Bond Index Funds-a Synopsis                          Page 3

Replicating, to an extent, the success they achieved with stock index funds, Vanguard, and 17 competitors have nurtured a small but steadfast base of bond index fund customers. Although this customer base has not grown as fast as that in stock index funds, bond index fund managers now handle $21 billion. Bond index fund assets have grown slowly in part because report of the virtues of fund indexing has for the most part spread through word of mouth, and because low-cost index funds rarely budget much for sales and marketing.

Bond index funds occupy a fairly small niche in the world of mutual funds; only 3% of all bond fund assets are in bond index funds and these assets are held disproportionately by institutional investors, who keep about 25% of their bond fund assets in bond index funds.

How they Work

Bond index funds use a technique called "sampling" to fill out their portfolios. Total Bond Market index funds, like those managed by Vanguard and Charles Schwab Co., as well as intermediate bond indexes like the Maxim Bond Index, usually aim to trace the performance of the Lehman Brothers Aggregate Bond Index. This benchmark is a collection of 5,545 bonds (as of 12/31/99) from the Treasury, corporate, mortgage backed, and international U.S. dollar-denominated debt sectors.

Various other short, intermediate and long duration bond index funds trace subsets of this index. For instance, the Vanguard Short-Term Bond Index Fund traces a subset of this index called the Lehman Brothers Mutual Fund Short Government/Corporate Index, which holds 1,874 bonds. Now, it wouldn't be cost-efficient for managers to include, say, all 5,545 issues from the Lehman Brothers Aggregate index, among other reasons because they would forgo very substantial volume discounts at auction.
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