triple-A rated local and state governments borrow money
— and less-solvent ones, too — investors who buy
their bonds typically enjoy federal, state, and local
tax exemptions on bond income.
think the tax breaks would give these governments an
advantage, letting them sell debt extra cheap, compared
with taxable bonds — because muni yields plus tax
benefits should tend to equal taxable yields, for
borrowers with comparable risk, says Alan Schankel,
managing director and municipal bond strategist at
Janney Montgomery Scott in Philadelphia.
that’s not what always happens with the bond funds
that many investors use to buy into the market. To the
contrary: Vanguard Group’s Long-Term Tax Exempt
municipal bond fund has typically posted higher yields
than its Total Bond Market Index funds, or even U.S.
Treasury-based funds, since the last big financial
markets crisis in the late 2000s, according to monthly
SEC yield data. Bond people argue about why this is —
the slow real estate recovery in many areas, Detroit’s
bankruptcy, Puerto Rico’s default, state pension
deficits, federal highway funding gaps — but towns and
states have had to pay more to borrow, and that has
boosted muni yields.
yet, Vanguard is cautious about herding customers into
muni-bond portfolios. Indeed, the Malvern, Pa.-based
fund giant, which last year took in a billion dollars a
day and boosted managed assets above $5 trillion, last
month took the occasion of the Trump tax cuts to issue
new instructions to the reps who run its largely
automated Personal Advisor Services (PAS) fee accounts,
guiding more savings into taxable bond funds, instead of
not just about which pays more, Vanguard argued:
"Since municipal bonds represent a relatively small
and less-diversified sector of the larger bond market,
investors should require clear and compelling tax
savings when substituting munis for taxable bonds,"
according to an internal memo last month from Vanguard’s
Investment Strategy Group (ISG) to its Personal Advisor
Services (PAS) reps, who manage partly automated
advisory accounts for Vanguard investors that pay a fee
for the service.
the new tax law, Vanguard added, has made taxable bonds
the right choice for more investors. Even if muni fund
yields, for now, remain higher than similar-rated
taxable bond funds.
the past, reviewing the spreads between taxable bonds
and tax-free munis over a period of more than 25 years,
Vanguard recommended that investors taxed at the old 28
percent marginal tax bracket, and above, buy some muni
funds instead of taxable-bond funds. The tax exemption,
for these investors would at least compensate for the
fact that munis in the past tended to yield lower
"after analyzing the new tax brackets, ISG’s most
recent guidance indicates a threshold of 32 percent as
being the appropriate ‘breakpoint’ for municipal
bond purchase going forward," according to the
memo. So, new and "rebal" (rebalancing)
investors earning as little as $91,000 (for single
investors) up to as much as $305,000 for couples will
now be directed toward taxable bond portfolios.
so certain? "Long-term trends indicate that taxable
bonds have had historically higher yields," Emily
M. Farrell, head of U.S. business public relations at
Vanguard, told me. "While it is true that muni
bonds can yield more than taxable bonds at certain
points of time, we have long cautioned investors against
making tactical shifts, particularly when we expect
markets to revert back to the long-term trend."
like stocks, should eventually regress to the old mean,
the argument goes. Wait around, and you should be glad
you stuck with the trend.
— and can — Vanguard’s largely automated advisory
service be flexible enough to note that munis are
currently yielding more than equivalent high-quality
taxable bonds — especially in states like New York and
California, where high tax rates, and recent federal
limits on state-and-local income tax deductions, hit
some investors extra hard?
all reads as standardization-over-customization even if
it isn’t in the client’s best interest," Dan
Wiener, publisher of the Independent Adviser for
Vanguard Investors newsletter, which sells advice to
people choosing Vanguard funds in competition with the
company’s own advisory services, told me when I ran
the language past him.
course Vanguard "is absolutely correct that
tax-equivalent yields are important comparisons,"
Wiener added. But de-emphasizing munis despite years of
higher returns makes it’s easy for investors to wonder
if the long-term strategy fits the investor’s needs as
well as the adviser’s: "This policy goes to the
heart of why you can’t just assume the robo advisers
are really working on your behalf. Sometimes their
policies are designed to make it efficient to run the
system" whether or not it maximizes investor
or no, it would be wrong to think a Vanguard advisory
client is locked into one approach, Vanguard says.
"A key element of Personal Advisor (Services) is
ongoing engagement with a human adviser," who could
agree a particular client might be better off with munis,
Vanguard spokeswoman Farrell told me in an email.
"These types of portfolio decisions are made in
consultation with the client, and customized in
deference to individual preferences, unique tax
situations, and/or concerns about capital
private advisers — who, like Wiener, compete against
automated services like Vanguard’s — agreed there
are considerations besides yield to keep in mind, even
at the low rates currently paid by creditworthy bond
we are in an opportunity where munis provide risk and
returns that outstrip, for example, a U.S.
Treasury" bond portfolio, said Terry J. Siman, who
heads the Philadelphia office of $22 billion-asset,
California-based United Capital. "But honestly, the
delta (interest-rate spread) that we are talking about
is nominal. It’s not all that meaningful in an overall
portfolio. The notion that robo-advisory clients are
being cookie-cuttered — while true — that’s what
people should expect from an automated service,"
along with low fees. "That’s a fair trade."
the end, bond preferences are also a question of
strategy; for example, more-volatile taxable bonds are
in vogue among advisers when prices are rising, says
Matt Fabian, partner at Connecticut-based Money Market
Analytics. "Are you looking to provide total return
— coupon income plus capital gains — or just
after-tax income? Most brokers these days prefer the
latter, since the price direction of, really, everything
has become so uncertain."