Vanguard High-Yield Tax-Exempt: Don’t Call It Junk

Names can be deceiving. French fries aren’t really French, and Vanguard High-Yield Tax-Exempt fund (symbol VWAHX) isn’t a high-yield bond mutual fund. In the bond investing world, the words high yield are interchangeable with junk—meaning bond issues rated below investment grade that pay high yields and come with an elevated risk of default. Vanguard High-Yield’s peer group, however, is muni bond funds with long maturities. Though the fund’s 15% stake in junk-rated or unrated muni debt is higher than the category average of roughly 4.5%, the typical fund in the actual high-yield muni category has 10 times that much—45%—in junk and unrated bonds.

The remainder of the fund’s assets are in investment-grade issues. Its yield is a generous 2.3%, which, because income from municipal bonds is exempt from federal taxes, is the equivalent of a 3.9% yield for investors in the highest federal tax bracket.

Should interest rates remain low, the muni market is a relatively safe place to hunt for yield, says Mathew Kiselak, who’s helmed the fund since 2010. In the 10 years through 2016, muni bonds defaulted only 0.18% of the time, compared with a 1.74% default rate for corporate bonds. Even so, the fund’s portfolio is built with a watchful eye toward risk.

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Portfolio construction starts with a custom benchmark modeled on the Bloomberg Barclays Municipal index, with a tilt toward lower-quality, higher-yielding names. From there, Kiselak relies on input from Vanguard’s extensive muni bond team. In 2019, the fund began shifting assets from single-A-rated bonds to higher-quality, double-A-rated debt. Within the fund’s slug of triple-B-rated debt (one step above junk and 22% of assets), the team favors bonds backed by revenues from essential services, such as airports, hospitals and toll roads, all of which are unlikely to fare poorly even in a recession.

Low costs allow the fund to deliver nice returns without wading deep into junky waters. The 0.17% expense ratio is less than a third of the average for similar funds. Over the past decade, the fund’s 5.3% annualized return bested 91% of peer funds. The fund has beaten the Bloomberg Barclays muni index in nine of the past 10 calendar years.