Fixed Income Investing: Actively Managed Funds vs. Index Funds
We continue our miniseries on active funds vs. index funds. In the previous newsletter September 19, 2016: Stock Investing: Actively Managed Funds vs. Index Funds, we discussed the rationale behind our preference of low cost index stock funds over active stock funds. In this newsletter, we look at fixed income funds.
Unlike in stock investing, in principle, we prefer using a selected list of actively managed fixed income bond funds instead of bond index funds. However, that does not mean we like any actively managed bond funds. In fact, there are only handful of bond funds that qualify as our candidate funds.
Capitalization weighting in a bond index fund is questionable
The very first objection to invest in a bond index fund is that it does not present an intuitive sense to use market value (capitalization) to decide how much an index fund should invest. For example, if a company borrows more, its bonds will have bigger capitalization, thus, its bigger weights in an index fund. Similarly, if government issues more debts, its bonds get more weight. This is exactly what has happened lately as the prices of U.S. Treasury bonds have risen so much. Even John Bogle, the champion of indexing, has voiced concerns on this.
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