Municipal Funds Veer From Safety to Danger

To maintain its ladder, Thornburg does little trading. Instead, the fund typically buys long bonds and holds them until they mature. Then the fund takes the principal from the matured bonds and reinvests in more long issues.

In today's market, Thornburg is able to put its cash to work in high-yielding long bonds. That provides an edge over funds focused on shorter maturities. "We have a steady source of cash that is enabling us to buy attractive bonds," says portfolio manager Christopher Ihlefeld.

No matter how markets fare going forward, one of the top performers is likely to be Vanguard Intermediate-Term Tax Exempt(VWITX Quote). In up and down years, the fund has usually finished in the top half of its category. The success is due to Vanguard's customary low fees.

While rock-bottom expenses benefit all Vanguard funds, costs are particularly important for municipal portfolios because the yields and returns in the category are relatively low. Consider that during the past decade, Vanguard Intermediate-Term has returned 3.8% annually, compared to 3.3% for its average peer. That gap can be explained by fees, because Vanguard charges a tiny expense ratio of 0.15%, compared with 0.92% for its average competitor.

High costs can be a special drag for bond funds because the fees are subtracted directly from yields. To compensate for their hefty expenses, some funds own riskier bonds that offer higher yields. But Vanguard Intermediate-Term has no reason to dabble with shaky bonds or complicated trading strategies.

Instead, the fund keeps most of its assets in bonds rated AA or AAA. That cautious approach helped protect shareholders this year and should continue generating competitive results when calm returns to the bond markets.