NEW YORK — More money is flowing into mutual funds and exchange-traded funds that track bond indexes, lured by low expenses.
Before jumping into a bond index fund, though, keep in mind that they come in many flavors.
Yields are low for every type of bond. Bonds with strong credit ratings generally offer yields of 2.3 percent, for example, nearly half of what they offered a decade ago.
“If you’re already in a low-rate environment, you don’t want to give away half of that in management fees,” says Gregory Davis, global head of Vanguard’s fixed-income group.
Active management comes at a price — $65 of every $10,000 invested in actively managed bond funds went to cover operating costs last year. For bond index funds, just $11 of a $10,000 investment went to expenses.
The top priority for investors should be finding a low-cost bond fund, Davis said. Some actively managed bond funds can have low expense ratios.
The pitch for actively managed bond funds is that their ability to choose bonds means they have the potential to perform better.
The bond market is set to become more volatile, now that the Federal Reserve has ended its bond-buying program and may be close to raising short-term interest rates for the first time since 2006. It’s during these types of markets that active managers can best show their worth, said Mark Cernicky, bond-market strategist at Principal Global Investors.
Bond index funds are often invested heavily in areas that active managers say will be most hurt by a rise in rates: government bonds and longer-term debt. More than a third of the Barclays U.S. Aggregate index, the benchmark for many investment-grade bond funds, is in Treasurys.
Active funds can buy more corporate bonds, shorter-term debt or other bonds that hold up better in periods of increasing interest rates.
At the start of the year, most bond-fund managers expected interest rates to rise.
But they were wrong. Interest rates ended up dropping and, at one point, the 10-year Treasury’s yield fell below 2 percent.
The unexpected result hampered active bond-fund managers, and most haven’t kept up with the Barclays index. The average intermediate-term bond fund has returned to 4.7 percent this year, versus 5 percent for the index.
Many active managers have failed to keep up with the index over the last three years.
Of those that specialize in long-term government bonds, just 1 percent beat the related Barclays index. That’s according to the latest data from S&P Dow Jones Indices, which runs through June.
