3 Strong Choices Among Core Bond Funds

Neal Kosciulek: When considering options for a core bond fund, it is important to remember that for most investors the primary purpose of a bond position within a portfolio is to diversify equity risk. When the equity market is in turmoil, bonds can serve as ballast.

With its origins dating back to the early 1970s, the Bloomberg Barclays U.S. Aggregate Bond Index is synonymous with core bond market exposure.

The index is primarily comprised of U.S. Treasury bonds, U.S. Agency bonds, and investment grade U.S. corporate bonds. The index weights bonds by their market value. Market-value weighting free-rides off the collective wisdom of market participants to set bond prices. That said, it also means that issuance activity dictates the makeup of the benchmark.

For example, the Bloomberg Barclays U.S. Aggregate Bond Index is more conservative now than it was before the financial crisis. This shift was driven by a surge in new issuance of U.S. Treasuries. Prior to the crisis, Treasury bonds represented just 20% of the total market-value weighted index. Today, they represent 40% of its value.

As it focuses on investment-grade issuers, the index takes minimal credit risk. Credit risk is generally positively correlated to the stock market, so funds tracking the Agg should effectively diversify equity risk in a portfolio. Agg-tracking funds will tend to lag peers when credit risk is rewarded and outperform during intermittent flights to quality, when Treasury bonds in particular tend to perform relatively well.

There are several funds that track the Bloomberg Barclays U.S. Aggregate Bond Index. Our favorites are helmed by experienced teams, backed by responsible parent firms, and boast low fees.

IShares Core US Aggregate Bond ETF AGG, Schwab US Aggregate Bond ETF SCHZ, and Vanguard Total Bond Market ETF BND each carry a Morningstar Analyst Rating of Silver. All these funds are substantially similar. To spot the minor differences between them, you need to put them under a microscope. Up close, you’ll notice the iShares fund charges a 0.05% fee--marginally higher than the 0.04% toll taken by SCHZ and the 0.035% toll taken by BND. Also, the Vanguard fund tracks the float-adjusted version of the Agg. This means that the value of bonds held by the Federal Reserve are excluded when weighting the bonds in its portfolio. This adjustment shouldn’t have a material impact on the fund’s performance, and it has historically mirrored the performance of the other funds.

In our opinion, all three funds would make a sensible selection for core bond market exposure.