Quote:
Originally Posted by GGG
What’s the logic on being anti-bond index? Tax efficiency? I get the anti-index investing logic in general but why are bonds worse?
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Almost every index is market cap weighted. This is a great feature for equity indices, because it lets the winners run. So when Nvidia is up infinity percent in 10 years the index doesn't sell, it keeps the position, so when it's up another 100% the next year it benefits greatly (momentum effects, basically). It also has some "efficient market" benefits, because the companies the market believes are most valuable get the biggest weighting. (Air quotes because I think the market is only mostly efficient, but for this discussion that's good enough, imo). This does generally result in the biggest weighting to the best equities, which is an important feature.
By contrast, weighting bonds by market value is generally a bad idea. It isn't obvious to me that companies with lots and lots of debt should be the highest weightings in your fixed income portfolio. And allocating more money to companies as they become more indebted isn't a positive momentum effect.
A lot of people don't like bond funds at all, because they don't mature like a regular bond, so you don't have the same guarantee of receiving your principal back. I think that's a mostly specious objection, because holding bonds to maturity is actually a variety of different investments with different risk profiles (ie a 5 yr bond becomes a 4yr then a 3yr then a 2yr the a 1yr then redeems). From a portfolio construction point of view constant maturity is difficult to do without a fund unless you're dealing with very large portfolios. And any time a bond fund has losses individual bonds also have losses, but people just (like regional banks) use the held to maturity fallacy that they haven't actually lost the money unless they sell.
**I'm aware that bond indices restrict their universe in various ways, generally credit rating. But that still exposures you to the largest debtors within a band. So a long term AAA fund in 2007 would have had lots of GE paper and almost no Berkshire Hathaway.