The rise of low-cost, index-based options in the mutual fund and ETF space has created a truly amazing environment for investors. Companies like Vanguard, BlackRock, and Charles Schwab have created ways for investors to access diversified pools of stocks and bonds for very little (to almost zero) cost. This translates into more money that stays in your accounts and compounds over time.
Yet despite this advantage, there is still an insane amount of money in actively managed mutual funds with terrible performance. I shake my head whenever I screen for gigantic funds with billions under management that have ripped off investors with exorbitant fees and lackluster performance.
Many of these funds have been around for decades and do a poor job of disclosing their track record versus a benchmark or other industry peers. Furthermore, they love to hide behind multiple share classes and opaque expense reporting to further cloud the picture.
The majority of the active versus passive debate seems to hone in on stock-picking managers who have failed to live up to expectations. However, there are also a plethora of large bond funds that should be scrutinized as well.
I’m not talking about the specialized funds with “strategic”, “absolute”, “unconstrained” or “income” in their names either. You can expect those unconventional strategies to take a different path than a typical fixed-income benchmark. The funds on this list are all meant to be diversified, core positions that act like a typical bond, yet have failed to deliver results that justify their costs.
Principal Core Plus Bond C (PBMCX)
Exp Ratio: 1.75% 30-Day SEC Yield: 1.05% Assets: $4 billion Sales Charge: 1%
If the 1.75% expense ratio of an intermediate-term bond fund doesn’t catch your eye, I don’t know what else will. This very costly C-share mutual fund from Principal has $4 billion invested in a wide-ranging array of government, mortgage, and corporate debt.
It’s essentially a broad basket of U.S. bonds that is trying to meet or beat a diversified index such as the iShares Core U.S. Aggregate Bond ETF (AGG). The difference is that AGG only charges 0.08% per year and you know exactly what you own inside of it.
According to Morningstar data, this fund has underperformed the Barclays U.S. Aggregate Total Return Index by -1.80% per year for the last 10-years. Funny how that performance gap is almost the exact drag its fees impose. Obviously the active management in PBCMX has been unable generate meaningful returns to justify its high cost.
American Funds Capital World Bond C (CWBCX)
Exp Ratio: 1.73% 30-Day SEC Yield: 0.67% Assets: $12.5 billion Sales Charge: 1%
CWBCX takes a different tact by diversifying its portfolio on a global scale. This fund falls into the world bond category, which makes it more difficult to compare against a traditional U.S.-centric benchmark.
Fortunately, Morningstar has been able to compare this fund against other peers in its category and found it to be lacking in substance. CWBCX has trailed its peer group by -1.04% per year over the last 10 years. It also carries a hefty 1.73% expense ratio that eats heavily into its returns and overall yield.
Investors may be better off getting global bond exposure through a combination of domestic and international ETFs with much lower expenses. The aforementioned AGG is one U.S. option to consider, while the Vanguard Total International Bond Index Fund (BNDX) can be used for foreign exposure. Owning a combination of these two ETFs would allow you to tailor your global bond asset allocation to meet your risk tolerance and outlook.
Oppenheimer Core Bond C (OPBCX)
Exp Ratio: 1.65% 30-Day SEC Yield: 0.97% Assets: $1.7 billion Sales Charge: 1%
OPBCX was decimated during the 2008 financial crisis, which makes its long-term performance much worse than its more recent achievements. This intermediate-term bond fund tails the Barclays (LON:BARC) U.S. Aggregate Bond Index by -4.52% per year over a 10-year look back.
Despite gaining some ground and becoming more correlated with its benchmark over the last several years, this fund still has an overwhelmingly high expense ratio. The generic mix of securities, meager yield, and lackluster returns just don’t add up to meaningful value for shareholders.
According to Morningstar, the fund also has a very high cash position of 22% as of 8/31/16. This is unusual for a core bond fund that is expected to be predominantly invested in fixed-income. Perhaps the managers are betting on a significant change in interest rates or pointedly shaking up the portfolio to try and jumpstart momentum.
Hartford Total Return Bond C (HABCX)
Exp Ratio: 1.59% 30-Day SEC Yield: 1.62% Assets: $2 billion Sales Charge: 1%
Another expensive bond fund that has fallen short due to excessive fees is HABCX. This fund invests the majority of its portfolio in investment grade bonds with the flexibility to hedge investments in currency and other derivative securities. This long/short strategy is often implemented in total return bond funds to offset certain risks or capitalize on opportunities the managers feel are undervalued.
HABCX has underperformed the Barclays U.S. Aggregate Bond Index by -1.52% per year over a 10-year time horizon. Its returns have essentially met or exceeded the benchmark before fees are accounted for. Unfortunately, that’s not the end result that investors actually realize in their own accounts.
Long story short – investors would be much better off swapping for a cheaper share class or substituting this holding for an ETF in their portfolio.
BlackRock Core Bond Portfolio Investor C (BCBCX)
Exp Ratio: 1.55% 30-Day SEC Yield: 0.84% Assets: $3.2 billion Sales Charge: 1%
BlackRock has become almost as synonymous with indexing as Vanguard due to their lineup of low-cost iShares ETFs. Nevertheless, even this massive company isn’t immune to a few eyebrow raising funds.
BCBCX is an actively managed intermediate-term bond fund with a 1.55% expense ratio. This $3.2 billion portfolio has underperformed the Barclays U.S. Aggregate Bond Index by…you guessed it….1.55% per year over the last 10 years.
Despite the attempt at unique positioning, this fund has struggled to overcome its big fee drag and investor returns have suffered as a result. You’re probably better off in a much lower cost ETF from BlackRock instead.
American Funds Bond Fund of America C (BFACX)
Exp Ratio: 1.40% 30-Day SEC Yield: 0.81% Assets: $32 billion Sales Charge: 1%
The term “billions” is thrown around on Wall Street with so much regularity that we have become partially desensitized to the true value of this number. However, when you are talking about $32 BILLION, that’s some real money.
American Funds is one of the larger mutual fund companies that is known for many of their famous stock-focused strategies. Nevertheless, the returns in their flagship bond fund have massively underperformed the intermediate-term bond category. The sheer size of this fund is staggering when you consider how ugly the performance has been.
BFACX has a gaping -2.15% annualized split between its net performance and that of the Barclays U.S. Aggregate Bond Index over the last 10 years. While lowering the expense ratio may help, this fund has had obvious issues with respect to its portfolio process and decision making.
Hopefully this fund is able to turn around its fortunes in the near future. However, there are still a wide variety of better bond fund alternatives out there for this large pool of assets to consider.
The Bottom Line
Here are some key takeaways from this analysis:
- Almost all C-share mutual funds are riddled with fees that you likely aren’t even aware of. This is in the best interest of the fund company, not the shareholders (you!).
- One thing I didn’t even mention in this comparative analysis are the 1% sales loads that every broker got paid to place you in these funds. What a nice finder’s fee for them.
- Expenses matter in terms of total return to shareholders. Often the portfolio manager is actually performing up to par, but their excessive fees are killing net performance.
- Not all active managers should be lumped in the same boat. There are many that are able to consistently beat their benchmark in exchange for a reasonable management fee. Make sure you research and understand all facets of a strategy before you decide to invest.
- Not every mutual fund can be replaced by an equivalent ETF. However, the expanding menu of low cost indexes and active ETFs in the bond category make it much easier every year to find an attractive alternative.
Disclosure : FMD Capital Management, its executives, and/or its clients June hold positions in the ETFs, mutual funds or any investment asset mentioned in this article. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.