A total bond fund is a mutual fund or exchange-traded fund that seeks to replicate a broad bond index. A total bond fund owns many securities across a range of maturities from both public and private sectors. The most common index used as a benchmark is the Barclays Aggregate Bond Index, which captures Treasury bonds, corporate bonds, municipal bonds, and high-grade mortgage-backed securities.
Key Takeaways
- A total bond fund tracks the performance of its underlying index, which in turn monitors the entire bond market.
- Investing in a total bond fund gives investors exposure to the bond market similar to more traditional bond investments but offers a very liquid option in what is traditionally a very illiquid sector.
- For total bond funds to work effectively, they need to have a similar maturity profile to the bonds in the underlying index.
- One of the most popular total bond funds is the Vanguard Total Bond Market Index Fund.
How a Total Bond Fund Works
Total bond funds may invest in bonds of similar maturity, class, and rating to replicate an issue that is not available for purchase by the fund. These restrictions exist because of the diversity and relative illiquidity of the bond markets compared with equities markets. It is essential for a total bond fund to have a similar interest rate and maturity to the base index.
Interestingly, total bond fund portfolios have slightly more room in their security selection than total stock funds do. Because individual bond issues have less liquidity than stocks, some funds might bypass certain issues in the benchmark index while selecting other bonds not in the index.
Many total bond funds often have a small allocation—around 20% of assets—from which bonds can be chosen at the managers’ discretion and held outside the Barclays Index. This may include international bonds, derivatives, and lower-rated corporate paper. This approach allows fund managers to invest in some noncorrelated assets while keeping the overall risk profile of the fund within the same range as the Barclays Index.
The most critical risk metrics to keep in line with the index are the maturity, more specifically the weighted average maturity, and the duration, or sensitivity to changes in interest rates.
Vanguard Total Bond Market Index
The Vanguard Total Bond Market Index is designed to provide broad exposure to U.S. investment-grade bonds. Reflecting this goal, the fund invests about 30% in corporate bonds and 70% in U.S. government bonds of all maturities (short-, intermediate-, and long-term issues). As of June 2022, the fund had a 10-year annualized return of 1.34%.
Like other bond funds, one of the risks associated with the fund is that increases in interest rates may cause the price of the bonds in the portfolio to decrease, thus pricing the fund’s NAV lower. Because the fund invests in all segments and maturities of the fixed income market, investors may consider it their core bond holding.
Related Terms: bonds, mutual funds, exchange-traded funds, interest rates, corporate bonds, government bonds.
