The Case for Bonds, and the Problem With Bond ETFs

2006 has seen the introduction of many toys for the "Global Macro Hedge Fund in my E*Trade Account" crowd. ETF sponsors have wrapped all sorts of exotic assets such as foreign currency, precious metals, emerging markets, commodities, and short positions into ETFs. The previous obscurity of these asset classes kept them safely out of the hands of retail investors.

The main asset class that the fast money crowd ignores is bonds. This is only to their loss. I don't think I can say it better than PIMCO, on the role of bonds in an asset allocation strategy:

Bonds can play an essential role in asset allocation by diversifying risk, generating income, and preserving wealth across a range of economic and financial market conditions that can cause wide fluctuations in stocks and other asset classes.

Bonds act as ballast for portfolio. They give your ship stability in rough waters and prevent it from becoming top heavy and unstable. Benjamin Graham recommended that investors should always have at least 25% allocated to high quality bonds. For most investors he felt the target allocation should be even higher.

Now (mid October 2006) the stock market is making new highs, it is a good idea to rebalance and make sure that you are invested in harmony with your risk tolerance. Investing in bonds as an asset class is too complex to do by yourself. Hence the need for a cheap and well managed bond fund.

The problem with the passive bond ETFs is that they can not pick up obvious alpha via duration management (i.e. they don't adapt to an inverted yield curve) and they can't exploit spreads between equivalent risk bonds. Without the ability to dynamically reposition the portfolio or hedge interest rate risk, bond ETFs tend to get quite bouncy. Maybe too bouncy for most investors.

Thought by many as the best fixed income manager of the past 25 years, PIMCO's Bill Gross manages the PIMCO Total Return Fund [PTTDX], with $93 Billion in assets. PTTDX is core bond fund with an intermediate duration and average AAA credit rating. This fund is suitable for all investors.

PIMCO is also the leading subadvisors for bond mutual funds run by other companies. Bill Gross's team also manages the Managers Investment Group's Fremont Bond Fund [MBDFX] and Harbor Bond Fund [HABDX]. The Fremont Bond Fund is on the no transaction fee list at most online stockbrokers including Scottrade. Both of these funds have the same strategy as the name brand PIMCO Total Return fund (charging 0.75%) but charges 0.60%.

Comments

[WC Whiner]

I like some income if it's stuffed into a tax-deferred account, too.

That said, I am puzzled by your throwaway comment that, "foreign currency, precious metals, emerging markets, commodities, and short positions" were "safely out of the hands of retail investors" before ETFs came along. Even if you restrict yourself strictly to exchange-traded managed vehicles, the closed-end fund industry had delivered things like GIM (inception 1988, non-US sovereign debt, hence a currency and relative-rate play), ASA (inception 1958, not a typo, gold), EMF (inception 1987, emerging markets), PEO (inception 1929, again no typo, oil) and AMO (inception 1994, does a little short-selling).

What seems different to me is not availability, but marketing.

[Amish]

I would like to comment that the PIMCO and HABDX both have expense ratios far more than Vanguards VBTIX. If you held them for 10 years than the return at 6% (about the that for the last 10 yrs) 6868, 6619 and 7783 in dollars after expenses. Even if u think the former 2 would earn 1% more than the diff is about 800 and 500 ( more) than VBTIX resp. But you would have an additional 650 dollar that youo would have invested (becos of lower expenses over that time)

PLUS the yield in the Vanguard funs is higher.

What do u think??

[Amish]

Also the data above is by running the 3 funds thro the NASD mutual fund analyzer.

[Panskeptic]

I like the guy who said, "Never fool around with married women and never buy bonds." It seems to me that there are plenty of alternative investments that can stabilize a stock portfolio without going near a bond. That's one of the great results of the ongoing ETF explosion.

[Chamois16]

Why are these two funds(MBDFX and HABDX) ~70% in cash rather than bonds?