Vanguard's Big Move in Bond ETFs

09/08/2009 10:47 am EST

Focus: FUNDS

Daniel Wiener

Editor, The Independent Adviser for Vanguard Investors

Daniel Wiener, editor of The Independent Adviser for Vanguard Investors, says the giant fund company plans to roll out seven new bond index funds and ETFs in November.

As the bond market bumps along near its all-time highs, and investors have become newly enamored of bond [exchange traded funds], Vanguard announced it will make an enormous new foray into bond indexing.

The seven new bond index funds that Vanguard expects to introduce on Monday, November 2nd track seven Barclays Capital bond indexes and will be available in institutional fund shares, Signal shares and ETF shares. The corporate bond funds will all have front-end loads ranging from 0.25% to 1.00%, making them pretty unattractive. I would say the bulk of assets that investors send to these funds will be going into the ETFs

As a whole, the seven bond sector funds will cover approximately 92% of the entire Barclays Aggregate Bond Index now tracked by Vanguard Total Bond Market Index (VBTLX). Only asset-backed bonds, foreign government bonds, taxable state and municipal bonds, and commercial mortgage-backed bonds are missing from this lineup's holdings.

What's interesting about Vanguard's move is what they didn't put into this new lineup. The fund group continues to avoid the foreign bond markets, offering no funds that invest in non-dollar-denominated debt. They also have not offered any tax-exempt bond index funds or ETFs.

Among the short-term funds, the new Short-Term Government Index looks pretty comparable to Vanguard Short-Term Federal (VSGBX). Their risk profile during the 2008–2009 credit crisis was about the same, with both dropping about 1.1% at worst, before beginning to regain strength.

On the intermediate-maturity side, the [new] Intermediate-Term Government Index has essentially the same maturity as Vanguard Intermediate-Term Treasury (VFITX). This index did exceptionally well during the crisis, marking an MCL of just -3.1% versus the Treasury fund's 3.4% loss.

On the long side, the new Long-Term Government Index and Long-Term Corporate Index hold fairly long bonds relative to the existing Vanguard funds. It's a testament to great management to see how well Vanguard Long-Term Investment-Grade (VWESX) held up relative to the corporate index, generating better average returns and smaller losses.

Comparisons between Vanguard GNMA (VFIIX) and the new Mortgage-Backed Securities Index are tough, since the index holds both Fannie Mae and Freddie Mac bonds in addition to Ginnies. One would expect the shorter average maturity of the GNMA fund might have kept losses lower, but mortgage bonds don't really react to interest rates in the same way as plain vanilla bonds, since falling rates tend to lead to refinancings, which can cut yields, and returns. In any case, the new index fund could be a big winner for Vanguard.

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