Core bond funds typically provide investors with broad exposure to the investment-grade area of the bond market through investments in a wide variety of market segments (most notably, U.S. Treasuries, mortgage-backed securities, and investment grade corporate bonds). Core funds also hold a broad representation of maturities (i.e., short, intermediate, and long), but most core funds typically average out into the intermediate range.
Core funds are so named since the idea is that if investors owned only one investment grade bond fund in their portfolio, the core fund could essentially cover all the bases. This is a relatively new term – investors who are investigating this segment will find many funds in the category have changed their names within the past three years to include the word “core”.
Two Types of Core Funds: Active and Passive
Core bond funds can either be active, which means that the managers frequently change the portfolio’s makeup to capture opportunities or avoid risk, or passive, which means they track an index.
Bond index funds, while not carrying the “core” label, can in fact represent a core holding for many investors. Funds that track an investment-grade bond index such as the Barclays Aggregate Index have many advantages, including broad diversification, low expenses, and the certainty that the fund will not suffer extreme underperformance in a given year due to a manager’s bad decisions. At the same time, however, index funds tend to have a higher weighting in government bonds and a relatively high sensitivity to interest rate movements.
Two Important Drawbacks of Core Bond Funds
One issue to be aware of with core bond funds is that not every issuer views the concept of “core” in the same way. A core fund issued by one company may look much different than a core fund issued by another. In addition, active managers can take a wide range of approaches - with varying degrees of success. In addition, certain funds will adopt more of a “go-anywhere” approach that incorporates high yield bonds or other investments not held in the investment grade indices. Since there is so much variability within the category, be sure to investigate each fund closely to see what it holds, how it has performed over time, and how it has held up during market downturns. In short, don’t just assume a core bond fund will meet your objectives on the basis of its name alone.
The second issue with core funds is that most don’t hold weightings in international, emerging market, or high yield bonds. As a result, core bond funds may not necessarily provide the level of diversification that investors expect. Also, since these market segments tend to have lower exposure to interest rate movements, a core fund without investments in these areas may have above-average exposure to interest rate risk than a fully diversified portfolio. An investor who wants to achieve total diversification may consider supplementing their core funds with high yield and/or international funds.
How to Invest in Core Bond Funds
Investors have the choice between mutual funds or exchange-traded funds (ETFs). Mutual funds can be purchased directly from the company or through a broker, while ETFs require a brokerage account. Two of the largest core bond mutual funds are PIMCO Total Return Fund (ticker:PPTDX), DoubleLine Total Return Fund (DLTNX), while three of the most well-known ETFs are Vanguard Total Bond Market ETF (BND) and iShares Core Total U.S. Bond Market ETF (AGG), and PIMCO Total Return ETF (BOND).
Disclaimer: The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities. Be sure to consult investment and tax professionals before you invest.