Bond Index Funds Trail, Exposing Flaws
Investors who rely too heavily on the Vanguard index fund could trail in future years. At the moment, many bond analysts believe that Treasuries are overvalued. If Treasuries collapse, funds that track the Barclays Aggregate could be in for a long period of subpar performance.
Faced with headwinds, Vanguard Total Bond has returned 6.3% this year, trailing the average intermediate-term fund by 6 percentage points. Some bond ETFs have done even worse. Among the trailing ETFs are iShares Barclays Aggregate Bond (AGG), which only returned 3.5%, and SPDR Barclays Capital Aggregate Bond (LAG) (LAG), with a 3.3% return. Part of the problem can be attributed to how the ETFs are assembled. To track the benchmark, the open-end Vanguard fund holds more than 10,000 separate securities. But the iShares ETF only holds a sample of some 250 bonds. This year the ETFs did not hold some top-performing bonds. "Because of the sampling, the ETF performance can vary substantially from the index," says Nadig of indexuniverse.com.
Besides the flawed sampling, ETFs can also suffer when their shares sell for premiums or discounts to the value of the net assets in their portfolios. As demand for an ETF grows, the price of the shares can move to a premium. In the case of a fund that tracks a major stock benchmark, such as the S&P 500, the premium usually vanishes quickly. Taking advantage of the mispricing, institutions make arbitrage trades, producing fast profits and driving prices back into line with the value of net assets. But bonds do not trade so smoothly, and premiums can persist for days or weeks.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV