Sometimes, the names of mutual funds and ETFs can be misleading; Vanguard’s “Total Bond Market” fund seems to be a prime example of an investment that could benefit from a new name.
What’s Inside the Fund
These funds fail to capture the entire scope of the bond market because they are tied to the Bloomberg Total Bond Market Index. This index only covers the rated and domestic portion of the market, including U.S. government bonds, agency-backed securities, and corporate bonds.
At the same time, the index has a much longer list of market segments that it does not include. Domestically, the fund does not provide exposure to inflation-protected securities (TIPS), municipal bonds, high-yield bonds, or senior loans. The fund also lacks any exposure to international bonds.
Many investors desire the low-risk profile associated with holding rated domestic bonds, so this is not necessarily a problem. However, investors in these funds must understand that they are not fully diversified in terms of geography and risk factors. What this means is that the funds actually hold only a small part of what should truly be considered the “Total Bond Market.”
Why This Matters
This point is important because the types of securities held in the Bloomberg Aggregate Bond Index tend to have above-average sensitivity to interest rate movements. This means that when bond yields rise and prices fall, the value of these funds will also decline. This is an important consideration if the potential opportunity for rising interest rates in the future by the U.S. Federal Reserve is causing weakness in the bond market after the economy recovers from the recession triggered by the COVID-19 pandemic.
Focusing on interest rate-sensitive securities also means that BND and VBTLX lack exposure to the market segments most impacted by “credit risk,” such as high-yield bonds and senior loans. Sometimes, this can be a positive, especially during times when events entice investors to take on risk and seek the relative safety of lower-risk assets.
However, this also means that investors won’t benefit when conditions of improving economic growth and rising stock prices and positive sentiment allow credit-sensitive segments to outperform investment-grade bonds, as happened in 2013.
Moreover, many of those segments not covered by the funds tend to offer the potential for higher total returns over time. This means that those who only hold the Total Bond Market Index fund may be sacrificing performance slightly, which is a particular concern for younger investors.
Getting Real Exposure to the Bond Market
Vanguard Total Bond Market Index funds are not a bad option. On the contrary, they are a cheap, low-risk way for investors to add bonds to their portfolio. At the same time, don’t let the word “Total” in the name fool you.
If you want to gain real exposure to the total bond market, you can complement this fund with other products to round out your portfolio. Over time, this capability is likely to increase due to the rising volume of senior loans and international corporate bond markets. Keep these points in mind if you are considering these Vanguard funds as a first step to adding bonds to your portfolio.
Source: https://www.thebalancemoney.com/vanguard-total-bond-market-index-funds-416992
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