The tax exempt status of municipal bonds could be in jeopardy as Congress mulls over whether to tax the income from these debt issues. In the meantime, Vanguard has eight ETFs to contemplate when looking to attain muni exposure.
As noted in Investment News, Morningstar data revealed that fixed income ETFs have taken in over $150 billion in inflows through the end of May. Municipal bonds, in particular, have been a compelling option for fixed income investors in the current market environs. Higher credit risk is typically part and parcel for higher yield, but munis have been offering a combination of both credit quality and yield.
As the government looks for ways to increase revenue, the tax-exempt income that munis provide could be on the chopping block. The Urban Institute & Brookings Institution identified the impact of repealing the tax-exempt status of munis. On the plus side, it could create $250 billion in government revenue over the next decade while arguments against it include higher borrowing costs for certain states and cities.
Consequently, the appeal of munis and their tax exempt status could turn investors away, thereby diverting funds that could go to local governments who use the funds to build infrastructure. This could also trigger a muni selloff as investors seek other bonds or assets for higher yields to offset the loss of the tax exemption status. The argument certainly presents a slippery slope that’s left for debate in the White House, but for now, investors can continue to reap the tax-free benefits of munis with ETFs.
Consider These ETFs
For a broad exposure option, consider the Vanguard Tax-Exempt Bond ETF (VTEB). It tracks the Standard & Poor’s National AMT-Free Municipal Bond Index, giving investors exposure to debt issues from state or local governments or agencies whose interests are exempt from U.S. federal income taxes, and the federal alternative minimum tax. It’s a good place to start if investors want an easy, all-encompassing muni ETF option.
For tailored exposure to short-term, intermediate, and long-term bonds, Vanguard offers the following options:
- Vanguard Short-Term Tax-Exempt Bond ETF (VTES): tracks the S&P 0-7 Year National AMT-Free Municipal Bond Index, balancing tax efficiency with tax-exempt yield.
- Vanguard Intermediate-Term Tax-Exempt Bond ETF (VTEI): tracks the S&P Intermediate Term National AMT-Free Municipal Bond Index, and has an average stated maturity of nine years.
- Vanguard Long-Term Tax-Exempt Bond ETF (VTEL): tracks the S&P 10+ Year National AMT-Free Municipal Bond Index. This index encompasses muni bonds with maturities of 10 years or higher, maximizing yield if investors don’t mind the rate risk.
State-Specific Options
The previously mentioned Urban-Brookings Tax Policy Center report mentioned California and New York. Certainly, larger states will bear the brunt of the impact of a tax-exempt repeal for munis in their own respective ways. In the meantime, Vanguard does have tailored muni exposure to these specific states, which are ideal options for their respective residents.
For California, there’s the Vanguard California Tax-Exempt Bond ETF (VTEC). The fund also caters to tax-sensitive investors, and focuses on an intermediate-term time horizon to strike a balance between yield and mitigating rate risk. Heading over to the East Coast, and New York in particular, there’s the Vanguard New York Tax-Exempt Bond ETF (MUNY). The fund tracks the S&P New York AMT-Free Municipal USD10 Million Par Bond Index, focusing on bonds issued by the state of New York.
An Active Pair
Active management has been captivating investors as of late with active funds continuing to garner interest. Fixed income ETFs that implement an active strategy, especially in an uncertain bond market like now, are also getting their fair share of demand. With that, Vanguard has pair of active muni bond funds to look at.
First up is the Vanguard Core Tax-Exempt Bond ETF (VCRM). Like VTEB, VCRM seeks to offer investors an all-encompassing muni bond option albeit the use of an active strategy. Vanguard’s Fixed Income Group can tailor the holdings of the fund to suit the current market environment for added flexibility. Investors leery of active funds as being too expensive can quash that notion as VCRM’s expense ratio comes in at a paltry 0.12%.
The same can be said for the Vanguard Short Duration Tax-Exempt Bond ETF (VSDM). Like VCRM, the fund employs an active strategy, but does the obvious – focus on short duration muni bonds. The fund’s average stated maturity is currently 4.4 years, falling within its target focus of two and seven years.
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