The Best Bond Index Funds: Part 1

Bond Index Funds Rising

Fixed-income investors adopted indexing more slowly than did equity shareholders. Part of the reason was that indexers began with stock funds, turning to bonds only later. Another was that active equity managers were the first to become discredited. By 2010, they were distinctly unpopular, while fixed-income managers Bill Gross and Jeff Gundlach remained investment royalty.

The latter has changed. Gross was pushed out of the company he founded. Meanwhile, Gundlach’s flagship fund, DoubleLine Total Return Bond DBLTX, has reverted to the mean. Over the past 10 years, the fund’s returns slightly trail its category’s average. (In fairness, the fund also has been somewhat less volatile.) With its star managers struggling, active bond management has lost favor. Index funds now account for 43% of the group’s assets. By 2027, they will outweigh their actively run counterparts, as has already occurred with equities.

Which means that there are now many excellent options for index-fund buyers. This article addresses the index-fund choices for three taxable investment-grade categories: 1) intermediate core, which is the biggest fixed-income group, 2) short-term, which contains funds with portfolio durations of 1.0 to 3.5 years, and 3) ultrashort, which houses funds with durations of less than 1.0 year.

The Method

I compiled this Best Funds list in the same way as my previous articles on top index funds, which addressed 1) domestic and then 2) international equities. I screened for all passively managed mutual funds and exchange-traded funds that had five-year track records at year-end 2023. After eliminating investments that retail investors cannot buy, either because those funds are for institutions or because they are only sold through 401(k) plans, I selected the five cheapest funds.

I could, of course, have chosen the candidates based on performance—either the highest returns over that five-year period or the strongest risk-adjusted results. However, that strikes me as a different issue. When purchasing index funds, investors face two separate decisions. One, which index is best? Two, how much must I pay to own it? The first question lies far beyond the scope of this article. I have no idea if the Bloomberg US Aggregate Bond Index is superior to the Bloomberg US Gov/Credit Float-Adjusted 5-10 Year Index. However, I do show the benchmark tracked by each fund, along with that fund’s five-year return.

I have also included the percentage of assets that each fund holds in government securities, as that figure helps to explain performance. Finally, I display SEC yields. Morningstar does not consider income when calculating its Morningstar Ratings—the “star rating”—because total return is what ultimately matters. Whether shareholders receive their gains through capital appreciation or income is of secondary importance. That said, I acknowledge the counterargument. We might not care about yield, but many do. Fair enough. Ask to see SEC yields and ye shall receive.

Intermediate Core

With this category, which contains a plethora of strong candidates, I present eight winners. The table specifies every retail fund in the group that has an annual expense ratio of 0.05%. The sole exception is JPMorgan BetaBuilders US Aggregate Bond ETF BBAG, which I omitted because it has trailed its benchmark by 20 basis points per year more than its expense ratio would suggest.

All five major index brands are represented. In alphabetical order, they are Fidelity, iShares, Schwab SCHW, SPDR, and Vanguard. Intermediate core bond funds from the first four organizations replicate the Bloomberg US Aggregate Bond Index. Vanguard takes a different approach, using other Bloomberg benchmarks.

Vanguard Intermediate-Term Bond ETF BIV is the list’s standout, boasting the highest five-year returns and SEC yields. In this instance, the government-bond weighting misses the point. The fund actually owns more government notes than its rivals but has benefited from a difference that appears further down the credit ladder. It holds twice as many A and BBB rated notes as do the other seven funds, which explains both its higher returns and income.

Short-Term

Five short-term bond funds have expense ratios of 0.05% or less. Since that is normally the number of funds I seek, my task was quickly completed. This time, the government-bond percentage tells the tale. Fidelity Short-Term Bond Index FNSOX and Vanguard Short-Term Bond ETF BSV are primarily Treasury funds, while their rivals invest in corporate notes. The latter strategy is usually more lucrative, but it can be susceptible to financial crises, most notably during 2008.

Ultrashort

Ironically, the most conservative category, possessing the lowest expected returns, has the highest expense ratios. If I were to follow the same protocol as with the previous two tables, featuring only funds with expense ratios of 0.05% or less, I would list no funds at all. The prices of ultrashort funds are less competitive because there are fewer of them. Also, investors in very short portfolios are accustomed to paying steep fees, either to their banks or to their brokerage firms, via cash sweeps. (They don’t necessarily see those fees, but they pay them.)

Thus, I raised the ceiling to 0.15%. I also added Vanguard Ultra-Short-Term Bond VUSFX, which, although technically not an index fund, owns so many securities that it effectively behaves like one. (And no, I don’t know why the bond lists the much longer Bloomberg US Aggregate Bond Index as its benchmark.) The lesson is the same as with the previous categories. The fund with lower credit quality has posted the highest total return, although strangely it does not have a higher yield. The remaining four funds are very similar.

Next Week

Tuesday’s column will cover four remaining bond-fund categories: 1) high yield, 2) global (dollar-hedged), 3) muni national intermediate, and 4) inflation-protected.