The Vanguard Total Bond Market ETF (BND) surpassed the iShares Barclays US Aggregate Bond ETF (AGG) in assets last week. BND closed on December 1 with $13,797 million in assets, edging out AGG by $22 million. Both ETFs track the Barclays Capital Aggregate Bond Market index, a broad benchmark of investment-grade bonds that trade in the U.S.
iShares was first-to-market in September 2003 with an ETF that tracks the Barclays index. Being first in the fund industry creates a huge advantage. AGG attracted $6 billion in assets by the time Vanguard launch BND in April 2007. Figure 1 illustrates how the race has progressed since.
Figure 1: Assets in Millions for AGG and BND (through December 1, 2011)
It’s rare for the second-to-market ETF to catch a fund that had such a commanding lead in assets. However, investors were quick to see advantages in BND over AGG, and money started flowing in.
Fees are critical to index-fixed investing. Vanguard’s 0.11 percent expense ratio for BND is half of iShares’ 0.22 percent fee for AGG. When two funds follow the same index, it’s typical for the low-fee fund to have the highest returns. This duel is no exception. Through December 1, Vanguard’s 3-year return on BND has been 6.96 percent, while iShares’ return on AGG has been 6.81 percent, according to Morningstar.com.
The second advantage Vanguard has is that their ETFs are a share class of their open-end funds, while iShares’ ETFs are stand-alone funds. The multi-share class structure gives Vanguard fund managers flexibility in how they manage their funds.
Greg Davis, head of the bond index group at Vanguard, explains: “Our unique ability to offer an ETF as a share class of our existing large bond index funds results in an ETF with greater index replication, broader issuer diversification, lower costs, and a more efficient share creation/redemption process. The advisor market clearly understands these advantages.”
The growth in fixed-income ETF investing is expected to continue as more investors and advisors convert from active management to index fund investing. “I think you’re going to see a huge movement into indexation of bonds, much lower fees,” stated BlackRock (BLK)’s Chief Executive Officer, Laurence D. Fink, during an October 19 conference, according to a recent article in Bloomberg News.
Mr. Davis agrees, “The preference by many financial advisors to express their investment views using ETFs is leading to a continued move from higher-cost, actively-managed, conventional mutual funds to lower-cost ETFs…and we expect that trend to continue and maybe even accelerate.”
It is hard for active bond management to compete with bond index funds and ETFs. The average expense ratio for an actively managed bond fund is 0.75 percent, according to Morningstar. That’s more than 3 times the fee for bond index funds and ETFs. In the long-term, indexing will win.
Fixed-income fund investors are seeking any advantage they can find in this low interest rate environment. BND and other low-cost bond index funds and ETFs are one way to ensure a fair share of available returns.
