Vanguard Challenges Barclays Global Investors' Bond ETF Hegemony

Exchange-traded fund investors got a new choice in the fixed-income market yesterday, as Vanguard rolls out ETF shares for four bond index funds on the American Stock Exchange. The ETFs will charge just 11 basis points in expenses, and are:

· Vanguard Total Bond Market Index ETF (BND)

· Vanguard Short-Term Bond ETF (BSC)

· Vanguard Intermediate-Term Bond ETF (BIV)

· Vanguard Long-Term Bond ETF (BLV)

The launch will put pressure on Barclays Global Investors, which is currently the only company offering fixed-income ETFs in the U.S. BGI’s portfolio of fifteen bond ETFs has over $20 billion in assets.

The funds differ from the iShares offerings in three ways.

For one, the short-, intermediate- and long-term Vanguard bond ETFs do not have direct corollaries in the iShares product line-up.

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The exception is the Vanguard Total Bond Market Index ETF (AMEX: BND), which tracks the same Lehman Aggregate Index as the $5.5 billion iShares Lehman Aggregate Bond Fund (NYSE: AGG).

Secondly, even when the funds track the same index, however, they do so differently: the iShares use a sampling methodology, while the Vanguard funds replicate the index. For instance, while the iShares AGG holds just 120 bonds, the competing Vanguard BDN ETF holds over 2,500.

And finally, there are the fees: iShares charges 20 basis points in expenses for the government/credit ETFs, while Vanguard will charge just 11.

Competition can only be good for investors. iShares has significant first-mover advantage in this space, and its bond funds trade with tight spreads and excellent liquidity. But the Vanguard funds offer more complete coverage at significantly lower costs, and could prove to be worthy competitors in the space.

Fixed-Income Grows
Looking at the bigger picture, the Vanguard launches are a reminder of how far the fixed-income market has come for ETF investors this year. Fixed-income used to be a forgotten corner of the ETF marketplace. At the close of 2006, there were 351 equity ETFs trading in the U.S., with combined assets of $400+ billion; at the same time, there were just six bond funds, with assets of $20 billion. Since then, however, BGI has rolled out nine new ETFs, and now Vanguard is adding four to the mix. In addition, Ameristock Funds has five bond ETFs in registration at the SEC, and SSgA and others are likely not far behind.