Holding over 6000 bonds and a possessing a minuscule 10 basis point management fee, the behemoth Vanguard Total Bond Market ETF, ticker BND, is often referred to as a one-stop shop for investment grade fixed-income investors. In this article we’ll take a look at some of the critical vitals and yield and give an evaluation of Vanguard Total Bond ETF in an attempt to decipher if it is a worthy portfolio solution or not.

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When one considers any fixed income ETF, it is imperative to evaluate blended fund statistics in an attempt to understand what it is you are really buying. If we examine data taken directly from Vanguard’s web site, we can get an idea of what BND is all about.

Here is a breakdown of the fund’s individual issues:

So between Treasuries and agencies, over 65% of BND is allocated to U.S. government related fixed securities. The other 35% is mixed among corporates (25%) and 10% amongst smaller fringe issuers, including some foreign exposure. What this tells us is that basically we’re buying a government bond with some interspersed diversity.

It should then be no surprise that the credit quality of the fund is very high as detailed below:

Only about 13% of BND strays into Baa land, which is the low end of investment grade.

Now that we know what kinds of paper the fund holds, we need to examine the vitals of the fund’s *holding period*, because there is a big difference in the yield and capital fluctuation of an investment grade bond fund, or any bond fund for that matter, with low maturity and duration versus one with high maturity and duration.

The above block tells us that the 6343 bonds in the portfolio have an average maturity of 7.4 years. What does this mean? Well, if you have two bonds, one maturing in March of 2024 (ten years from now) and another maturing in March of 2019 (5 years) from now, your blended (average) maturity is 7.5 years [(10+5)/2].

Duration is a bit more difficult concept that takes into account a variety of factors, but basically tells us what the blended sensitivity of the fund’s holdings are to a 100 basis point movement in interest rates. It the case of BND is it 5.4, which tells us that if interest rates move by a full percentage point up, BND’s holdings will drop by a little over 5 percent. In general, the longer the maturity, the longer the duration, and consequently the more sensitive bond capital is to interest rate movement.

So if we simplify the above information, we are buying a mostly government-part corporate investment grade bond with a 7.5 year maturity. That’s great, but what is our reward for owning BND? What’s the yield? And this is an area where you need to pay particular attention and understand various methods of yield calculation.

Vanguard tells us that we are currently receiving an “SEC” yield of 2.23% as of March 3, 2004, which is based on blended yield to maturity. At a current price of $81.50, that implies a annual dividend of $1.82. However, let’s look at the last twelve months dividend payments for BND:

If we add all twelve dividend payments up we come up with roughly $2.05 in payments which would result in a trailing twelve month yield of 2.5 percent, which is another method of looking at yield. Another way would be to take the latest dividend payment, multiply it by 12 and divide by the price – again we would come up with roughly 2.5 percent. These are the numbers that the quote services would commonly pick up on. For example, my online broker shows a yield of 2.52%.

Before you buy a bond ETF, make sure you understand the yield that is being quoted and how it is being

calculated. Far too many investors see a number and either head for the hills or jump right in without contemplating what it is they are looking at.

So now we can attach a 2.5% yield to BND. As a proponent of individual bonds, I have to say that this yield does not necessarily excite me. In my opinion, on can do much better looking at upper single digit maturities in BBB/Baa rated paper, rather than going with something like BND. With an ETF, you also bear the risk of indeterminate capital peril in a ramping interest rate environment.

But for bond investors looking for a simple, intermediate-term, investment grade ETF solution in today’s market, Vanguard Total Bond seems like a worthy consideration. Tremendous diversification and low fees – the hallmarks of Vanguard – as well as a sleep well at night credit profile would be a few of the reasons to own this one.

In the end, while I think you could much worse than BND for your portfolio, I think you could do much better as well.

**About the author:**

Adam Aloisi has over two decades of experience investing in equities, bonds, and real estate. He has worked as an analyst/journalist with SageOnline Inc., Multex.com, and Reuters and has been a contributor to SeekingAlpha for better than two years. He resides in Pennsylvania with his wife and two children. In his free time you may find him discussing politics, playing golf, browsing antique shops, or traveling.

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