Apr 11, 2011
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.

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