Plenty of ‘meat on the bone’ in muni bonds, Vanguard portfolio manager says

Bond traders have been worried about “tight spreads” all year, meaning that investors weren’t getting much reward for taking on bonds with more risk than U.S. Treasurys. But Steve McFee, a portfolio manager at Vanguard who focuses on municipal bonds, says fixed income tied to local governments has more attractive pricing than corporate credit, in addition to the tax benefits. “[The corporate credit] market has been quicker to react to what is an attractive environment for fixed income. Our market has been a little slower. So that’s why I say there’s plenty of meat left on the bone for investing in credit munis,” McFee said. Vanguard launched two new municipal bond ETFs on Thursday to help investors take a bite at that opportunity: a Core Tax-Exempt Bond ETF (VCRM) , managed by McFee, and a Short Duration Tax-Exempt Bond ETF (VSDM) . Both funds will be run actively and carry a management fee of 0.12%. Sector outlook Municipal bond funds buy and hold fixed income instruments issued by state and local governments or related entities. One key benefit of the funds is that their income is often tax free, which investors should keep in mind when comparing the yield to other types of bond funds. Tax-equivalent yield is the amount of pretax yield a taxable bond would need to generate in order to be equal to that of a municipal bond. An investor who is in the 32% income tax bracket holding a muni bond with a tax-free yield of 3% would need to find a taxable issue with a 4.41% yield in order to generate the same level of income. State and local governments have been seen as a relatively safe investment since the Covid-19 pandemic, as federal relief and stimulus spending helped shore up budgets around the country. Now several years out from the bulk of those programs, the sector still seems to be on solid footing, McFee said. “Muni fundamentals remain resilient. We’ve come down a little bit from the peak fundamentally, where we saw stimulus flow through the economy during Covid, but we are still very strong fundamentally,” he said. McFee also said that he sees opportunity in municipal bonds that are BBB-rated. These issues are still deemed investment grade by credit agencies but are a little riskier compared to munis with AAA ratings. Munis in 2024 Municipal bonds have been a hot area for investing in 2024. Over the past month, major index funds iShares National Muni Bond ETF (MUB) and Vanguard Tax-Exempt Bond ETF (VTEB) have raked in about $2.2 billion of combined inflows, according to FactSet. Year to date, that number expands to more than $6.7 billion. The big iShares and Vanguard muni funds have each returned about 1.7%, year to date, compared with 1.6% for the iShares Core U.S. Aggregate Bond ETF (AGG) . And Vanguard is not the only asset manager pushing new muni funds into the market. State Street, Goldman Sachs and American Century are among the several firms that have debuted muni ETFs in the second half of 2024.