Now that interest rates have moved up, however, some investors are fleeing municipal bonds anticipating carnage in the asset class. Funds holding municipal bonds continue to see huge outflows, with $11.8 billion leaving the sector in August, according to Morningstar estimates.
However, the municipal bond market is certainly not as liquid as the stock market, so all this rushing for the exits might be creating some values.
The fact remains that bonds are necessary for portfolio diversification, and many investors in higher tax brackets can benefit from the fact that all income is free of federal taxation. For instance, the Vanguard High-Yield Tax Exempt (VWAHX) sports a yield of 4.3% based on last month’s distribution and closing share price, which means an investor in the 33% tax bracket would have to find a taxable bond yield of 6.4% to match this payout.
Predicting the future of interest rates is way above my pay grade, but the attractive yield offered by some of these municipal bond funds is quite compelling. Also, funds that specialize in intermediate-term bonds have appeal from a yield perspective, but are not as sensitive to rising interest rates.
Here are three funds to consider:
Vanguard High-Yield Tax Exempt
Vanguard High-Yield Tax Exempt (VWAHX) is not exactly what its name would imply. This municipal bond fund invests primarily in munibonds that have an average credit quality of Baa or higher.
Some investors see the words “high yield” and think “junk bonds,” which is not the case at all. Strong evaluation of risk has helped this fund offer compelling yield over time paired with manageable risk. Average maturity of the portfolio’s municipal bonds recently stood at 9.4 years with a duration of 7.3 years.
Vanguard’s fund currently offers an SEC yield of 3.9% (but, as mentioned before, a 4.3% yield based on last month’s distribution). The increase in yield has been brought about by a slight increase in the fund’s monthly distribution paired with declining bond prices.
The fund is down 3.7% YTD but has returned an annualized 4.5% during the past 10 years, according to Morningstar.
VWAHX currently has $6.8 billion in assets. Minimum investment is $3,000, and expenses are a low 0.2%, or $20 for every $10,000 invested.
Vanguard Intermediate-Term Tax-Exempt
Vanguard Intermediate-Term Tax-Exempt (VWITX) is a more conservative option than VWAHX and generally tends to invest in higher-quality bonds.
This municipal bond fund’s portfolio consists of an amazing 4,003 bonds, which illustrates its diversification, and it’s quite large in size with $34.2 billion under management.
Currently, the fund has an SEC yield of 2.6% and average maturity of 5.8 years, with duration recently at 5.6 years.
VWITX is down 2.2% YTD, but has advanced 4% annually during the past decade. The top two sectors represented here are state and local general obligation bonds and education bonds.
Expenses are low at 0.2% annually, and VWITX also requires a $3,000 minimum.
Fidelity Intermediate Municipal Income
Fidelity Intermediate Municipal Income (FLTMX) is also a worthy choice, featuring a bias toward high-quality bonds, with most of its bonds rated either A or AA in quality. Average maturity is 5.7 years, with duration currently 5.6 years.
Fidelity has greatly expanded into fixed-income products over the past few years, and this municipal bond fund is evidence of that. FLTMX is down 1.8% YTD, but has returned a solid 3.9% over the last 10 years.
FLTMX has a higher minimum than the two Vanguard funds, at $10,000, and its expense ratio is slightly higher, too, at 0.37%.
As of this writing, Bill Wysor was long VWAHX.