Vanguard municipal bond fund tracking error

From Bogleheads
Jump to navigation Jump to search


Vanguard municipal bond fund tracking error measures Vanguard's investment management performance.

Tracking error is one means of measuring active manager performance against an appropriate market index. Vanguard's national municipal bond funds are actively managed, defined asset class funds. The funds include four municipal bond funds structured across four bond maturity levels: short, limited, intermediate, and long term bonds. In addition to these four portfolios, Vanguard manages state specific municipal bond funds and a high yield municipal bond fund.

The municipal bond market

The municipal bond market is a very large market, with many illiquid securities. The following table shows the number of securities held by the funds and by municipal bond benchmark indices. The comparative indices include the Bloomberg Barclays Capital 1 Year Municipal Bond Index; the Bloomberg Barclays Capital 1-5 Year Municipal Bond Index; the Bloomberg Barclays Capital 1-15 Year Municipal Bond Index; the broad market is represented by the Bloomberg Barclays Capital Municipal Bond Index.


Table. Municipal Bond Market
Fund Date Fund securities Comparative index securities Broad index securities
Vanguard Short-Term Tax Exempt Fund 12/31/2014 1637 3622 46,179
Vanguard Limited-Term Tax Exempt Fund 12/31/2014 2724 14,907 46,179
Vanguard Intermediate-Term Tax Exempt Fund 12/31/2014 4465 37,500 46,179
Vanguard Long-Term Tax Exempt Fund 12/31/2014 1212 46,179 46,179

Tracking error

While Vanguard's municipal bond funds have tended to closely track index returns over longer holding periods, the 2007-2010 financial crisis produced volatile and high tracking errors for the funds: Short term fund -1.54%; Limited term -0.84%; Intermediate term -1.56%; and Long term -1.62%. The 2008 financial crisis was marked by the following disruptions in municipal market fundamentals:

  1. In 2008, first a freezing up of funding in the auction-rate securities market; later in the year investors saw the downgrading to junk status of most municipal bond insurers, with a coincident downward repricing of insured municipal bonds. On December 12, 2008, in response to the virtual disappearance of bond insurance, Vanguard merged it's insured long term municipal bond fund into its long term municipal bond fund. [1]
  2. Late in 2008, large sales imbalances in the marketplace due to institutional selling of municipal securities to meet obligations backed by defaulted mortgage securities;
  3. In 2010 a surge in supply of new municipal securities due to the impending termination of the Build America Bond program. [2]

The table below provides long term average tracking errors for Vanguard's municipal bond funds. Admiral share class data covers the period from 2002 (the first full year of operations of the share class) to the present. In 2012 Vanguard changed the funds' benchmark indexes and retrofitted the time series for each fund's relative performance.[note 1]


Table. Vanguard Municipal Bond Fund Tracking Errors [3]
Fund Investor shares Admiral shares
Year Tracking Error Year Tracking Error
Vanguard Short-Term Tax Exempt Fund [note 2]
Investor Admiral
1998-2014 -0.24% 2002-2014 -0.03%
Vanguard Limited-Term Tax Exempt Fund [note 3]
Investor Admiral
2001-2014 -0.48% 2002-2014 -0.45%
Vanguard Intermediate-Term Tax Exempt Fund [note 4]
Investor Admiral
2003-2014 -0.11% 2006-2014 -0.16%
Vanguard Long-Term Tax Exempt Fund [note 5]
Investor Admiral
1998-2014 -0.07% 2002-2014 0.07%


The relative performance of investor and admiral share classes can be best illustrated by viewing performance over a common holding period. The following table examines the average tracking error performance of each fund over the period beginning with the first full year of admiral share performance to the present. The lower expense admiral shares provide for lower tracking errors to benchmark performance. [note 6]


Table. Vanguard Municipal Fund Investor/Admiral share Tracking Errors
Fund Years Investor share
tracking error
Admiral share
tracking error
Vanguard Short-Term Tax Exempt Fund 2002-2014 -0.14% -0.04%
Vanguard Limited-Term Tax Exempt Fund 2002-2014 -0.47% -0.40%
Vanguard Intermediate-Term Tax Exempt Fund 2002-2014 -0.22% -0.15%
Vanguard Long-Term Tax Exempt Fund 2002-2014 -0.01% 0.07%

Vanguard municipal funds vs. municipal bond etfs

The advent of the exchange-traded fund gives investors access to indexed municipal bond portfolios. In January 2015, Vanguard joined the ranks of firms offering municipal bond ETF's with the creation of its first municipal bond exchange-traded fund, the Vanguard Tax-Exempt Bond Index Fund, designed to track the S&P National AMT Free Municipal Bond Index. The fund, which also offers mutual fund shares, became available on August 8, 2015.[4]

The following table provides a comparison of Vanguard actively managed defined asset class municipal bond funds with comparable indexed ETF funds from iShares® and SPDR®s.

Key points when comparing fund results:

  1. The Vanguard municipal funds are benchmarked to Bloomberg Barclays Capital municipal bond indices. IShares ETFs are benchmarked to S&P national AMT free municipal bond indices. SPDR ETFs are benchmarked to Bloomberg Barclays Capital Managed Money Municipal indices. The indices, while measuring similar segments of the municipal market, will provide different returns to investors. This is measured by index return dispersion, which can, at times, be considerable. In this instance, much of the return dispersion is due to the fact that the benchmark indices have different average modified durations.[note 7]
  1. A fund's expected tracking error is the net return after costs. The Vanguard funds have average expense ratios of 0.20% (lower cost admiral shares are available for a $50,000 minimum fund account balance). SPDRs have average expense ratios of 0.23% plus potential transaction costs (commissions, spreads, discount/premium) borne by the individual investor. IShares ETFs have average expense ratios of 0.25%, plus potential transaction costs (commissions, spreads, discount/premium) borne by the individual investor.
  2. The iShares market returns (see second tab in Table 5.) have been slightly lower than the net asset value return. The market returns for SPDRs have been higher than net asset returns for the short term fund and lower for the long term fund (see the fourth tab in Table 5.)
  3. The Vanguard funds' active management should result in higher variability in tracking error.
  4. IShares, SPDRs, and Vanguard municipal funds all hold more bond issues than do most other available municipal bond ETFs.[5]
  5. Both IShares and SPDRs ETFs track benchmarks which exclude private activity bonds subject to the alternative minimum tax (AMT). Vanguard's funds are allowed to invest up to 20% of net assets in private activity bonds subject to the AMT. [6]
Table.


(View Google Spreadsheet in browser, then File --> Download as to download the file.)
Note: If the spreadsheet is blank, select a different sheet, then back to that sheet. The image will be refreshed.

Notes

  1. Since 2000 Vanguard, in its annual reports, has reported the "most comparative benchmark" for each of the funds; prior to 2000 Vanguard measured all funds against the broad Municipal Bond Index. In 2012 Vanguard changed each fund's benchmark index.
    Table. Municipal Bond Market
    Fund Former Benchmark New Benchmark Retrofitted time series
    Vanguard Short-Term Tax Exempt Fund Barclays 3 year Municipal Bond Index Bloomberg Barclays 1 year Municipal Bond Index 1998-forward
    Vanguard Limited-Term Tax Exempt Fund Barclays 3 year Municipal Bond Index Bloomberg Barclays 1-5 year Municipal Bond Index 2001-forward
    Vanguard Intermediate-Term Tax Exempt Fund Barclays 7 year Municipal Bond Index Bloomberg Barclays 1-15 year Municipal Bond Index 2003-forward
    Vanguard Long-Term Tax Exempt Fund Barclays 10 year Municipal Bond Index Bloomberg Barclays Municipal Bond Index 1998-forward
  2. Vanguard Short-Term Tax Exempt Fund

    (View Google Spreadsheet in browser, then File --> Download as to download the file.)

    Note: If the spreadsheet is blank, select a different sheet, then back to that sheet. The image will be refreshed.

  3. Vanguard Limited-Term Tax Exempt Fund

    (View Google Spreadsheet in browser, then File --> Download as to download the file.)

    Note: If the spreadsheet is blank, select a different sheet, then back to that sheet. The image will be refreshed.

  4. Vanguard Intermediate-Term Tax Exempt Fund

    (View Google Spreadsheet in browser, then File --> Download as to download the file.)

    Note: If the spreadsheet is blank, select a different sheet, then back to that sheet. The image will be refreshed.

  5. Vanguard Long-Term Tax ExemptFund

    (View Google Spreadsheet in browser, then File --> Download as to download the file.)

    Note: If the spreadsheet is blank, select a different sheet, then back to that sheet. The image will be refreshed.

  6. Admiral shares of municipal bond funds require a $50,000 minimum investment.
  7. Effective durations are available from each fund's web report. As of 12/31/2014, the funds have the following effective durations:
    Short term funds:
    • iShares: 2.07 years
    • SPDR: 2.91 years
    • Vanguard: 2.50 years
    Long term funds:
    • iShares: 6.35 years
    • SPDR: 7.38 years
    • Vanguard: 6.00 years

References

  1. Vanguard 2008 Annual Report
  2. Annette Thau, How Safe Are Municipal Bonds, AAII Journal, March 2011, p. 24.
  3. All return data for this and all other tables is derived from the Vanguard website, individual fund pages, SEC N-CSR filings, and SEC N-30D filings
  4. Chappatta, Brian (Jan 6, 2015). "Vanguard Set to Offer Its First Muni-Bond ETF on Tax-Free Appeal". http://www.bloomberg.com/news/2015-01-06/vanguard-set-to-offer-its-first-muni-bond-etf-on-tax-free-appeal.html. Retrieved 27 January 2015.
  5. see commentary in Rick Ferri: Managing The Biggest Risk Of All.
  6. Alternative Minimum tax disclosure:

External links