The Vanguard Group recently released a series of publications discussing challenges and issues facing bonds and bond funds investors, and also posted a video discussing whether bond funds are a good alterative to money funds. Vanguard comments, "The historically low yield environment in the U.S. bond market and recent cautions from commentators about the potential bursting of the "bond bubble" have led some investors to question the role that fixed income plays in their portfolios. Vanguard believes that bonds bring the benefits of diversification and income to a balanced investment program but emphasizes that investors should have realistic expectations about future bond fund returns. Below is a recap of Vanguard's recent bond related research and commentary." Recent pieces includes: the video "Are bond funds a good alternative to money market funds?," "Reducing bonds? Proceed with caution," "The bond market: Challenges ahead," and a video of "Ken Volpert on the current bond landscape."
The video, subtitled, "Vanguard experts compare bond funds with money market funds," says, "With yields at historic lows, it may be tempting to use a bond fund to manage your money. Sarah Hammer of Vanguard Investment Strategy Group and David Glocke of Vanguard's Fixed Income Group caution that even a small increase in interest rates could reduce the value of your cash position."
The transcript asks, "With super low interest rates on money market funds, are short-term bond funds a reasonable substitute?" They say, "I think this is an important question and one that I want us to answer very seriously because we hear it a lot." Hammer comments, "It is. We are hearing it a lot; we're seeing it a lot with our clients.... Obviously, everyone's feeling the low yields across the board and our people are very concerned about how to get that extra yield. Looking at a bond fund in comparison to a money market fund can be pretty complicated. When you think about what your goals are for managing your cash, one of your primary goals may be to protect principal. We talked about the concept of duration. A bond fund has a much longer duration; it's much riskier than a money market fund, so it's not a true cash management vehicle because it does have duration risk."
Hammer adds, "When you compare the average maturity of a money market fund, which is going to be 60 days or less, to even a short-term bond fund that's going to be risky, have a duration of two, for example, you're talking about essentially a much riskier instrument. So, if you're looking to protect cash, if what you want is a true cash management vehicle, then a bond fund is not necessarily the right choice."
Glocke tells us, "On the bond fund side, a lot of investors made an asset allocation switch, and we saw a lot more money move into the fixed income market early in the financial crisis.... Even our index bond funds saw enormous flows that were coming into them. A lot of the extra return that comes from the decline in yields has taken place in some of these portfolios.... Investors that have been in those funds have had extremely high returns on a relative basis, historically. It's a little tough right now at this particular juncture. Fixed income portfolios should still be part of people's core investment. So there still should be an allocation. But as interest rates rise, those portfolios will adjust too."
Vanguard's Amy Chain says, "I think what I hear you saying is that bond funds make a great bond portion of a portfolio. But, you know, think real hard if it's a cash management or a cash position that you're looking for." Glocke adds, "Yes. Again to make the leap to go from a money market fund to, let's say, even a short duration bond fund of two years, like you mentioned ... It's a big leap. U.S. Treasury securities yield approximately 25 basis points in the two-year area. `So it doesn't take much of an increase in yield to go ahead and wipe out a whole year's worth of income in a portfolio like that. So it is something that you need to be cautious about."
Vanguard's piece, "Reducing bonds? Proceed with caution," says, "While investors are increasingly looking for alternative ways to improve the expected returns of their portfolios with bond alternatives, Vanguard's researchers conclude that bonds remain the best diversifier for equity risk and therefore deserve strategic allocation in a balanced portfolio." Finally, in "The bond market: Challenges ahead, they write, "Vanguard Chairman and CEO `Bill McNabb and Robert Auwaerter, head of Vanguard Fixed Income Group, discuss the challenges bond investors face during a much less hospitable climate than the one they've been accustomed to in the past."
