5-Star Buy for Short-Term Corporates

02/26/2015 9:00 am EST

Focus: FUNDS

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

S&P Capital IQ continues to anticipate that the Federal Reserve will begin increasing the overnight Fed fund target interest rate in 2015, asserts Todd Rosenbluth, S&P Capital IQ Director of Mutual Fund Research in Marketscope.

We believe the prospect of rising US interest rates will limit the total return opportunity received by investors from their fixed income portfolios in the coming year.

As such, investors will be well advised to focus on the interest-rate sensitivity and expense ratios associated with their fixed income mutual fund holdings.

In both regards, Vanguard Short-Term Corporate Bond Index Fund (VSCSX) stands out in this seemingly crowded universe. The fund earns our highest 5-star buy rating.

The mutual fund's average duration is just 2.8 years, slightly lower than the Lipper short-intermediate investment-grade debt fund peer group's 3.0 years and much more modest than the 5.7 years of the broader Barclays Aggregate Bond Index.

If interest rates were to increase 50-100 basis points in 2015, VSCSX should fall much less than the average bond mutual fund yet provide steady income.

Meanwhile, VSCSX has an extremely low expense ratio of 0.12% relative to its mostly actively managed peer average's 0.88%.

This, combined with the absence of a sales load and a lower turnover rate than peers'—not surprising given this is a passively managed product—helps the fund earn positive cost factor inputs from S&P Capital IQ.

We believe the 56% turnover rate is the result of the monthly rebalancing of the benchmark, Barclays US 1-5 Year Corporate Index, which it seeks to replicate.

Despite being passively managed, Vanguard Short-Term Corporate Bond Index Fund has risen 2.76% in the three-year period ended January 27, ahead of its actively managed mutual fund peers' 2.09% gain.

The fund holds corporate bonds issued by both domestic and international corporations. Approximately half of the assets are in bonds rated A by rating agencies that operate independently from S&P Capital IQ, with most of the remainder in BBB rated bonds.

Slight credit risk helps explain why the fund's 30-day SEC yield of 1.72% is higher than its peer group that has more exposure to AAA and AA bonds. Overall, the fund earns a five-star ranking for a combination of its performance, risk, and cost factors.

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