Vanguard Indexed Bond Fund

[JohnH]

Does anybody have any opinion on an indexed bond fund from vanguard - fund code VECBV. The fund tracks the investment grade bonds of the major corporations in Europe. I cannot post a link to the fund as I do not have enough posts. As an index fund, it tries to match the entire market for bonds in Europe. I would like to think that as it invests in so many bonds that the risk of default are quite low. I would like to view this as an alternative to putting money on deposit in a bank.

I am getting fed up of trying to move money from one bank account to another. It now seems that we have only two Irish Banks with which to invest in.

What are the prospects for Bond Funds as interest rates are rising ?

What are the default risks with the fund ?

What would the expected return be ?

 

[Marc]

john,

This is an excellent question and our Investment Committee has just reviewed this fund so I can share some of our findings.

Data source Bloomberg June 2001 to Feb 2011

The annualized average return was 4.41%pa compared to One Month Libor in Euros which was 2.67%pa.

So, on the face of it, this seems like a good strategy....

However, the worst one year return for the fund was -2.44% for the period 11/07 to 10/08.

Remember that risk and return are related. If you want a higher expected return, you have to be willing to bear more risk. Risk in this sense means risk of loss.

So, a "traditional" saver looking to get out of a bank account because of the risk, could be jumping out of the frying pan and into the fire.

Bonds have a role within a balanced and diversifed portfolio to reduce risk and provide liquidity but they are not an alternative to a bank deposit.

Two factors explain the majority of returns from a fixed interest portfolio as follows:
[FONT=&quot]
Credit Risk - The quality factor describes how low-grade obligations have higher expected returns than high-grade obligations.
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[FONT=&quot]Duration risk - The term factor describes how long-term bonds have higher expected returns than short-term bonds.
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[FONT=&quot]We believe, however, that these risk premiums have not been large enough historically to reward the additional risk. Therefore, we believe fixed interest is best kept short in maturity and high in credit quality. [/FONT]

The Vanguard fund scores well on the credit risk with an average rating of Aa3 (Moody judges obligations rated Aa to be high quality, with "very low credit risk")

When looking at the term structure, although 57% of the bonds have maturities of 5 years or under, the fund is exposed to some longer-term bonds and therefore if and when interest rates go up, this fund will suffer. Maybe not as much as some other funds but we would recommend not exceeding terms of 5 years in a bond fund.

Finally, additional diversification can be obtained by buying non-euro area bonds and hedging the currency risk back to Euros.

So, although this is a good fund, we would recommend the Dimensional Global Short-Fixed Interest fund in preference.

 

[North Star]

Re Vanguard bond fund

Hi John,

Whilst Vanguard is a large and successful low cost fund manager, as far as I understand their products are not available for Irish residents (happy to be corrected on this if the funds are available)
I have no issues with the product per se. However I would caution against this asset class based on the following 1) we are entering a period of rising interest rates, 2) increased inflation expectations and 3) probably higher bond issuance levels to finance growing public debt levels. If your objective is capital security over a medium time frame then the product may well be suitable, please see Marc's comments on credit risk etc.
If however you are looking for a reasonable return over the next 12 months then I would avoid all fixed income/bond funds unless they have a very short duration (exposure to interest rate movements) The average duration at the end of December 2010 was 4.3 years. Once yield curves have steepened up and rates have normalised then fixed interest may be worth considering as an asset class. This may occur over the next 12-18 months.
We advised our clients in November of 2010 to significantly reduce their exposure to fixed income funds and see no reason to change that view yet.

Our house approach to managing client's investments is that there is no one approach to investing that is fail safe - otherwise everyone would have adopted it by now. We try to assess the value in different asset classes and come to a position on this. Value whilst a simple concept can be difficult to measure. There are times however when an asset class represents such "poor" value that a clear investment decision can be recommended. We currently see no value in fixed income. This is our "informed" view and we of course acknowledge that we could be wrong. If you want I can pm you more info on the basis for our view on fixed income.

Regards [broken link removed]

 

[JohnH]

Thanks Marc and North Star for coming back so quickly

I will need time to digest the information before coming back to you.

I have just one more question in relation to bond funds. Is the annualized return (say 4.41% of the bond above) of a bond fund gross or net of tax.

Thanks again to you both.

 

[Marc]

John,

The annual return is before tax but after charges.

All the best

 

[Jim2007]

Does anybody have any opinion on an indexed bond fund from vanguard - fund code VECBV. The fund tracks the investment grade bonds of the major corporations in Europe. I cannot post a link to the fund as I do not have enough posts. As an index fund, it tries to match the entire market for bonds in Europe. I would like to think that as it invests in so many bonds that the risk of default are quite low. I would like to view this as an alternative to putting money on deposit in a bank.

I am getting fed up of trying to move money from one bank account to another. It now seems that we have only two Irish Banks with which to invest in.

What are the prospects for Bond Funds as interest rates are rising ?

What are the default risks with the fund ?

What would the expected return be ?

Hi John,

If you are looking for a close substitute to a deposit account, then Money Market Funds are what you should be looking at and not Bond Funds.

Jim.