Despite what its name might suggest, Vanguard is not the exchange-traded fund issuer you go to when racing to the newest in ETF innovation. But the firm comes out ahead in other ways. Let's see with its newest fund.
Given the company's history and position in the ETF landscape, Vanguard can't necessarily be blamed for not jumping into that race of cutting edge ETFs. If there is any race it's winning, however, it is the race to zero -- fees that is. Let's look at a new income-focused fund that Vanguard launched days ago, the Vanguard Short-Term Tax-Exempt Bond ETF (VTES) .
The firm already has the Vanguard Tax-Exempt Bond ETF (VTEB) , which provides national municipal debt exposure. That fund has a close to 14 year maturity and a 5.4 year duration. My guess is Vanguard felt that in this current rate environment having a shorter maturity and duration product would be beneficial to investors and so, launched
VTES
The fund sports a 7-basis point expense ratio, meaning that a shareholder with $1,000 invested over a calendar year would pay just $0.70 in fees over that period. The fund is billed as an index fund and tracks the S&P 0-7 Year National AMT-Free Municipal Bond Index. The index is fairly straightforward, and per the methodology guide looks to include bonds that are rated at least BBB- (investment grade) although any bonds that are pre-refunded are treated as investment grade. A pre-refunded bond is one that the issuer has already put an amount equal to the borrowed principal in escrow to cover the repayment of the bond at maturity. The index considers bonds issued only by states (and the District of Columbia) so bonds issued by any territories, including Puerto Rico are not eligible for inclusion. There are other criteria regarding individual bond deal sizes and par amounts but, I'm not going to go into all that detail here.
Why, you may ask?
Because, while fixed income index funds -- regardless of fund type track an index -- do not (with the exception of Treasury indexes funds) recreate the index bond for bonds the same way an equity index fund replicates its underlying index. As described in the prospectus, the fund "invests by sampling the Index, meaning that it holds a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics."
It goes on to say that at least 80% of the securities held in the fund will be from the list of index constituents. Again, this is not unique to VTES and is common practice across fixed income in general. You may recall I talked about the OTC nature of bond trading and pricing in an earlier article. Vanguard uses third-party ICE Data Services as its bond valuation provider for this fund.
What fixed-income funds look to do is recreate certain key characteristics of the index they are tracking, namely credit quality, maturity, duration, and yield. In the case of the underlying index here, it contains about 4,440 bonds with an average maturity of just over 3 years, a modified duration of 2.4 years, and a yield to maturity of 3.10%. VTES currently has 251 holdings and while the fund is too new to have any month-end statistics I would expect the profile to closely resemble the index.
Wrap it Up
While VTES has yet to publish month-end figures, I was able to scrape current holdings from the website and run some geographic exposure numbers. Roughly half the fund -- by both the number of bonds and weight -- is invested in 5 states including California, New York, Texas, Illinois, and Maryland. In all, 35 states and 140 individual municipalities are represented in the portfolio including public works projects, school districts, and state university systems among others.
Unlike other issuers, Vanguard doesn't stray too far from what it does best, which is delivering low-cost funds to bring investors broad market exposures. This addition to their municipal bond product suite does just that.
