What Is a Total Bond Fund?

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 the same exposure to the bond market as more traditional bond investments allow, but offer a very liquid option in what is traditionally a very illiquid sector.
  • In order for total bond funds to work, they need to have a similar maturity to the bonds in the underlying index.
  • One of the most popular total bond funds is offered by Vanguard, and is called 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 important for a total bond fund to have a similar interest rate and maturity to the base index.

Total bond fund portfolios actually have a bit more freedom in their security selection than a total stock fund does. Because individual bond issues have less liquidity than stocks, some funds have to bypass certain issues that are in the benchmark index while choosing other bonds that are not in the index.

Many total bond funds have a small allocation, around 20% of assets, from which bonds can be chosen at the discretion of the managers and held in assets outside the Barclays Index, such as international bonds, derivatives and lower-rated corporate paper. This allows fund managers a chance 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 important risk metrics to keep close to the index are the maturity, or more specifically the weighted average maturity, as well as 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 March 2020, the fund had a 10-year annualized return of 3.57%.

As with other bond funds, one of the risks of the fund is that increases in interest rates may cause the price of the bonds in the portfolio to decrease—pricing the fund’s NAV lower. Because the fund invests in all segments and maturities of the fixed income market, investors may consider the fund their core bond holding.