Munis: High Yield with Low Risk

02/15/2016 9:00 am EST

Focus: FUNDS

For high yield with low risk, consider the debt securities of state and local governments; municipal bonds typically provide tax-free income—at least at the federal level—and offer juicy yields as compensation for bearing greater odds of default, explains Tim Begany in Personal Finance.

Munis are safer than corporate because the government entities that issue them can often raise taxes to avoid default.

In addition, we are steering investors to one of the most conservative high-yield municipal bond investments: Vanguard High-Yield Tax-Exempt (VWAHX).

VWAHX diversifies across more than 1,200 municipal bonds from issuers throughout the US and favors those with the best credit ratings. Municipals rated A or better make up 70% of the fund, more than twice the peer-group average of 33%.

Mathew Kiselak, lead manager since 2010, also boosts returns by stretching duration; VWAHX has a fairly long duration of 6.3 years because it invests heavily in issues maturing in a decade or more.

VWAHX focuses on sectors with histories of stable cash flows, such as highways and bridges that produce toll and other fee revenue, as well as bonds used to fund hospitals and other crucial healthcare projects.

It allocates 10% of assets to bonds issued for education, as this sector is especially reliable when the economy is expanding. Substantial positions come from other safer sectors such as utilities, water infrastructure, and sewers.

The $9.1 billion mutual fund plays it safe but still has a robust tax-free yield and top-notch long-term track record. It’s also extremely cheap to own.

Shareholders currently receive a competitive tax-free yield of 3.67%. If you were in the 33% federal tax bracket, you’d need a taxable yield of nearly 5.5% to get the equivalent of what VWAHX offers on a tax-free basis.

For those in the top federal tax bracket (39.6%), the fund has a taxable-equivalent yield of almost 6.1%.

VWAHX gives away virtually nothing in performance despite taking less risk. Its annualized 6.43% rate of return over the past five years trails the category average by 0.41%, but that’s before expenses.

The fund beats the average because it charges a mere 0.2% of assets, versus the hefty category average of 0.97%.

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