ETFs are popping up all over, but until now not many have invested in bonds. While some famous rich person once said, "gentlemen prefer bonds", ETF investors clearly do not. While Vanguard was a little late to the exchange traded fund game, in recent years they have put the pedal to the metal in ETF launches. Now Vanguard is launching four new bond ETFs:

• Vanguard Total Bond Market ETF (BND) - Benchmark: Lehman Brothers Aggregate Bond Index
• Vanguard Short-Term Bond ETF (BSV) - Benchmark: Lehman Brothers 1–5 Year Government/Credit Index
• Vanguard Intermediate-Term Bond ETF (BIV) - Benchmark: Lehman Brothers 5–10 Year Government/Credit Index
• Vanguard Long-Term Bond ETF (BLV) - Benchmark: Lehman Brothers Long Government/Credit Index

The benefit of the four new Vanguard ETFs is lower fees – 0.11% compared to the 0.15% - 0.20% cost of the few other bond ETFs. Expenses in bond investing are a big deal as bond yields are low today – the less taken out of your coupon payments, the better. Until trading volumes pick up, investors who don't buy and hold may get a better total price with iShares as thinly traded ETFs tend to cost more to buy and sell.

Vanguard claims, “By operating as share classes of existing funds (rather than as stand-alone funds or unit investment trusts), Vanguard bond ETFs will be able to provide lower expense ratios and broader diversification among issues and issuers than competing products can, resulting in greater credit replication and the potential for tighter benchmark tracking.” In practice, early investors are getting a raw deal.

As of a little after 1PM on April 11th, 2007, the market price for the iShares Lehman Aggregate Fund (AGG) is up 0.19%. The new Vanguard fund based on the same benchmark, Vanguard Total Bond Market ETF (BND), is DOWN 0.15%. AGG has traded 243,000 shares compared to BND’s 14,000.

Why the performance gap? Lack of liquidity means trouble arbitraging the fund with the underlying fund holdings - the mechanism that keeps ETF’s market price close to the NAV. Those who bought BND near the market close yesterday paid a roughly 0.50% premium to NAV, while buyers of AGG paid a 0.20% premium. That’s three years worth of "savings" in fund expenses down the tubes.

Until this problem works itself out, stay away. Or consider Vanguard Total Bond Index (VBMFX). Sure its 0.20% a year, but you buy and sell at NAV commission free (at Vanguard).

Other bond ETFs:

iShares iBoxx $ Investment Grade Co (LQD)
iShares Lehman 7-10Yr Treasury Bond (IEF)
iShares Lehman Aggregate Fund (AGG)
iShares Lehman Credit Bond Fund (CFT)
iShares Lehman Intermediate Credit Bond Fund (CIU)
iShares Lehman 1-3 Year Credit Bond Fund (CSJ)
iShares Lehman Government/Credit Bond Fund (GBF)
iShares Lehman Intermediate Government/Credit Bond Fund (GVI)
iShares Lehman 3-7 Year Treasury Bond Fund (IEI)
iShares Lehman MBS Fixed-Rate Bond Fund (MBB)
iShares Lehman Short Treasury Bond Fund (SHV)
iShares Lehman 10-20 Year Treasury Bond Fund (TLH)

Info at Vanguard.com

Morningstar lists six ways you can make your mutual fund portfolio more tax efficient by minimizing your taxable fund distributions. Tax-efficient funds are those that make very few or relatively small taxable payments to shareholders; some funds try to keep trading activity low (minimizing realized gains which have to be distributed), some watch the way they buy and sell securities in an effort to minimize the tax burden to their shareholders.

1. Invest in Tax-Managed Funds - The managers of tax managed funds take special care to keep taxable distributions to a minimum. They generally don't do much trading, and attempt to "sell losing stocks to offset winners elsewhere in the portfolio." Tax managed funds mentioned in the article: Vanguard Tax-Managed Growth & Income (VTGIX), Vanguard Tax-Managed Balanced (VTMFX), and Eaton Vance Tax-Mgd Value A (EATVX).
2. Look for Closet Tax-Managed Funds - Many funds, such as Oakmark Fund (OAKMX) and Third Avenue Value Fund (TAVFX) don't officially call themselves tax efficient, but have managers that try to keep taxes low.
3. Don't Forget about Index Funds - Index funds track indexes such as the S&P 500, and the people that decide which stocks are included in such indexes don't add or remove stocks from them very often. Because these funds tend to have low turnover, they are generally very tax efficient.
4. Think about ETFs - Most ETFs track indexes, just like index funds do, and hence have low turnover. Low turnover usually equals high tax efficiency. In addition, ETFs unique structure minimizes taxable gains that have to be distributed to shareholders.
5. Make Other Investors' Losses Your Gain - Mutual funds that have had particularly bad performance periods (think tech funds in 2002), can 'carry forward' those losses and offset gains for years to come. This is one we particularly like because it also means you are probably making a contrarian investment – investing where others have just lost money.
6. Houseclean Your Own Portfolio - If you're planning on dumping a fund that has posted a loss, selling before December 31st will allow you to use the loss as a tax deduction on that year's taxes.

LINK

Of course, the most tax-efficient funds are the ones that stink when you own them, because they never distribute profits (there are none!) and often generate nice tax losses when you sell them.

See also:

Ask MAX: Capital Gains Quickies

How Mutual Funds Work - Capital Gains

Despite challenges from new-fangled upstarts, the good old Standard & Poor's 500 Index still reigns as the king of the stock indexes. It's the basis for such mutual fund giants as Vanguard 500 Index Fund (VFINX) and Fidelity's Spartan 500 Index Fund (FSMKX), and in all more than $4 trillion in investors dollars is tracking it (some of which is probably yours). Marketwatch reveals some fascinating facts about the S&P 500 index that you might not know:

• Some people see indexing as a static, sanitized investment strategy. To be sure, the S&P 500 represents about 75% of U.S. stocks by market value, but it's hardly monolithic. Just 86 of the original 500 companies are in the index today. The others were acquired, failed or dropped from the ranks.
• The S&P 500's strength -- ranking stocks by market value -- can be a weakness. In runaway bull markets especially, the index can become a poster child for speculative excesses. When investors ignore valuation and bid shares of the biggest companies to stratospheric heights, the index can become dangerously unbalanced.
• Today, about 18.5% of the S&P 500 is tied to technology and telecom stocks. That's second to financials, at 22% of the index's total value. Add the health-care sector, at 12%, and more than half of the index is represented.
• In the bear market that persisted through most of 2002, index-fund investors found no shelter as the S&P 500 lost half its value.
• To most investors, the S&P 500 is the stock market's apple pie, a uniquely American product. In fact, though the benchmark companies are U.S.-based, their customers are increasingly global. The S&P 500 has so much total international-sales exposure, your stock portfolio might not even need a separate international component for diversification.

LINK