A Good Way to Play the Bond Rally

Fund Watch

A Good Fund to Play the Bond Rally

Lower rates and a tilt toward high-quality debt should help this fund.

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While investors have been riveted by a mercurial stock market, bonds have rallied strongly. The Bloomberg Barclays U.S. Aggregate Bond index, a proxy for investment-grade bonds, has returned 7.2% over the 12 months that ended July 12. The “Agg” and similar indexes serve as benchmarks for so-called core bond funds: broadly diversified collections of high-quality debt. Lately, such funds have proved why they deserve space in a diversified portfolio. Each time the stock market has dipped over the past year, the Agg has held up, returning 2.3% during the 18.2% stock slide in late 2018 and 1.8% during a 5.7% downdraft in May.

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Not all core bond funds are created equal, though all of them predominantly hold intermediate-term bonds (those with maturities ranging from two to 10 years). Few have delivered more-consistent returns at a better price than Vanguard Intermediate-Term Bond Index (VBILX).The fund tracks an index of government and corporate bonds that are five to 10 years from maturity—a variation of the Agg. Intermediate-Term Bond currently holds roughly 55% of assets in U.S. Treasuries (which carry virtually no risk of default), with the remainder in investment-grade corporate debt. Vanguard’s tilt toward high-quality debt relative to its average peer (which keeps 23% of assets in Treasuries and holds a small stake in junk bonds) has benefited the fund at crucial times. During the 2008 financial crisis, the fund outpaced 80% of core bond funds.

As of July 12. Sources: Bank of America Merrill Lynch, Morningstar Inc., Vanguard.

The fund is more sensitive than its peers to interest rate moves. That hurts performance when interest rates rise but boosts results when rates fall (bond prices and interest rates move in opposite directions). The portfolio’s 6.1-year average duration (a measure of interest rate sensitivity) implies that a one-percentage-point move in interest rates would boost or cut the fund’s net asset value by 6.1%. That the Federal Reserve is mulling rate cuts this year bodes well.

The fund’s Admiral shares charge 0.07% a year, well below the peer average of 0.62%. The fund ranks among the top half of peers in eight of the past 10 calendar years, including so far in 2019. Its 15-year annualized return of 5.0% beats 99% of core bond funds.