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Stock index funds are becoming more and more popular with investors, and with good reason. Over the long term, stock index funds have beaten about two-thirds of actively managed funds — largely because index funds generally charge much less.
But its a different story when it comes to bond index funds. For example, Vanguards Total Bond Market (VBMFX), trails 81% of active funds over the past five years and slightly more than half of actively managed funds in the same category over the past 15 years despite charging much less than the average taxable bond fund.
To see a list of high yielding CDs go here.
So why are bond index funds faring so badly compared to their stock counterparts. Steven Goldberg of Kiplinger says: The biggest factor is the enormous amount of government debt. Most stock indexes weight securities by their market value (share price times number of shares outstanding).
An example: Apple has some 6 billion shares outstanding and recently traded at $95.97. Multiply the two numbers and you get its market value of $579 billion. Apple has the highest market capitalization of any U.S. company, so it accounts for 3.3% of Standard & Poor’s 500-stock index.
A company’s stock market value is influenced slightly by how many shares it issues. But the much bigger factor is how popular the stock is with investors. Since going public in 1980, Apple has climbed nearly 200-fold.
Bonds are different. Yes, they rise and fall in price, but not nearly as much as stocks do. The price of an investment-grade bond typically doesn’t deviate much from the price on the day it was issued. That means the most important factor in its market value, and thus its weighting in an index fund, is the size of a particular issue.
So when you buy the Vanguard index fund or a similar fund sponsored by another firm, you’re investing 70% of your money in government debt. That’s a giant allocation — “way too much, in my view,” Says Goldberg.
However, some bond funds are better than others? Goldberg has three options for private investors — check them out here.
Todays Other Top Stories
Learn Bonds: – Caterpillar: Hold, don’t buy, this core holding. – Caterpillar Inc. (NYSE: CAT), a worldwide leader in the manufacture and sale of heavy equipment and diesel engines, deserves to be a core holding, and if you own it, keep it. But I’m reluctant to recommend starting a new position at current valuations. There are several reasons. But first, let’s take a look at CAT’s business.
The Bond Buyer: – Muni strength to continue in second half: Analysts. – The second half of 2014 promises more positive returns for municipal bonds even as investors react to declining credit quality in Puerto Rico, according to midyear analyst reports.
MarketWatch: – Fitch takes various rating actions on enhanced municipal bonds and TOBs. – Fitch Ratings has taken various conforming rating actions on enhanced municipal bonds and tender option bonds (TOBs) corresponding to actions taken on their associated enhancement providers or underlying bonds.
Reuters: – High-yield drives biggest U.S. muni fund outflows since January. – Investors pulled $790.3 million out of U.S. municipal bond funds – most of it in the high-yield sector – in the week ended July 9, marking the biggest outflows since January, according to data released by Lipper on Thursday.
MarketWatch: – DC Water announces successful sale of $350 million green century bonds. – DC Water issued $350 million in taxable, green century bonds this week, marking several firsts for the Authority and the municipal sector.
Bloomberg: – Puerto Rico luring hedge funds on record price drop: Muni Credit. – Hedge funds and investors in distressed municipal debt are buying into Puerto Rico after prices on the territory’s securities set record lows on concern that its electric utility will restructure its bonds.
The Dispatch: – Municipal bond market remains a worthwhile risk. – The decline in U.S. Treasury yields this year has made it more difficult to find value in U.S. government bonds. The search for value and yield has become more challenging and driven investors into alternate fixed income asset classes.
Businessweek: – Munis cheapest to Treasuries since March amid biggest ‘14 exodus. – Municipal bonds are the cheapest in four months relative to Treasuries as speculation that debt from Puerto Rico will default spurs the biggest exodus from local-debt mutual funds since January.
ETF Trends: – Muni ETFs look cheap after Puerto Rico induced sell off. – Municipal bonds, along with related exchange traded funds, are trading at their deepest discount to U.S. Treasuries in four months after another round of debt concerns over Puerto Rico’s finances sparked a sell-off in muni funds.
Reuters: – Dealers saw Fed portfolio larger for longer -NY Fed survey. – U.S. primary dealers did not expect the Federal Reserve to start trimming its bloated balance sheet until early 2016, after the central bank finally raises interest rates, according to a survey conducted last month.
Business Standard: – Bond yields seen rising on concerns of debt fund redemptions. – Bond yields are seen rising due to concerns that there would be redemption of debt mutual funds. The fears had built up after Finance Minister Arun Jaitley proposed yesterday that the long-term capital gains tax on debt-oriented mutual funds will be hiked. Traders have already started trimming their portfolio and selling pressure is seen continuing even next week.
MoneyNews: – Bond market poses greater transparency threat than equities do. – Recent revelations regarding opaque dark pools and algorithmic traders in the equity market has left a major market still in the dark: the bond market.
WSJ: – U.S. Government bonds set for weekly price rally. – Treasury bonds strengthened Friday, set for a weekly price rally, as investors believe the Federal Reserve will keep interest rates low amid uneven global economic growth and geopolitical risk.
Investment Grade Bonds
FT: – Corporate bond sales hit five-year highs. – Global companies have turned to international debt markets in the first half of 2014 to meet their funding needs, seizing on low borrowing costs and strong investor demand to push sales of corporate bonds to the highest level in five years.
High Yield Bonds
S&P Capital: – High yield bond mutual funds see retail-cash inflows despite small ETF outflow. – Retail-cash inflows for high-yield funds totaled $107 million in the week ended July 9, with a $133 million inflow to the mutual fund segment dinged by an outflow of $26 million from exchange-traded funds, according to Lipper.
Income Investing: – Junk bond default rate at just 1.9% in Q2 – Moody’s. – If you’re worried that junk bonds look pricey, you should be. But if you’re worried that junk bonds are about to start defaulting left and right, fear not.
Market Realist: – Why the high-yield debt issuance in 2014 overtook 2013 levels. – Issuers continued to take advantage of near record low yields for high-yield debt for financing acquisitions and leveraged buyouts, paying dividends, and refinancing costlier debt.
Fortune: – Corporate America is getting junkier. – According to S&P, 71% of all new corporate debt issued last year got a junk rating. More and more of corporate America is getting rated junk. Investors, though, don’t seem to mind.
Market Realist: Overview: – High-yield debt market borrowers set new 2014 records. – The week ending July 4 was characterized by milestones being reached in high-yield debt primary markets. Issuance levels in 2014 for high-yield debt, at $186 billion year-to-date, surpassed volumes in the comparative period of 2013.
Businessweek: – Notice to bond buyers: We’re all out of high-grade notes. – Investors are piling into junk debt this year partly because they can’t find enough higher-quality bonds for sale.
Emerging Market Bonds
Western Journalism: – Money to be made in Venezuelan debt if you can stomach the risk. – If you are looking for a high yield in emerging markets, you need to look in Latin America. And if you look at LATAM, your choice is really between Venezuela and Argentina.
Reuters: – India, Indonesia lead emerging market gains on reform hopes. – Indian shares surged more than 1.5 percent on Thursday, approaching recent record highs and bonds rallied in reaction to a growth-focused budget, outgunning the gains on broader emerging market assets.
WSJ: – Pimco’s Gross cut U.S. government-related holdings in June. – Pimco’s Bill Gross cut the U.S. government-related debt holdings at the giant Pimco Total Return Fund in June while adding holdings of riskier bonds sold by U.S. companies and foreign governments.
Robeco: – Mitigating rate risk in high yield investing. – The prospect of the first interest rate rises for many years as economic growth improves has led many investors to question their high yield strategies. Deciding what type of fund to be in depends on your outlook.
Gross: The end of #QE on Halloween may spook risk markets in July.
— PIMCO (@PIMCO) July 11, 2014
Remember bond investors: “the smell is always worst closest to the poop pile.” #muniland
— Cate Long (@cate_long) July 11, 2014
Back to bonds, bull flattening resumes w 5s30s now just under 170bps, or ~85bps flatter than 1yr high in November
— David Schawel (@DavidSchawel) July 11, 2014