(PUB) Investing 2015

government-focused funds— Short- Term Treasury , Short-Term Federal and Short-Term Government ETF — as money market funds without a stable price because of their low, low yields. That’s still pretty much the case, and while investors do earn enough yield here to distinguish them from money market funds, I still rate each one a Sell. Yes, your default risk is essential- ly zero with the three government- concentrated bond funds, but consider what happens if you are willing to take on some corporate bond exposure. As you can see in the table on page 5, with Ultra-Short-Term Bond, you have half the duration, 1.0 years versus 1.9 to 2.3 years, but you give up little, if anything at all, in yield compared to the government funds. Yet, if you’ve already decided that you are com- fortable with the interest-rate risk of short-term bonds, well, you’ll pick up more income with any of the following funds. Short-Term Bond Index , which tracks the Barclays 1–5 Year Govern- ment/Credit index, is a step in the right direction. But with roughly two-thirds of the portfolio in government bonds, the index fund’s 1.13% yield still lags well behind Short-Term Investment- Grade . Add in that it has a slight- ly higher duration of 2.7 years than its actively managed siblings, which means it will be a bit more sensitive to changes in interest rates, and you can see why I rate this fund a Hold. Short-Term Corporate ETF isn’t a bad choice for index and ETF adher- ents. The fund tracks the Barclays U.S. 1–5 Year Corporate index and hence holds only corporate bonds— where actively managed Short-Term Investment-Grade will have some expo- sure to government-backed bonds. As a result, the ETF’s risk is a bit higher. While the active fund took a 7.6% hit during the 2008 credit crisis, the index this ETF tracks fell 9.7%, in large mea- sure because it had no shock absorber in government bonds. Additionally, I have a lot of respect for Vanguard’s bond team and so lean toward active manage- ment when I can. >

Short-Term Investment-Grade has long been my choice for a higher- yielding shock absorber and cash sub- stitute in my Model Portfolios . The 2008 credit market debacle tested this claim—and my faith in the fund. Because it doesn’t invest more than a smidgen in government-backed securi- ties (just over 10% today), Short-Term Investment-Grade took a beating during that brief episode—losing 7.6% at its worst. Its prior worst was a decline of 2.2%. But its recovery from the credit crisis was swift, my confidence was restored, and I remain a huge fan. Intermediate-TermTreasury Sell. Intermediate-Term Gov’t ETF Sell. Intermediate-Term Bond Idx. Hold. Intermediate-Term Corp. ETF Buy. Intermediate-Term Invest.-Gr. Buy. Intermediate-term bonds (remember, we talked about this in the August issue) have been tough to beat when you consider both bond risks and bond returns. Over rolling three-, five- and 10-year periods, intermediate-maturity funds have generated 70% to 80% of the return you’d earn from a long-term fund with only half the risk—not a bad trade-off. However, I would again steer clear of Vanguard’s government-oriented funds, Intermediate-Term Treasury and Intermediate-Term Government ETF . As with their short-term coun- terparts, there’s nothing really wrong with these funds, but the yields here are really low at only 1.44% and 1.54%, respectively. That is below the 1.83% yield on Short-Term Investment Grade, and with these funds you have at least twice the interest-rate risk. I just don’t see the value. Similar to its shorter-maturity sib- ling, Intermediate-Term Bond Index is made up of a mix of Treasury, gov- ernment agency and corporate bonds. The fund tracks the Barclays 5–10 Year Government/Credit index, and differs from Total Bond Market in that there are no mortgage bonds here, so you aren’t getting an all-encompassing “bond market” index fund. If you are going for a broad index, why not pick the broadest one available?

So, as with short-term funds, my top intermediate-term picks are the corpo- rate-oriented bond funds— Interme- diate-Term Investment-Grade and Intermediate-Term Corporate ETF . Yielding 2.77% and 3.51%, respec- tively, both funds offer a nice pickup over Intermediate-Term Treasury’s 1.44% yield. Of the two, the actively managed Intermediate-Term Invest- ment-Grade is, again, my top pick. I have a lot of confidence in Vanguard’s bond team to navigate the market and sidestep the blow-ups that the index can’t avoid. Total Bond Market Hold. The world’s largest bond fund fits in the intermediate-term category, but I think it deserves its own write-up. Not only is it a popular choice among investors who are looking for one- stop bond exposure, it’s also a staple in Vanguard’s Target Retirement and STAR LifeStrategy funds, as well as its 529 Plans and balanced annuity funds of funds. In addition, it’s often the only broad bond market option for investors in corporate 401(k) plans. Investors here are essentially buy- ing the entire bond market at rock- bottom cost. The portfolio holds over 7,600 positions in an effort to track an index of nearly 9,500 bonds, the Barclays U.S. Aggregate Bond index. Its assets are spread among corpo- rate bonds (about 30%), Treasury and agency bonds (45%), mortgage-backed securities (20%) and foreign bonds (5%). After more than two decades, the fund has proven a worthy competi- tor to many actively managed funds, and its worst decline was a 5.8% loss over seven months in 1987, which was recovered in four months. This is a fine fund. However, the portfolio’s large allocation to Treasury and mortgage-back bonds has me con- cerned for the future. As I mentioned at the outset, given how low yields are today, I don’t see how the fund can repeat its performance of the past decades in the years ahead. I think the investment-grade option will give inves- tors the biggest bang for their bucks over the next few years.

6 • Fund Family Shareholder Association

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