Importance Of Bond Fund Expense Ratios

December 22, 2017

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

If stocks experience their long-overdue swoon, bonds will again offer comforting ballast to a well-diversified portfolio, according to CFRA. Yet bond performance will likely be held back by the expectation the Federal Reserve will maintain its rate-tightening timetable of three additional hikes in 2018, according to Sam Stovall, CFRA's chief investment strategist.

Given those dampened return expectations, we think investors should ensure the expense ratio of any fixed-income mutual fund or ETF as part of their due diligence review—much more so than a backward look at past performance.

The average taxable high-yield-bond mutual fund charges a 1.1% net expense ratio. While the high fee was less important in 2016, when the average fund earned a 13.3% total return, the gain year-to-date through Dec. 8 was just 6.2%.

The AB High Income Fund (AGDAX) and BlackRock High Yield Bond Portfolio (BHYAX) are examples of high-yield mutual funds that: a) are favorably rated by CFRA; b) are outperforming in 2017, consistent with their strong long-term term records; and c) have below-average net expense ratios.

AGDAX offers a higher yield than BHYAX, but recently incurred more interest rate risk. Investors wanting active management can determine which CFRA rating input—expense ratio, yield and risk are just a few—matters most to them.

Fixed-Income ETFs

Investors are increasingly turning to fixed-income ETFs to provide lower-cost exposure to the high-yield space. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) is the largest of them, with $18 billion in assets. HYG has a 0.49% expense ratio and trades approximately 14 million shares daily, providing ample liquidity for institutional and retail investors.

Meanwhile, the Xtrackers USD High Yield Corporate Bond ETF (HYLB), launched in December 2016 by Deutsche Bank, charges only 0.20%. HYLB is smaller, at $430 million in assets, but trades 200,000 shares daily, which should be sufficient for many investors. However, the bid/ask spread for HYLB is wider than HYG.

As important as low costs should be for high-yield investors, returns have been—and will likely continue to be—more modest for bond funds that take on less credit risk.

Short-Term Investment-Grade Debt

The short-term investment-grade-debt mutual fund peer group was up 2.3% in 2016 and just 1.6% year-to-date through Dec. 8. The average fund charges a 0.74% expense ratio.

Examples of CFRA five- or four-star-rated mutual funds in this peer group with strong returns in both years and below-average expense ratios are the DoubleLine Low Duration Bond Fund (DLSNX) and Invesco Short Term Bond Fund (STBYX). Relative to AGDAX and BHYAX, these funds have more exposure to bonds that sport higher yields in exchange for greater risk.

For investors seeking lower-cost ETF short-term investment-grade alternatives, the iShares Core 1-5 Year USD Bond ETF (ISTB) and the Vanguard Short-Term Corporate Bond ETF (VCSH) are among the strong choices.

While ITSB has a slightly lower expense ratio (0.06% vs. 0.07%), the bigger difference between the two ETFs is tied to their holdings. ISTB has a stronger credit profile, due to its holding of Treasuries and other government bonds in addition to corporate bonds: VCSH only holds corporate bonds, many of which are rated A and BBB.

In separately rating bond ETFs and mutual funds, CFRA includes a fund's expense ratio, credit quality, duration and yield in addition to some recent relatively performance metrics. If 2018 proves more challenging for bond investors, a more holistic review of the fund alternatives is needed.

CFRA Research acquired S&P Equity & Fund Research in late 2016. To learn more about CFRA Fund ratings, visit www.cfraresearch.com.

At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him at @ToddCFRA.

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