Vanguard Bond ETFs: No Surprises, Lowest Costs

The fixed income ETF space is another area where we could see some serious expansion. International bonds, even in emerging markets, has been of great interest to a wide variety of investors in the global search for yields.

So the good news is that along with BGI’s release of new fixed income ETFs on top of the six they had at the end of 2006, Vanguard is coming along with their first foray into the space. Vanguard has filed a registration statement with the SEC to offer ETF versions of four existing Vanguard bond index funds. Vanguard ETFs are structured as separate share classes of an existing Vanguard mutual fund counterpart.

The bad news is that Vanguard isn’t really venturing into new territory. Here’s the lineup with a table from Vanguard’s website:

With an expense ratio of 11bps, these are cheap especially in comparison with the appropriate iShare counterpart. For example, for the broadest exposure, Vanguard’s Total Bond Market ETF is nearly half the cost of AGG which sits at 20bps. They both track the Lehman Brothers Aggregate Bond Index.

Comparisons between the remaining three Vanguard ETFs with their iShare counterparts is not as simple. First, the Lehman 1-3 Year Treasury Bond Fund (SHY), Lehman 7-10 Year Treasury Bond Fund (IEF) and Lehman 20+ Year Treasury Bond Fund (TLT) all have a 15bps fee which is not that far off Vanguard’s proposed 11bps. Next, you’ll note the difference in benchmarks:

In this environment, and at first glance when looking at this table, you might not expect to see any significant performance differences between the Vanguard and iShare ETFs within each of the three groupings. However, a little digging on their respective websites leads to some interesting findings. The first thing I notice is the number of holdings in each fund.

I couldn’t find data as of the same date, but despite this you still see quite a difference here. Just as an example/proof, the page from the iShares website shows the 10 holdings in TLT and, yup, they’re T-bonds going out about 20 to 30 years.

TLT’s ETF counterpart from Vanguard will be a share class of their Long-Term Bond Index Fund [VBLTX]. Although their data is a bit dated (as of September 30th, 2006), it does confirm that the number of holdings is roughly around 650 securities and lists them

Unlike TLT which is limited to US treasuries, Vanguard’s version is quite diversified in terms of type of issuer, maturity and credit quality.

A quick review of the other Vanguard mutual funds (VBISX, VBIIX, VBLTX) show a similar degree of diversification far beyond what iShares provides. So, although at the very beginning I said that Vanguard is not venturing into new territory, they are providing something different and at a low cost.

So, for the short-term fixed income group, here’s the 3-year comparison price chart:

Here’s the 3-year comparison price chart for the intermediate-term fixed income group:

Here’s the 3-year comparison price chart for the long-term fixed income group:

Not too much to comment on with these three charts. In the chart for the short-term funds, we see greater month-to-month volatility in Vanguard’s fund versus the iShare which is not surprising. What surprises me a bit is how similar the month-to-month volatility is for the 2nd and 3rd charts. There are a small number of months, like April 2005, where there’s a bigger jump in the iShare versus the Vanguard fund, but otherwise they move almost in lock step.

Last thought. I wonder why Vanguard didn’t enter with a real return bond ETF? Vanguard’s Inflation-Protected Securities Fund Investor Shares [VIPSX] tracks very closely with iShares’ Lehman TIPS Bond ETF (TIP):

With TIP priced at 20bps, Vanguard could do what they did against AGG with an 11bps fee (along with other situations like (EEM) versus (VWO)) and force BGI to consider their overall ETF pricing strategy. With many of the recent and proposed ETF offerings venturing into new spaces, and with their associated relative higher costs, I’d like to see BGI go toe-to-toe with Vanguard in the more traditional asset classes and bring costs down.

Comments

[Jonathan Herz:]

The five letter Vanguard symbols you mention in your article aren't ETFs. They are open-end funds.

2007 Jan 22 02:22 PM

[Mark Hartman:]

The ETFs will be a share class (identical holdings) of the existing MFs the author mentioned - there are no ticker symbols yet for the ETFs.

2007 Jan 22 03:35 PM

[Richard Kang1:]

JH/MH
You're both right of course. I've asked the editors to remove the ("VITBX") link after the first table. Hopefully with that revision, this becomes less confusing.

2007 Jan 22 03:47 PM

[Jonathan Herz:]

Thanks for the clarification.

2007 Jan 22 05:02 PM

[Anand Gupta:]

When will the Vanguard Bond ETFs available for buying?
Thanks,
Anand

2007 Jan 26 07:10 PM