This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

The Hazards of Bond Index Funds

NEW YORK ( TheStreet) -- Shareholders of Vanguard Total Bond Market Index (VBTLX) have reason to be disappointed.

In 2012, The Vanguard mutual fund returned 4.2%, compared to 7.0% for the average intermediate-term fund, according to Morningstar.

During the past five years, Vanguard has lagged 60% of its peers. The poor showing is particularly notable because the mutual fund has $120 billion in assets and ranks as the biggest passive bond fund.

Will the index fund continue lagging actively managed competitors? Probably. The problem is that the Vanguard fund has most of its assets in government bonds. Those are likely to lag if the economy keeps growing and interest rates rise.

Vanguard Total Bond Market tracks the Barclays U.S. Aggregate Index, the most popular bond benchmark. Designed to reflect the composition of the investment-grade bond universe, the benchmark has 37% of its assets in Treasuries and 24% in mortgages securities that are backed by the government. Only 21% of assets are in corporate bonds. This is very different from the typical actively managed bond mutual fund, which has a bigger stake in corporate bonds and less in government issues.

During the financial crisis, corporate bonds sank because investors worried about defaults. But after the markets hit bottom, corporate issues rallied hard and enabled actively managed funds to outdo the benchmark.

Corporate bonds no longer sell at bargain prices. But corporates should continue outperforming if the economy grows, as many economists expect.

According to many forecasts, consumers should seek more loans to buy houses and cars. That will push up interest rates. Rising rates hurt bonds of all kinds as investors dump older issues with low yields. But corporate issues tend to do better than the benchmark in periods of rising rates because investors worry less about defaults when the economy is sound.

Investors recently got a taste of how government bonds can fall. During the past month, interest rates on 10-year Treasuries climbed from 1.77% to 1.94%. With prices of government issues falling, the Vanguard index fund lost 0.4%, while the average intermediate fund about broke even.
1 of 3

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $95.18 1.64%
FB $117.44 -0.95%
GOOG $692.33 -0.84%
TSLA $232.32 -3.92%
YHOO $36.02 -1.40%


Chart of I:DJI
DOW 17,750.91 -140.25 -0.78%
S&P 500 2,063.37 -18.06 -0.87%
NASDAQ 4,763.2240 -54.37 -1.13%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs