What to Expect From the Vanguard Ultra-Short-Term Bond Fund

The fund wonbe a money market fund but also won't be your typical short-term bond fund

Vanguard intends to launch an actively managed Ultra-Short-Term Bond fund in February with a weighted maturity of zero to two years. At least 65% of the portfolio will be in high-quality bonds, but it will also be allowed to invest as much as 30% of assets in “medium-quality” bonds according to the preliminary prospectus. The managers have the option of putting 5% of the portfolio into non-investment-grade bonds as well.

VanguardVanguard already has an ultra-short-term muni fund — Vanguard Short-Term Tax-Exempt Fund (VWSTX). This new fund complements it on the taxable, investment-grade side of the ledger.

What’s most interesting about this new option is not that Vanguard is finally offering a low-risk way of dealing with rising interest rates, but that it has argued for some time that risks of investing in short-term or even intermediate-term bond funds are mitigated by the value of rising monthly distributions — particularly when they are reinvested. The appeal of an ultra-short bond fund will probably be for those investors taking income distributions out of their holdings rather than reinvesting. Price moves will be small and yields should rise at a decent rate as interest rates rise.

So, Vanguard’s Ultra-Short-Term is not going to be a money market fund, but it also isn’t going to be your typical short-term bond fund. So, what should investors expect?

Vanguard hasn’t yet said which index it will use to benchmark this new fund, and it could be readying a custom index to suit its purposes, but SPDR Barclays Short Term Corporate Bond ETF (SCPB) may be able to shed some early light on the subject. As the name implies, that Barclays index is made up entirely of corporate bonds and has an average maturity of 0.54 years. I expect Vanguard’s new ultra-short-term fund will be tilted primarily toward corporate bonds, and we already know that it will have a slightly longer average maturity than the Barclays index.

Still, over the past decade through the end of November, the Barclays Short Term Corporate ETF returned 33.1%, or 2.9% annualized. Compare that to the 3.6% annualized return earned by Vanguard Short-Term Investment-Grade Fund Investor Shares (VFSTX) or the 2.1% annualized gain from Short-Term Tax-Exempt Fund — all represent a significant step up from the 1.6% annualized return from Vanguard Prime Money Market Fund (VMMXX).

Looking at the risk side of the equation, the Barclays index’s largest decline was shallow and short-lived — a 2% loss suffered in October 2008 and recovered in just two months. That is closer to Short-Term Tax-Exempt’s decline of 0.5% than Short-Term Investment-Grade’s 7.6% drop. I suspect that Ultra-Short-Term Bond will look much more like a taxable counterpart to Short-Term Tax-Exempt, which I’ve compared to Limited-Term Tax-Exempt in the chart below illustrating the two funds’ historical drawdowns.

20141222 Wiener

Ultra-Short-Term Bond fund shares will sport a 0.2% expense ratio and require a minimum initial investment of $3,000, while the Admiral shares’ expenses will run 0.12% and require a minimum of $50,000.

Ultra-Short-Term Bond’s NAV can and will float. So, it’s not a money market fund, as Vanguard took pains to point out. But risk should be low, and investors who can handle small changes in NAV may indeed find this fund a good alternative to a money market, one that likely will provide more yield and greater returns over time.

Will Ultra-Short-Term Bond debut on schedule? That remains to be seen. In the past few years, Vanguard has cancelled or delayed several new fund launches. Stay tuned.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/12/vanguard-goes-ultra-short/.

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