The Vanguard Total Bond Index Owns No Long-Term Debt

For a lot of wealthy investors that look to stockpile or inventory their wealth, either as an emergency fund or dry powder, the Vanguard Total Bond Index (VBMFX) is a popular choice because it is loaded with nothing but U.S. government-issued debt as well as some AAA and AA bonds.

It is distinguishable from a money market fund because it owns most of the same debt instruments, except for longer durations. If you purchase those $1 shares in a money market fund, you are making the safest short-term investment possible because it is nothing but U.S. government debt that matures in thirty days or less. As long as the U.S. government does not imminently dissolve its obligations, you are getting paid. That’s why the interest collected is often less than a tenth of one percent.

As cautious investors look for something slightly higher yielding but also generally safe, the obvious place to branch out is intermediate-term bond funds like the Vanguard intermediate index because it contains U.S. government bonds and the highest-quality corporate debt. The duration also switches from 30 days to years.

You extend the duration, and you get to earn an interest that can at least track or modestly exceed the rate of inflation so that you don’t lose purchasing power during your contemplated holding period. Those are the basic terms of bond investing.

What I find notable about the professionals managing the Vanguard Total Bond fund is that they have chosen to lower the duration of its bond holdings—suggesting that they believe long-term debt will perform poorly.

Specifically, the prospectus for the bond index permits the management team to choose a duration between 5 and 15 years of length. If the management team thought that bond yields were high and destined to fall, then it would load up on bonds with extended durations near the fifteen side of the range. Alternatively, if it thought that bond yields were destined to rise, it would load up on bonds of shorter duration.

Right now, the average length of an individual bond owned in this Vanguard fund is 6.3 years (down from an average duration of almost 9 years in 2011). That is about as short of a duration as the prospectus permits.

Upon my review of the fund’s duration, I noticed that only 0.3% of the fund’s assets are held in U.S. government with a maturity of 30 years or longer. For a historical comparison, in 1998, when the thirty-year bond yield was almost 6%, about a fifth of the fund was invested in thirty-year maturities.

The conclusion is that the Vanguard management thinks that interest rates are likely to rise in the coming years. The absence of a single percentage point in long-term treasuries is one of the greatest examples of a high-profile management team signaling that we are living through a bond bubble right now. It is wise that they are not saddling Vanguard’s bond investors with any overpriced, super long-term obligations.