Bond Fund Expense Ratios
The bond fund expense ratio is an easy calculable and important ratio for investors to use when evaluating bond funds. The ratio compares the costs of investing in a bond fund to the cash flow of the fund. Bond fund principal is measured by the Net Asset Value. NAV represents the impartial third party evaluation of a fund based on the weighted average price of every bond in the portfolio. The expense ratio is the sum total of trading, management fees and marketing costs. Expense ratios may also be computed separately for each category.
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Bond Fund Expense Ratios
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Expense ratios may demonstrate to investors whether a bond fund is suitable for their investment objectives. High yield bond funds and long-term bond funds contain higher credit and maturity, or duration, risk than short maturity, high credit bond funds. These bond funds must be adept at reacting to changes in interest rates and bond ratings. This requires more trading and thus higher expense ratios. If the portfolio manager does not correctly estimate market direction the fund may incur higher trading expenses and under-performance.
Bond Fund Management Fees
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Management fees vary among funds, yet there is little research to suggest that the amount of management fee is related to bond performance. Management fees are the largest part of an expense ratio. Typically, bond fund expenses run about .35 percent or 35 basis points. Shorter duration funds cost less and high yield funds, requiring larger credit staffs, charge more. Investors might consider a bond index fund where specific bonds are purchased that match the credit and maturity of a widely followed group of bonds. These funds are passively managed, meaning changes are only made when the index is changed. Management fees may be as low as 10 basis points. Expense ratios will be the lower than in any other type of bond fund.
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Current Yield and Net Current Yield
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Expense ratios do not reflect all investor concerns in comparing bond funds. Current yield is determined by dividing the income of a fund by the net asset value. Net current yield subtracts the sum of all bond expenses from the current yield before dividing by the net asset value. Load funds are funds sold with a specific entry or exit fee that is paid to the broker in addition to regular annual expenses and is subtracted from the NAV. Expense ratios must take into account one time charges because these expenses effectively raise expense ratios. A 5 percent load held for 10 years will reduce a bond fund net current yield by over 50 basis points per year.
Principal and Income
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Bond funds will try to maximize yield, often through the use of low-rated, unrated, or derivative securities. These actions may increase yield, but also run the risk of losing principal measured by NAV if the trading plan does not work. Investors should review the history of the NAV of the fund to see if it has varied while yield has increased. Bond funds with high current yields, even after expenses, may come at the expense of principal. Review and rank bond funds for total return which includes all net income and changes in NAV as well as using expense ratios.
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References
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