Vanguard Total Bond Market Index Funds
The Vanguard Total World Stock ETF (VT) does, as its name implies, provide full exposure to the wide range of global equities, investing across all geographies and market capitalization ranges, the Vanguard Total Bond Market ETF (BND) and its mutual fund equivalents, Vanguard Total Bond Market Index Fund (VBMFX) and Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX), only cover a fraction of the bond market.
What's Inside the Fund
These funds fail to capture the entire breadth of the bond market because they’re indexed to the Barclays Aggregate Bond Index. This index only covers the domestic, investment-grade portion of the market, including U.S. Treasuries, Agency mortgage-backed securities, and corporate bonds.
At the same time, the index has a substantially longer list of market segments that it does not include. On the domestic side, the fund doesn’t provide exposure to Treasury Inflation Protected Securities (TIPS), municipal bonds, high yield bonds, or senior loans. The fund also holds no exposure to international bonds, either the developed or emerging markets.
Many investors want the lower risks associated with holding domestic, investment-grade bonds, so this doesn't necessarily pose a problem. However, investors in these Vanguard total bond market funds should understand that they are not fully diversified in terms of geographies and risk factors and that in reality, the funds hold only a small fraction of what should truly be considered the “total bond market.”
Why It Matters
This important consideration matters because the types of securities held in the Barclays Aggregated 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 fall as well. This is an important consideration if the potential for future interest-rate increases by the U.S. Federal Reserve causes the bond market to weaken in the years ahead, as some experts predict.
The concentration in interest-rate sensitive securities also means that BND, VBMFX, and VBTLX lack exposure to areas of the market most affected by “credit risk,” such as high yield bonds and senior loans. Sometimes, this can be a positive, especially during times when events cause investors to grow risk-averse and seek the relative safety of lower-risk assets.
However, it also means that investors won’t gain any benefit when the conditions of improving economic growth, rising stock prices, and positive sentiment cause the credit-sensitive segments to outperform investment-grade bonds, as was the case in 2013.
Also, many of those segments not included in the funds tend to provide higher total return potential over time. This means that those who own only a total bond market index fund may be costing themselves some performance, which becomes an issue of particular concern to younger investors.
Getting True Bond Market Exposure
The Vanguard Total Bond Market Index funds aren't a bad option. On the contrary, they’re an inexpensive, lower-risk way for investors to add bonds to their portfolio. At the same time, however, don’t let the “total” in the name fool you.
If you want to get true, total bond market exposure, you can supplement this fund with other products to round out your portfolio. Over time, this capability will likely grow due to the expanding size of the senior loan and international corporate bond markets. Keep these points in mind if you’re considering these Vanguard funds as a first step to adding bonds to your portfolio.
Jacara does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.