Does index investing work in bonds?

(Purpose -The purpose of this paper is to examine operating characteristics, risk and performance measures of all available vehicles for index investing in US bond funds during the 15-year period from April, 1994 to March, 2009. The results shed light on the important issue of bond index mutual funds (BIMFs) and bond exchange-traded funds (BETFs) performance compared with average of all bond mutual funds. Design/methodology/approach -Data were obtained from Morningstar Principia. Operating characteristics include expense ratios, annual turnover rates, and tax cost ratios. Performance measures include average annual returns and return percentile rank in category, risks (measured by standard deviation) and risk-adjusted returns (measured by the Sharpe ratio). Findings -BIMFs and BETFs have significantly lower expense ratios and annual turnover rates than category averages. Their returns and risk-adjusted returns are significantly higher than bond category averages. Research limitations/implications -Future studies will be able to benefit from a larger sample size, longer performance records, and the strength of bond index funds in foreign markets. Practical implications -Both BIMFs and bond exchange-traded mutual funds have significantly lower expense and annual turnover rates, making them preferred investment choices. Social implications -Efforts by active bond mutual fund managers to beat index benchmarks have largely failed. Investors should be wary of bond mutual fund managers touting their ability to beat the average or a bond index. Originality/value -The advantage of investment in BIMFs and BETFs is clear.