Interm. Invest-Grade vs. Interm. Corp Index

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RMO87
Posts: 136
Joined: Fri Jan 18, 2008 9:11 am
Location: Kansas City, MO

Interm. Invest-Grade vs. Interm. Corp Index

Post by RMO87 » Wed Jan 10, 2018 10:51 pm

I currently have $28K in Intermediate Investment-Grade, but recently noticed the lower expense ratio (0.07% vs. 0.20%), higher yield (3.27% vs. 2.77%), and better one-year return (5.25% vs. 4.15%) of Intermediate Corporate Index Admiral. Are things like the relatively better yield and return likely to continue--that is, is this to be expected due to greater risk taken by the Corp Index fund? I believe what originally swayed me into choosing the Invest-Grade fund was that the Corp Index fund has a 0.25% purchase fee. Why does this fund charge such a fee in the first place?

Thanks,
Ryan

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spdoublebass
Posts: 355
Joined: Thu Apr 27, 2017 10:04 pm
Location: NY

Re: Interm. Invest-Grade vs. Interm. Corp Index

Post by spdoublebass » Wed Jan 10, 2018 11:17 pm

I'm not an advanced investor don't place any weight in my response.

I think that the Intermediate Investment Grade fund in Actively managed.

The Intermediate term corporate bond in an Index. This fund has lower ER but does have a purchase fee if I remember correctly. The ETF version of this fund, VCIT, does not have purchase fee and is the same ER .07%

I'm sure others will give you more advice.
Resist much, obey little.

lack_ey
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Joined: Wed Nov 19, 2014 11:55 pm

Re: Interm. Invest-Grade vs. Interm. Corp Index

Post by lack_ey » Wed Jan 10, 2018 11:19 pm

The index fund is taking more risk now, both term risk (longer duration) and credit risk (lower quality). The investment-grade fund includes some Treasury bonds, and I think the securitized bonds and maybe the corporate bond allocation may be higher quality on average than what's in the index. The I would expect the index fund to take more credit risk generally, and probably more term risk most of the time.

It's not a huge difference, though. As of the last portfolio statistics date (end of November), the index fund had 53.5% in Baa bonds, while the investment-grade fund had 21.1% in Baa and 1.5% below that (a small percentage not rated too). The fund durations were 6.4 and 5.5 respectively.

The extra term risk and credit risk were both additive in 2017, but that is not generally going to be true (though historically on average and long term in the future we probably expect both to provide excess return over cash). Currently both actually seem priced for relatively low forward returns. The yield curve is not all that steep, especially given market expectations of 2-3 Fed funds rate increases (increments of 0.25% each) to come in the year with perhaps some more in the future. And credit spreads are at their lowest level since before the financial crisis.

The index fund charges a 0.25% purchase fee because it is difficult to trade these underlying bonds efficiently. If there were no fee, fund flows would be disruptive and hurt existing fund shareholders via excessive transaction costs on the churn. The non-index fund can get around this because it owns some Treasury bonds, which are a lot more liquid. It can wait to trade the corporate bonds when it can get better prices and choose which to buy and sell because it doesn't have to follow an index's composition and characteristics. A temporary drift in allocation is not a big deal for it.

The ETF for the intermediate-term corporate bond index fund doesn't have a purchase fee for investors because it couldn't. And investors are buying and selling on the secondary market to others anyway; only redemptions/creations through authorized participants cause fund assets to change, and it's not up to the fund but rather the APs to transact in the underlying bonds for cash. The fund just trades ETF shares for bonds when exchanging with APs.

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