Apr 11, 2011
Q&A
Can you address the pros and cons of short-term bond funds versus laddered bond strategies holding individual issues?

EFF/KRF: Short-term bond funds have low return volatility and, because the yield is reset when one bond matures and we use the proceeds to buy another one, they are reasonably good hedges against inflation. The bonds in a laddered strategy typically have longer maturities, so (unless the bonds are inflation protected securities) they do not hedge inflation as effectively. A laddered strategy may have less risk, however, for investors with comparably laddered liabilities that are fixed in dollars. Moreover, some investors find the guaranteed dollar payoff of some laddered strategies attractive. Regardless of what subsequently happens to interest rates, the nominal dollar payoff on a Treasury bill, for example, is known when it is purchased. Of course, if the bonds might default, even the dollar payoff on a laddered strategy is not guaranteed. If the bond market is efficient, all the pros and cons of different bond strategies are properly priced, so the ultimate choice is a matter of taste and personal circumstances.

 
ABOUT FAMA AND FRENCH
Eugene F. Fama
The Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Kenneth R. French
The Roth Family Distinguished Professor of Finance at the Tuck School of Business at Dartmouth College
This information is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Dimensional Fund Advisors and does not represent a recommendation of any particular security, strategy or investment product. Dimensional Fund Advisors is an investment advisor registered with the Securities and Exchange Commission. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.