Buy Side

Vanguard Takes Low-Fee Road With ETFs

Vanguard is jumping into the municipal bond exchange-traded fund fray, proposing to launch three muni ETFs with the lowest fees in the industry.

The Valley Forge, Pa.-based asset manager filed a prospectus with the Securities and Exchange Commission yesterday registering three passively ­managed muni funds.

The objective of the funds is not novel: they will try to replicate indexes that track the performances of certain sectors of municipal bonds.

What is new is the proposed fees Vanguard will charge: just 12 cents out of every $100 in fund assets annually.

While expenses across municipal ETFs are not always precisely comparable because of differences in size and mission, a 0.12% expense ratio is far lower than any competing product.

iShares, which manages more than a third of the muni ETF industry’s assets, charges either 25 or 30 cents per $100 of assets for its 10 funds — more than double the fees on the three proposed Vanguard funds.

State Street Global ­Advisors, the second-biggest municipal ETF manager, charges 20 cents per $100 for its five tax-exempt ETFs, and 30 cents for its taxable muni ETF.

The weighted average fee for the industry’s funds is roughly 25 cents per $100. Fees range from 20 cents to 35 cents per $100 of assets.

“Vanguard provides services to the funds on an at-cost basis, charging only what is necessary to provide high-quality investment management, ­administrative, and shareholder services,” a company spokesperson said in an e-mail, in reply to a question about how the firm can charge lower fees than everyone else. “The result is lower expenses on our funds.”

Each of the three new Vanguard funds will seek to replicate the performance of an index. The target indexes are the ­Standard & Poor’s National 1-5 Year AMT-Free Municipal Bond Index, the Standard & Poor’s National ­Intermediate AMT-Free Municipal Bond Index, and the Standard & Poor’s National Long AMT-Free Municipal Bond Index.

ETFs seek to mimic the performance of an index through a process known as ­representative sampling. This entails ­populating a portfolio with a sample of bonds that in aggregate match the risk characteristics of the broader index.

ETFs trade publicly and their asset values are updated daily by a pricing service. The goal is for the trading price of the fund to match the asset value, and for the asset value to match the target index, as closely as possible.

The indexes these three funds seek to mirror track tax-exempt municipal bonds with maturities of one to five years, five to 15 years, and 10 to 25 years.

The first municipal ETFs came to ­market late in 2007. According to the Investment Company Institute, there were 28 muni ETFs at the end of April with $6.94 billion in assets.

With only a few dozen funds, the muni ETF space is diverse. Aside from funds aping broad, plain-vanilla bond indexes, there are funds tracking short-term ­floating-rate debt and prerefunded ­municipal bonds supported by cash flows from escrowed Treasuries. There are funds dedicated to bonds issued by governments in California and New York, and there are funds with specific target-maturity dates.

While most municipal ETFs’ goal is to replicate a target index, a handful — notably two from Pacific Investment ­Management Co. — try to beat their ­target indexes.

Two funds mimic indexes tracking Build America Bonds — the taxable municipal security created under last year’s stimulus legislation — and a third is on the way.

Muni ETFs are as big as the iShares S&P National AMT-Free Fund with $1.95 billion in assets, and as small as the Grail McDonnell Municipal Bond ETF with $2.5 million in assets.

Dividend yields range from 0.36% on the Invesco PowerShares VRDO Tax-Free Weekly to 5.82% on Van Eck Global’s Market Vectors high-yield fund.

Depending on the target index, most municipal funds were doing well until the market hiccup that began last month.

For instance, the iShares S&P National Fund at the end of May was up 1.9% for the year and 5.2% since the beginning of 2009. It has since pulled back a bit to less than 1% amid a mild sell-off in ­municipals.

The Vanguard spokesperson said the company’s municipal ETFs are intended to appeal to financial advisers, institutions, and retail investors.

The new muni funds are part of a broader offering of 19 funds Vanguard announced Thursday, including 16 equity ETFs.

Citing data from Lipper, Vanguard said its average exchange-traded fund expense ratio is 0.18%, compared with an industry average of 0.52%.

Vanguard manages 46 ETFs with more than $100 billion in assets.


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