It took nearly two decades, but one of Vanguard's ETFs just reached a major milestone.
The Vanguard Total Bond Market ETF (BND -0.21%) broke $100 billion in total assets at the end of November. It's the first bond index fund to cross the threshold. And while the recent run in bond prices has helped, the $16 billion investors have put into the fund so far this year have played a much bigger role.
Investors heavily focused on the stock market may think they've missed the opportunity in bonds. Yields have dropped significantly over the last couple months as investors become more optimistic that the Federal Reserve will cut interest rates next year. As a result, The index fund has moved 6.1% higher from its October low while paying its monthly dividend.
But investors still have an opportunity to buy bonds while they offer a high yield, and the Vanguard Total Bond Market ETF is a great way to gain exposure to the asset class.
The bond rally could be just getting started
Despite the strong price performance for bonds over the past month, we may still be in the early days of a recovery in the asset class.
The main driving force behind bond prices are prevailing interest rates. If interest rates climb, the value of existing bonds goes down. That's what we saw over the last couple years. But when interest rates go back down, the value of existing bonds goes up.
In fact, just the expectation of interest rates going down will drive the value of existing bonds higher. And that's exactly what happened last month.
The Federal Reserve is expected to start cutting interest rates next year, but there's still uncertainty about when those cuts start and how quickly it'll lower rates. Barring a recession, the Fed should slowly push interest rates back down. But after its rapid rate-hiking campaign over the last two years, slow is a relative term.
Some analysts see as many as five rate cuts next year. As things currently stand, the majority of traders expect rate cuts by next March, if not when the Fed meets in January. By the end of next year, the market expects the Fed to cut rates by 1 to 1.25 percentage points.
Of course, much of that is priced into current bond prices. The 10-year Treasury, for example, yields less than 4.2% after its stellar run over the last few weeks. That's around the same as the expected fed funds rate at the end of next year.
10 Year Treasury Rate data by YCharts
But investors can essentially lock in those high interest rates for a long time by buying a bond fund today. That should result in strong long-term performance for the asset class.
Vanguard now expects nominal returns from bonds of 4.8% to 5.8% over the next decade. J.P. Morgan projects 5%-plus returns over the next 10-15 years. That compares to long-term expectations of just 1.5% to 2.5% growth before the Fed started raising rates in 2022. For reference, the Vanguard Total Bond Market ETF produced an annualized total return of just 3.65% from 2010 through 2019.
So the rally in bonds is far from over.
Should you add bonds to your portfolio?
Bonds are typically a great way to diversify a stock portfolio. Historically, bond pricing is inversely correlated with stock pricing.
However, the financial markets have recently been moving in the same direction. Companies relying on debt to fuel their growth now make up a substantial portion of the stock market. Those companies benefit when interest rates go down (sending bond prices higher). That's because the expected future interest expense for those businesses declines, boosting their projected earnings.
That said, bonds still provide excellent protection for a stock portfolio in an economic downturn. Given an uncertain macroeconomic environment and high yields with strong long-term outlooks for bonds, it's worth adding some exposure for most people who desire some insurance for their stocks.
The Vanguard Total Bond Market ETF is a great way to get that bond exposure. With an expense ratio of just 0.03%, it's one of the least expensive options on the market for a total bond market fund.
