Investing - Theory, News & General • Muni bonds: VTEB vs. VWIUX/VWLUX (and why so much difference in distributions?)

Question: Looking in PV, it appears that intermediate muni funds (e.g. VWIUX) suffered less in the 2022 debacle (i.e.rate increase) than intermediate taxable bond funds, such as VBTLX or VSIGX (TBM or intermediate Treasury). Why?

In 2022, Intermediate-Term Tax-Exempt had its yield increase from 0.86% to 3.26%, Intermediate-Term Treasury had its yield increase from 1.21% to 3.80%, and Total Bond Market had its yield increase from 1.57% to 4.12%. So the muni yield did not increase as much, and the taxable funds also have a longer duration. Even now, with rates having increased, both taxable funds have a longer duration.

The callability effect is more significant for long-term munis, If an intermediate-term fund holds a 10-year callable bond, the bond cannot have its duration increase beyond 10 years (or even to 10 years since duration is less than maturity) even if the call probability becomes zero. In contrast, a 25-year bond callable after 5 years can behave like a 5-year bond (duration close to 5 years) or a 25-year bond (duration likely around 20 years) depending on the call probability.

The other reason munis may be less volatile is that the break-even tax rate should be close to constant. If investors believe the break-even rate to be 25%, then they will buy munis with a 1.5% yield when corporate bonds of comparable risk have a 2% yield. If corporate yields rise to 4%, muni yields need only rise to 3% to remain competitive after-tax. This would cause muni rates to change by only 75% as much as corporate rates. For munis versus Treasuries, the effect would be the same as long as the corporate-versus Treasury risk premium doesn't change.

Statistics: Posted by zero_coupon — Sun Dec 24, 2023 12:09 am — Replies 55 — Views 7390