How Much Do Bond Funds Really Cost You?

bond-index-fundsBond funds represent the easiest and most convenient way for fixed-income investors to access the bond market. Diversified amongst dozens, hundreds, or even thousands of individual issues, funds offer simplicity for those without the time, energy, or wherewithal to build bond portfolios of their own.

Of course there is no free lunch here – all bond funds are assessed an ongoing management fee. While you won’t have to write a monthly check and won’t see fund costs proudly promoted by most funds, I can assure you that your returns are “invisibly” reduced by fees on an ongoing basis.

  To see a list of high yielding CDs go here.  

The difference in fees can be far-flung. Vanguard, a provider of indexed investment solutions, which proudly promotes its low costs, lists 13 bond ETFs on its web site with annual expense ratios of between .08% and .12 percent. In nominal terms that means for every $1000 invested in one of these funds, you would only pay between 80 cents and a buck twenty  to own them, per year.

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With yields on the above funds ranging from .38% in the case of VGSH, its Short-Term Government Bond ETF all the way up to the current 4.42% SEC yield of VCLT, Long-Term Corporate Bond, there’s a lot of investment grade choice here, but arguably not a lot of robust yield.

Investors looking for a bit more cash flow may opt for high-yield ETFs or even levered, managed, closed-end high-yield funds that can provide elevated yields. Of course when one moves from the investment grade realm over to high-yield, generally more risk is being undertaken in exchange for the juicier yields.

If we take a look at the two high-yield ETFs generally looked at as bellwethers – HYG, the iShares product – and JNK, the Barclays SPDR product, we see expense ratios of half-a-percent and .40%, respectively. A search on CEFconnect.com reveals expense ratios for 33 funds classified as high-yield of anywhere between .48% all the way up to a whopping 2.21% for Pacholder High-Yield Fund, ticker PHF. Yields on HYG and JNK are in the 5.5% area while the CEFs currently range generally from 7% all the way up to 9.5 percent.

So an investor can expect to pay very little, in the case of a Vanguard ETF or low-cost equivalent, or significantly more when active management and leverage are brought into the mix. And though fund cost should certainly be a consideration, it should not be the only consideration. As I’ve mentioned in times past, a fund posting gross returns of 12% with a 2% fee provides the same outcome for an investor as the fund with gross return of 10.5% and .5% worth of fees.

But since bond funds, as opposed to stock funds, are unlikely to have wide disparity in performance given the general nature of the asset, I consider fee a more important data point in the case of the bond fund. 

All things considered when examining apples to apples funds, cheaper is better. But when things are not apples to apples I like to normalize fee by looking at expenses relative to yield. In the case of the long-term Vanguard Fund VCLT an investor pays 12 basis points for 4.42% of yield. In the case of HYG .50% for 5.5% of yield and EAD, Wells Fargo Income Opportunity, a random levered, HY CEF I selected, 1.2% for 8.83% of yield. The “Impact” is the fee divided into the current yield.

Fund               Yield                 Fee                   Impact

VCLT             4.42%                      .12%               2.7%

HYG               5.50%                      .50%               9.1%

EAD             8.83%                      1.20%            14.6%

So you can see that there’s a big difference in the impact of how much one pays as higher yields and active management enter the fray. As one considers funds from one “area,” the fee impact may be another data point to consider alongside credit and duration profile, performance history, and other factors.

In the end, although fees aren’t highly visible to bond fund investors, they do have a demonstrable impact. As the size of one’s portfolio increases, seemingly small fee variances can have more than a small impact on your bottom line – potentially amounting into many thousands of dollars over an investor’s lifetime. All the more reason to shop around when looking for your next bond fund.

About the author:

aloisiAdam 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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