A lot of investors associate Vanguard almost exclusively with low-cost passive indexing on the equity side. But what many people may not realize is that in recent years, Vanguard has also built a fairly robust presence in active fixed income management. In classic Vanguard fashion, though, they have kept the fees on many of these newer active bond ETFs refreshingly low.
Honestly, if some of the old-school bond stalwarts like PIMCO want to stay competitive, I think lowering fees would be a good place to start. That trend has been a big benefit for passive income investors looking for sources of yield outside the usual mix of dividend stocks and covered call ETFs.
A lot of investors completely wrote off bonds after 2022, but I think that reaction went too far. If you are selective with both your duration exposure and your credit exposure, there are still plenty of opportunities in fixed income today. Here is a look at two higher-yielding Vanguard active bond ETFs that both pay monthly income distributions.
Ultra-Short-Term Active Bonds
If you are looking for a steadier ride, consider the Vanguard Ultra-Short Bond ETF (BATS: VUSB). Under normal circumstances, VUSB attempts to maintain a dollar-weighted average maturity between zero and two years. That places its duration, which is a measure of interest rate sensitivity, roughly around one year. In practice, this causes the ETF’s net asset value to fluctuate far less than longer-duration bond funds.
The bulk of the portfolio is invested in short-term high-quality bonds, including asset-backed securities, government-issued debt, and investment-grade corporate bonds. Right now, the majority of the portfolio is rated BBB or A, with a smaller allocation in AA and AAA rated securities.
Even with that relatively conservative positioning, VUSB still manages to generate a respectable 4.3% 30-day SEC yield after deducting a low 0.10% expense ratio. That places it roughly around the current federal funds rate range. One thing to remember, though, is that prevailing interest rates directly affect this kind of strategy. If short-term rates rise, VUSB’s yield generally rises too. If rates fall, income generation will likely decline.
Taxes are another important consideration here. Because a meaningful portion of the portfolio consists of corporate debt, much of VUSB’s income is taxable at both the federal and state level as ordinary income. For that reason, this ETF may be better suited for a tax-sheltered account like a Roth IRA.
Finally, Vanguard explicitly cautions investors that VUSB is not a substitute for a money market fund. Unlike a money market fund, its net asset value is not fixed at $1 per share. While Vanguard rates it just 1 out of 5 on its internal risk scale, there is still some mild volatility involved.
High-Yield Active Bonds
If you want a bit more yield than VUSB and are willing to accept greater credit and interest rate risk, consider the Vanguard High Yield Bond ETF (BATS: VGHY). This ETF charges a 0.22% expense ratio to actively invest in non-investment-grade corporate bonds, also known as junk bonds.
Looking at the portfolio composition, just under 50% of the fund is currently allocated to BB-rated bonds, which represent the highest-quality tier of non-investment-grade debt. Another 34% sits in B-rated bonds, while about 8.8% is allocated to CCC-rated or lower debt, which carries substantially greater default risk.
Overall, though, the portfolio still tilts toward the higher-quality end of the junk bond universe. That positioning currently translates into a strong 6.34% 30-day SEC yield after fees, which is fairly compelling for income-focused investors. The tradeoff, once again, is taxes.
Unlike municipal bond ETFs or Treasury-focused strategies, VGHY holds corporate bonds almost exclusively. That means the distributions are generally taxed as ordinary income at both the federal and state level, which can take a sizable bite out of your after-tax returns if held in a taxable brokerage account. Personally, I would strongly prioritize something like VGHY inside a Roth IRA or another tax-advantaged account whenever possible.
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