 12, 2018 4:38 pm
I don't think you're missing anything important. The durations of these funds will vary a bit from time to time, and right now, they're a bit closer.

The general advice here is to hold intermediate-term bond funds, which nicely balance interest rate (duration) risk and return. If you look at yield curves these days, you're not being compensated very well for taking increased duration risk. 2.92% 30 day yield on VCLAX vs 2.49% for VCADX.
Thanks for the reply. Well, another way of phrasing it is that it’s a 17% yield increase for 30% higher duration. Given that duration risk has a potential upside as well, it doesn’t seem totally negligible.

I guess the underlying thing I’m confused about is how much I can trust the duration to stick to a target over time. Ideally I’d specify an average target duration in my IPS and then hold the funds to meet it. But seeing this abnormally low duration for so-called “long-term bonds” makes me question if this is up in the air and not reasonable to target — for example because munis might not be issuing enough long-term bonds in particular market conditions.

The 7 years duration per se is not that scary to me. But if I choose VCLAX as a “slightly juiced-up intermediate muni”, is it possible it will evolve into a true long-term muni fund and make me take more risk than I thought I was taking?

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Cyclesafe
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Re: Which Vanguard California Muni fund?

Post by Cyclesafe » Wed Dec 12, 2018 5:03 pm

One consideration is that many munis are callable. When interest rates came down, I expect bonds with higher coupons - especially longer term bonds - were called.
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Steadfast
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Re: Which Vanguard California Muni fund?

Post by Steadfast » Thu Dec 13, 2018 1:50 pm

bluquark wrote:
Wed Dec 12, 2018 4:53 pm
Steadfast wrote:
Wed Dec 12, 2018 4:38 pm
I don't think you're missing anything important. The durations of these funds will vary a bit from time to time, and right now, they're a bit closer.

The general advice here is to hold intermediate-term bond funds, which nicely balance interest rate (duration) risk and return. If you look at yield curves these days, you're not being compensated very well for taking increased duration risk. 2.92% 30 day yield on VCLAX vs 2.49% for VCADX.
Thanks for the reply. Well, another way of phrasing it is that it’s a 17% yield increase for 30% higher duration. Given that duration risk has a potential upside as well, it doesn’t seem totally negligible.

I guess the underlying thing I’m confused about is how much I can trust the duration to stick to a target over time. Ideally I’d specify an average target duration in my IPS and then hold the funds to meet it. But seeing this abnormally low duration for so-called “long-term bonds” makes me question if this is up in the air and not reasonable to target — for example because munis might not be issuing enough long-term bonds in particular market conditions.

The 7 years duration per se is not that scary to me. But if I choose VCLAX as a “slightly juiced-up intermediate muni”, is it possible it will evolve into a true long-term muni fund and make me take more risk than I thought I was taking?
I think it's possible that the long term fund could extend its current average duration. I would read the prospectus to figure out what their strategy and constraints are. I just use the intermediate fund and don't worry about maximizing yield. I guess you could use both funds in whatever proportion you deem appropriate.
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Re: Which Vanguard California Muni fund?

Post by grabiner » Thu Dec 13, 2018 9:44 pm

bluquark wrote:
Tue Dec 11, 2018 8:52 pm
I'm trying to decide whether to use VCLAX ("Long-Term California tax exempt") or VCADX ("Intermediate-Term California tax exempt"). I see they have the following properties:

VCLAX: Average maturity 17.1 years, average duration 7.3 years
VCADX: Average maturity 9.1 years, average duration 5.5 years

I read in a few places that "duration" is the only one that matters and stated maturity is basically just an irrelevant factoid.
This is not quite the case with municipal bonds, because most munis are callable. Increasing rates decrease the probability of calls, and thus increase the duration. Thus, the fund with a 7.3-year duration might lose 0.73% if rates rise by 0.1%, but 8.3% rather than 7.3% if rates rise by 1% because the duration averaged 8.3 during the rate rise and is 9.3 at the end. It is slightly riskier than the duration indicates.

This phenomenon is known as negative convexity. It works against you in both directions, as durations decrease when rates fall and increase when they rise. Investors don't like it, and thus demand higher yields on bonds with negative convexity. This accounts for the higher yield on long-term munis, and also on GNMAs, which have a similar effect because homeowners will refinance mortgages when rates fall.
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