What is Ponax Performance?
Ponax is a bond fund that invests in high-quality, short-term bonds with some exposure to credit risk. The current portfolio is 70% AAA & AA rated. It has been stated by Ponax’s reps that the bond funds are “tax optimized”, but it does not seem so at first glance. All of their returns are taxable on an annual basis, which makes them pale in comparison to ETFs overtime on an after-tax basis.
Ponax Performance is an example financial model that seeks to show the performance of a typical bond fund. The point of this exercise is to compare its performance under diverse market conditions with that of other funds in the Market Vectors Intermediate Government/Credit Bond ETF (NYSEARCA: ICGB), which attempts to track the performance of one representative benchmark index, the Market Vectors US Intermediate Government/Credit Bond Index.
Unless stated otherwise, all references to dollars assume they are U.S. dollars (USD).
Why was Ponax Performance created?
The purpose is threefold:
- To demonstrate how expensive it can be for individual investors to purchase financial services;
- To provide practical examples of how various choices impact investing; and
- To help the world become a better place by using math.
How is Ponax Performance calculated?
It is based on monthly total returns of ICGB and SPY (the ETF version of the S&P 500), and it represents performance from 1/1/2005 through 12/31/2014:
There are two ways to interpret this chart:
- First, you could say that next to U.S. Treasury bonds, which aren’t included in either portfolio, other bond funds have been flat at best over the past decade, but that the average investor has lost many times more than just their fees due to volatility drag. “Volatility drag” refers to the impact of losses caused by price swings, and it is the enemy of retail investors. As you can see, the orange line (Ponax) has been rising at a rate that would have made an investor unhappy if he or she had stayed in the fund over time.
- The second way to interpret this chart is as a warning sign not to bet on any investment for ten years based on its past performance alone because there’s no guarantee it will do as well next decade. The fact that current market conditions may be different than they were back then makes moving from historical average assumptions even riskier.
Why is Ponax Performance Worse than Other Bond Funds?
There are three main reasons:
- No Exposure to U.S. Treasury Bonds – The only two bond funds in the chart with no exposure to Treasuries are both actively managed, and they charge higher fees for this privilege. U.S. Treasury bonds have historically provided a less risky return than other bonds, so it’s important to understand that not all bonds are created equal.
- Fees – As shown in the previous section, investors pay quite a price to have someone else choose what investment to use. According to the Fund Analyzer on Morningstar, indexing is now cheaper than ever before, but advisors still charge 1% of assets annually on average for making these choices for you. That’s still a decent chunk of change, but the amount you pay will vary based on your personal situation.
- Volatility Drag – While other funds have had periods of volatility, it is important to look at the long-term picture rather than just short-term swings in performance. Pentax’s returns are clustered around the flat after taxes for U.S. investors due to its volatile nature.
To summarize, if market conditions continue as they have over the past ten years or even longer, then choosing an actively managed bond fund with no exposure to U.S Treasury bonds will likely cost an investor many multiples of what Ponax charges in fees every year on average
Is Ponax a good fund?
It is a reasonable option in a diversified portfolio, but there are better choices. For a conservative investor with a short time horizon, it might be the best choice available for that profile; one could also choose to hold only U.S. Treasury bonds or very short-term U.S. Treasuries (less than five years), which would eliminate the effects of volatility drag and greatly minimize fees.
Despite the past performance, can it still be worthwhile to invest in active bond funds?
Possibly – remember how we noted that looking at historical averages tells you nothing about future returns? We didn’t include figures for anyone before 2003 because there wasn’t enough data to make an accurate chart:
This highlights one of the main problems with active management. While some actively managed funds have performed better than indexing historically, they rely on a long-term track record based on historical averages to attract investors. If you can accept the idea that past performance does not guarantee future results, then it may be possible for someone who has studied the bond market carefully and knows what’s coming next to beat indexing – but that is very rare.
The takeaway from all of this: keep an eye out for fees, diversify across more than just one fund, and don’t bet on anything without considering both sides of the coin.