Cheapskates Win

NEW MORNINGSTAR research on bond funds echoes what the late Jack Bogle preached—and proved—for decades: Costs are the greatest predictor of fund performance, not stock or bond selection prowess. In investing, you get what you don’t pay for, said Bogle, Vanguard Group’s founder and creator of the first index mutual fund.

There’s a school of thought that claims it’s easier for active bond fund managers to beat their indexes than it is for their stock fund colleagues. Whether that’s true or not, the fact remains that funds with lower expense ratios outperform more expensive ones, and they do so with less volatility. Those are the findings of Morningstar’s Chief Ratings Officer, Jeffrey Ptak, relayed in a recent column titled, “Why Pay Up for Bond Funds?”

“Costlier bond funds not only return less than cheaper funds, on average, but they’re more volatile,” Ptak wrote. “That’s not a coincidence. For even among funds of the same type, pricier offerings are more likely to take on higher risk to clear the higher fee hurdles they face.”

Upon reading that, my thoughts turned to today’s “bond king,” Jeff Gundlach. Several years ago, I considered investing in his flagship DoubleLine Total Return Bond Fund (symbol: DLTNX), but I was dissuaded by the fund’s high expense ratio, which today is 0.73%. Especially when bond yields in the 2010s were so low, I couldn’t justify paying that much for fixed-income exposure.

It’s also important to consider the purpose of fixed-income holdings in your portfolio. Since I’m still working and have a high percentage of my investments in stocks, I view Treasurys as the best way to hedge that risk. I use Treasury bond index funds as opposed to alternatives such as the Vanguard Total Bond Market Index Fund’s Admiral Shares (VBTLX).

Vanguard’s Total Bond fund tracks an index that includes all types of investment-grade bonds, with roughly half in Treasurys, but with corporates and securitized bonds also owned. Gundlach and his team, by contrast, invest the vast majority of their fund’s assets in securitized mortgage bonds. That presents a different risk profile but offers a higher yield.

DoubleLine Total Return sports a trailing 12-month yield of 3.66%, according to Morningstar, versus just 2.66% for Vanguard’s Total Bond Market fund. Its yield advantage is even greater over my short-term Treasury fund. Yet I don’t need yield right now, nor do I need the higher interest-rate risk of these other funds.

Despite vastly higher costs, Gundlach’s fund has destroyed the index fund since the former’s inception just over 13 years ago. DoubleLine Total Return has returned 3.5% per year, versus 2.2% for Vanguard Total Bond. Yet all that outperformance was concentrated in the DoubleLine fund’s early years, before it attracted most of its current $34 billion in assets.

Over the 10 years ended May 31, DoubleLine Total Return, with an annual gain of 1.2%, has lagged behind Vanguard Total Bond’s 1.4% annual return. Paying DoubleLine nearly three-quarters of a percentage point every year cost investors money over the past decade. Vanguard Total Bond’s expense ratio is just 0.05%.

Unlike most of the high-cost funds in the recent Morningstar study, the DoubleLine fund exhibited less volatility than the bond index fund. The DoubleLine fund fell just over 16% in the recent bond bear market, versus nearly 18% for Vanguard’s bond index fund. That’s good, yet hardly enough to let investors sleep more soundly—or to justify the higher costs.

And most active bond fund managers can’t match Gundlach’s record. The bottom line: I’d think twice before investing in any high-cost fund. Management skill rarely compensates investors. The only certainty is that high fees handsomely compensate management.

William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles.

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