(PUB) Investing 2015

•

Fund Family Shareholder Association

www.adviseronline.com

AS WITH ALL THINGS,

but in particu-

lar when it comes to investing, having

options is a good thing, but having too

many choices can lead to paralysis.

For investors this can mean delaying

a decision, and possibly failing to act

altogether.

Consider your choices among

Vanguard’s bond index funds. For over

a decade, investors got along just fine

with four options:

Total Bond Market

and three funds of varying maturities

that held both corporate and Treasury

bonds. There’s nothing wrong with

those “old” index funds, and they remain

pretty good options to this day, but six

years ago, Vanguard took a big leap in

expanding investors’ options, and pos-

sibly causing some a bit of “analysis

paralysis” by launching seven new bond

index funds and ETFs that further slice

and dice the market. And two years ago,

when they converted those funds’ Signal

shares to Admiral shares and dropped

the minimum investment hurdle, the

potential for indecision mounted.

With Federal Reserve Chair Janet

Yellen hinting strongly that an interest

rate hike is coming in December, many

investors are re-evaluating their bond

fund allocations, making today an ideal

time to ask how those seven relatively

new bond index funds have fared in the

marketplace, and as viable investment

choices. The answer: Some have done

better than others.

As you can see in the top table, the

corporate bond index funds have been

much more popular than their safer

government bond options—all have

grown to more than $1 billion in assets.

Short-Term Corporate ETF

and its

open-end shares have been the run-

away favorites. Meanwhile investors

have nearly ignored the government

bond indexes—

Intermediate-Term

Government Bond

Index

only passed

the $1 billion mark three months ago. I

thought

Mortgage-Backed Securities

ETF

had the potential to be a big win-

ner for Vanguard, and in some ways it

has served the firm well; $2.2 billion

is nothing to scoff at, particularly con-

sidering that over the past six years,

investors pulled roughly $18 billion

from

GNMA

As I predicted six years ago, the bulk

of assets invested in these funds—80%

or so—has gone into their ETF shares.

However, the transition from Signal

shares to Admiral shares increased the

availability and popularity of the open-

end funds. That’s no surprise, as the

Admiral shares are no more expen-

sive than the ETF shares. Still, the

front-end loads on the Admiral shares

Intermediate-Term Corporate

Bond Index

(0.25%) and

Long-Term

Corporate Bond Index

(1.00%) will

continue to lead interested investors to

buy the ETF versions.

Why have investors favored the cor-

porate bond index funds, which hold

investment-grade taxable bonds, over

the government bond indexes, which

invest in U.S. Treasury bonds as well

as other debt guaranteed by the U.S.

government or agencies? It all comes

down to yield.

Look at

Short-Term Corporate

ETF

and

Short-Term Government

ETF

. As the lower table shows, the cor-

porate index fund has a slightly longer

duration (more interest-rate risk), but

with a yield of 1.93% versus a paltry

0.52% on the government fund at the

end of October, people are choosing

the higher yield. Investors face a similar

trade-off—longer duration but a higher

yield—when weighing the two inter-

mediate-maturity funds. On the long-

maturity end, one can find a higher

yield and lower duration in

Long-Term

Corporate ETF

So far the (relatively) new bond

index funds and ETFs have pulled in

$24 billion or so, but it does not appear

those assets have come at the expense

of their older and larger sibling funds. I

am sure some of the roughly $10.8 bil-

lion that investors put into Short-Term

Corporate ETF would have otherwise

found its way into

Short-Term Bond

ETF

Short-Term Investment-

Grade

. But as those two funds actu-

ally pulled in more money than the

corporate index fund over the past

six years—nearly $25 billion and $15

billion, respectively—it doesn’t look

like investors have been dropping the

old for the new, except, as I noted ear-

lier, for the disparity between outflows

at GNMA and inflows to Mortgage-

Backed Securities ETF. However,

BOND ETFS

Yield’s Gravitational Pull

Investors Bought Corporate Bonds

Fund

ETF Share Admiral Institutional

Total

ETF Share

% of AUM

Short-Term Government

$648

$246

$68

$962

67%

Intermediate-Term Government

$452

$420

$229

$1,101

41%

Long-Term Government

$315

$142

$157

$614

51%

Government Subtotal

$2,676

Mortgage-Backed Securities

$1,765

$443

$41

$2,249

78%

Mortgage-Backed Subtotal

$2,249

Short-Term Corporate

$10,793

$1,289

$765

$12,848

84%

Intermediate-Term Corporate

$5,946

$455

$343

$6,743

88%

Long-Term Corporate

$1,044

$71

$303

$1,418

74%

Corporate Subtotal

$21,009

TOTAL

$20,963

$3,064

$1,907

$25,934

81%

Note: Values represent millions of dollars. As of 10/31/2015.

Seeking Yield

Fund

Duration

(years)

SEC

Yield

Short-Term Government

1.8 0.52%

Short-Term Corporate

2.8 1.93%

Intermediate-Term Government

5.2 1.39%

Intermediate-Term Corporate

6.4 3.39%

Long-Term Government

17.2 2.71%

Long-Term Corporate

13.5 4.80%

Mortgage-Backed Securities

3.9 1.63%

Durations and SEC yields as of 10/31/15.