From those humble yet historic beginnings, the fund has turned into an investment widely held by individuals, financial advisors, and institutions. They have embraced Vanguard’s beliefs in holding a broadly diversified, low-cost portfolio of stocks and bonds, and maintaining a long-term view.
The fund has now grown to about $175 billion in assets. Last summer, Vanguard Fixed Income Group surpassed $1 trillion in assets under management.
“The success that the fund has had wouldn’t be possible without having a top-notch team of investment professionals on the trading, portfolio management, and credit research sides. They work in a very collaborative fashion to make sure we’re delivering the best possible results for our clients,” said Greg Davis, global head of Vanguard Fixed Income Group. “It’s really been a global team effort managing the index process, with best practices coming from all three regions [U.S., Europe, Pacific].”
In April 2007, Vanguard launched an ETF share class for the fund, offering a way for more investors to gain access to its total bond market exposure. It has been so successful that many firms now offer competing products. Since then, Vanguard has expanded its fixed income index lineup to provide investors with a variety of exposures to the market.
Merits of bond indexingVanguard’s fixed income index funds track benchmarks that accurately represent various segments of the market. The Fixed Income Group employs indexing techniques that allow our funds to match the key characteristics and tightly track the returns of their respective benchmarks. Total Bond Market Index tracks the Bloomberg Barclays U.S. Aggregate Float Adjusted Index, which provides investors with exposure to the broad investment-grade market. Some critics of index investing in the fixed income market argue against it as they do for the equity market. Most often, they cite concerns with bond index construction to conclude that indexing isn’t compatible with the bond market.
“I think the argument for indexing is that the sum of all of the active managers equals the market,” said Ken Volpert, who has been responsible for bond indexing since 1992 as head of the bond index group until 2007, head of the taxable bond group until 2014, and now as global head of bond indexing . “And the aggregate bond index really represents the investment-grade market. If you add up all the active managers, you basically get the market as well. So if you can get the full market exposure with lower expense ratios and lower trading costs, over time you may be able to outperform the average active manager.”
Bond market liquidityConcerns about liquidity in the bond market remain the same today as they have over the last 30 years because of the market’s over-the-counter nature and wide range of issues.
“Liquidity in fixed income markets has always been less than perfect,” said Joshua Barrickman, Vanguard’s head of fixed income indexing Americas. “That’s not something new. We’ve seen a lot of developments in market structure over the last couple of years in terms of a response to regulation and the new reality that dealers have to face. Electronic trading, new entrances in the market-making side, ETFs, and things of that nature have stepped up to fill the gap.”
Bulls boosted bondsThe fund’s long-term performance has been fueled by a nearly 30-year bull market for bonds as the short-term interest rate set by the Federal Reserve has trended downward. (Bond prices and yields move in opposite directions.) Most important, the fund’s low expense ratio and tight tracking have allowed shareholders to capture this market.
“It’s been pretty much almost peak to trough in terms of rates,” Volpert said. “It’s been riding a wave of lower, lower yield which leads to greater performance historically. But it also raises challenges for all bond investors as well as stock investors.
“We have had such a large run in yield, such a large decline in yields, that what has been a tailwind for all types of investors is now potentially a headwind. I think investors should expect much lower returns in stocks and bonds overall in the next 10 to 20 years than they’ve had over the last 20 years.”
As the fund has grown, Vanguard has passed on the savings from economies of scale to shareholders. In the fund’s first annual report in 1987, its expense ratio was 0.28%, compared with today’s asset-weighted expense ratio of 0.06%.
Diversification across the boardRegardless of the interest-rate environment and the outlook for the economy and the financial markets, bonds remain a crucial part of a well-allocated investment plan. Total Bond Market Index Fund can serve as a core fixed income holding for a diversified portfolio of stocks and bonds.
“Bonds as a diversifier to equity volatility—I think that works in any market environment,” Barrickman said. “It still has the same principles of an asset that’s negatively correlated with equities. You still expect to get that benefit, even in a low-rate environment.”
As its name implies, the Total Bond Market Index Fund is also well-diversified across the investment-grade bond universe, with roughly 70% of its assets in U.S. government bonds and 30% in corporate bonds of all maturities. Today, the fund holds over 8,400 bonds.
“When stocks crater, bonds will rally,” Volpert said. “And the broad bond index represented by Total Bond Market is largely government, so it’s actually going to perform relatively well and be a nice offset to declines in stock prices.”
Data as of September 30, 2016.
Average asset-weighted expense ratios reflect the fund’s expense ratio as a percentage of net assets based on both the percentage of net assets and the expense ratio of each share class.
All investing is subject to risk, including the possible loss of the money you invest.
Past performance is no guarantee of future returns.
Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.