The Vanguard High-Yield Tax-Exempt fund (VWAHX) is “one of the best more adventurous” offerings for long-term municipal bonds, according to Morningstar Yet for Vanguard’s Mat Kiselak, the fund’s name doesn’t necessarily do it justice — and he disagrees with the term “adventurous.” Instead, it’s more of a hybrid product, he said. The fund invests at least 80% of its assets in investment-grade municipal bonds, and only up to 20% in those below investment grade. Bonds rated BBB- or Baa3 and above are considered investment grade. “Everything we do in this fund is by design and is disciplined,” said Kiselak, the fund’s portfolio manager. Municipal bonds are issued by government entities, such as a city or state, and raise money for public projects, such as building roads or schools. They are generally free of federal income taxes on interest and may avoid state and local levies, depending on where you live. VWAHX 1Y mountain Vanguard High-Yield Tax-Exempt fund The fund, which trades under the ticker VWAHX, currently has a 30-day SEC yield exceeding 4%. Add in the tax advantage for those in the 37% federal income tax bracket, and the yield gets closer to 7%, he said. The fund has earned a five-star rating from Morningstar. “Vanguard High Yield Tax-Exempt Bond continues to be one of the strongest candidates for straightforward exposure with slightly more risk to the long end of the municipal market,” Morningstar associate analyst Elizabeth Templeton wrote in March. VWAHX has a total of $14.6 billion in net assets as of May 31 and an expense ratio of 0.17%. It has a total return of 3.87%, according to FactSet. Its minimum initial investment is $3,000. While it has no limitations on the maturity of individual securities, it is expected to maintain a dollar-weighted average maturity of 10 years to 25 years. “It gets really, really attractive to be out on the curve,” Kiselak said. After the muni market’s runup in 2021 and rout in 2022 , it has now become more of a natural environment, he said. “The market has a tendency to get overdone to the cheap side and that is what we found,” he said. “It was a great opportunity to add risk.” Yet, even with below investment grade assets, Vanguard does its due diligence with a team of experts vetting each potential holding. “We are not risk averse, but we are very opportunistic about how we apply our risk,” Kiselak explained. “We can afford to be ultra-selective.” Jeff DeMaso, founder and editor of the newsletter “The Independent Vanguard Adviser,” said it is a great fund for investors who are focused on income. “They just want the highest level of tax-free income that they can get, and they are not worried about volatility, and they are not going to be thrown off by the fund declining in price,” said DeMaso, who has a hold rating on the fund. Indeed, longer-dated bonds are more sensitive to changes in interest rates, and their prices are more likely to fluctuate as a result. This is known as duration risk and it factors in a bond’s maturity, yield and coupon. Bond yields move opposite to their prices. Opportunity in health care Health-care muni bonds make up about 15% of the fund, Kiselak said. Generally speaking, health-care munis, mainly BBBs, have underperformed a bit because of supply side issues with labor and inflation, he said. Now that the team has sifted through the issues, they are focusing on what they like for the long haul. “Now we see an opportunity,” Kiselak said. He’s now selectively adding BBB-rated health-care munis. Exposure to Puerto Rico The fund also has some exposure to Puerto Rico bonds. In 2022, the island’s government formally exited bankruptcy after completing the restructuring of more than $70 billion in debt. VWAHX had exited the Puerto Rico trade eight years ago after analysts felt they couldn’t do their due diligence due to lack of information and lack of trust. Now, Kiselak says the fundamentals, like the reduction in debt, are much better than they used to be. “At this point we feel we are being compensated for the risk and then some,” he said. “We expect it at some point to make investment grade.” Preparing for a recession The team is also starting to think about a potential recession and how that may affect their holdings. “We have a tendency of lightening up on credit in certain segments of the market we think are impacted when the economy slows down,” Kiselak said. That typically means focusing on more high-quality types of bonds, like water, sewer, education and general obligation, he said. General obligation bonds are supported by the taxing authority of the government entity issuing them. Further, health care is also not an area that tends to be affected during a slowdown, Kiselak added.
