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The Honolulu Advertiser
Posted on: Sunday, February 18, 2007

Bond buyers able to choose from great low-cost strategies

By Jonathan Clements

BOND WEB SITES

Web sites to help boost your bond portfolio's return:

  • Research market-listed funds at www.etfconnect.com.

  • Buy government bonds through www.treasurydirect.gov.

  • Check individual bond prices at www.investinginbonds.com.

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    If you want more yield, you've got to cut costs.

    With the benchmark 10-year Treasury note and most money-market funds languishing below 5 percent, these are tough times for income investors. My advice: Look to pocket more of the bond market's yield by trimming Wall Street's take.

    The good news is, that's easier than ever. But this good news clearly hasn't reached lots of investors — and their portfolios are paying the price.

    Today, bond buyers can choose from some great low-cost strategies.

    Last month, for instance, Barclays Global Investors launched eight more iShares exchange-traded bond-index funds, bringing its bond lineup to 14 funds. These ETFs, which you can buy through a full-service or discount broker, charge expenses of just 0.15 percent or 0.2 percent a year.

    Vanguard Group also plans to launch four bond ETFs, which will mimic the strategies of its four existing bond-index mutual funds. Among those four mutual funds, the one with the poorest relative performance has whipped 73 percent of its competitors over the past 10 years — and the best has beaten 93 percent, according to investment researcher Morningstar.

    But why pay fund costs? You can cut out all commissions and expenses by heading to www.treasurydirect.gov and buying newly issued Treasury bonds directly from Uncle Sam. Some brokerage customers, including online investors at Charles Schwab and Fidelity Investments, can also purchase newly issued Treasurys at no cost.

    Similarly, you may be able to minimize trading costs by buying newly issued corporate and municipal bonds. Larry Swedroe, co-author of "The Only Guide to a Winning Bond Strategy You'll Ever Need," likes to purchase AAA-rated munis that way.

    "Establish a relationship with a broker who will look for new issues for you," he suggests. "But you've got to buy and hold. If you sell in the secondary market, you could lose 3 percent, 4 percent or 5 percent to the trading spread."

    Other options? Consider closed-end bond funds. Like ETFs, closed-end funds are listed on the stock market. A closed-end fund's share price, however, often trades below the fund's per-share portfolio value, allowing you to get in at a discount.

    "If you can buy something at 85 or 90 cents on the dollar, that can make a lot of sense," says Andrew Gardener, president of Houston's Tanglewood Legacy Advisors. To find closed-end funds trading at discounts, try the "fund sorter" at www.etfconnect.com.

    Bond-market aficionados will argue over which of the above strategies is most attractive.

    But here's what puzzles me: There are all these cheap ways to buy bonds — and yet huge sums sit in high-cost alternatives.

    Consider U.S. high-quality taxable-bond funds. Over half charge expenses of 1 percent a year or more — and these funds account for 26 percent of taxable-bond-fund money. These figures, calculated by Morningstar, are based on funds with investment minimums of $10,000 and below that are open to all investors.

    The outlook for these funds isn't promising. In 2006, a whopping 73 percent of them had performance that ranked in the bottom half of their category.

    This dismal performance is no surprise. If a high-expense stock fund gets lucky and buys the right stocks, it can overcome its costs and generate dazzling short-term gains. But with high-quality bonds, there isn't much opportunity for a manager to add value. Result: Differences in bond-fund expenses are typically the biggest driver of differences in fund performance.

    Many of the high-expense bond funds are broker-sold "load" funds.

    "You need to ask your adviser why you're in those funds when there are so many better alternatives available," says Michael Smither, managing partner at IndexEdge Investment Consulting in Austin, Texas.

    Indeed, you might talk to your broker about ditching your high-cost funds and buying a bond ETF instead. You will end up with a low-cost fund — and your broker will also get a commission.

    But don't expect your broker to be happy: After that single sale, it could be years before you make another bond trade.