Managed Bond Funds rather than Index Bond Funds?

[ER Eddie]

I currently have an AA of 65/35, with the 35% in low-cost, index bond funds (mostly intermediate term or total bond index), with Vanguard and Fidelity. The CPA who does my taxes suggested that I look into managed bond funds. He said that they can provide better returns than index bond funds, assuming you get a good manager and a fund with a track record.

He wasn't trying to sell me anything. He explained that bond funds are different, because they're distorted by the way the US government both prints the bonds and buys the bonds. A good manager understands those distortions and can use them to effect. He admitted that he was not an expert in the area, but he had read a fair amount suggesting that managed bond funds might be a good idea. I have a significant amount of money in bond funds, and I do feel as if it's just sitting there collecting dust, keeping up with inflation but not doing much else besides being a source of diversification and security against a crash (which I admit is no small thing).

So, any thoughts about managed bond funds? Pros and cons? Things to watch out for?
Suggested funds? I know that I'll be trading a low-cost fund for one with a higher management fee, and that'll be the big difference. I also know that this group is typically DIY, anti-management. But it's also my go-to source for financial advice.

Thanks in advance for any insight.

 

[pdxgal]

managed vs index bond funds

My FA said the same thing. She's super smart, has a great track record in managing my mom's investments for 12 years, so I trust her judgement on this. For the part of my portfolio that she actively manages she buys individual bonds, many of them local munis. That way I'm able to get significant tax benefits vs buying into a more general managed bond fund.

 

[audreyh1]

I currently have an AA of 65/35, with the 35% in low-cost, index bond funds (mostly intermediate term or total bond index), with Vanguard and Fidelity. The CPA who does my taxes suggested that I look into managed bond funds. He said that they can provide better returns than index bond funds, assuming you get a good manager and a fund with a track record.

He wasn't trying to sell me anything. He explained that bond funds are different, because they're distorted by the way the US government both prints the bonds and buys the bonds. A good manager understands those distortions and can use them to effect. He admitted that he was not an expert in the area, but he had read a fair amount suggesting that managed bond funds might be a good idea. I have a significant amount of money in bond funds, and I do feel as if it's just sitting there collecting dust, keeping up with inflation but not doing much else besides being a source of diversification and security against a crash (which I admit is no small thing).

So, any thoughts about managed bond funds? Pros and cons? Things to watch out for?
Suggested funds? I know that I'll be trading a low-cost fund for one with a higher management fee, and that'll be the big difference. I also know that this group is typically DIY, anti-management. But it's also my go-to source for financial advice.

Thanks in advance for any insight.

Personally I prefer bond index funds to managed bond funds. They are much lower cost. They tend to hold much higher credit quality bonds than managed bond funds. I don't hold bond funds to outperform, I hold them as a balance against equity funds. And in times of equity market stress, bond index funds often do better than managed bond funds because they have a larger chunk in top quality credit.

An active bond fund manager is often chasing lower quality credit to eek out that extra yield plus make up for the much higher fund expense ratio.

Just compare bond indexes AGG and VBMFX to actively managed core intermediate bond funds during the 2007-2009 crisis, and you'll see what I mean.

 

[pdxgal]

another thought

It's true many of the folks here are DIY, myself included. Years ago I read "Your Money or Your Life" and recall the chapter about how to set up an income stream with treasury bond ladders. At the time I thought it sounded pretty do-able. But that book was originally written when interest rates were close to double digits. I think more recent editions (and the YMOYL website) acknowledge that the in today's era of low interest rates the originally recommended strategy may not work well anymore, and a more involved (?) approach is necessary. I've got an MBA and a decent grasp of financial stuff, but buying and selling bonds is something I'll gladly leave to my FA. I figure the cost to have her do it probably is paid for by the higher returns she can most likely get vs DIY or even generic managed bond fund.

 

[OldShooter]

... He admitted that he was not an expert in the area, but he had read a fair amount suggesting that managed bond funds might be a good idea. ...

This doesn't sound like a very good basis for making an investment decision, nor does asking SGOTI what he thinks. I would ask the CPA for some references to what he has read and study them for yourself.

The easiest way to improve yields in a conservative bond portfolio is, of course, to buy individual bonds, but you have ruled that out.

 

[Marc]

My Fidelity rep recommended that I consider replacing my two low cost bond funds (Fid Corporate Bond and Fid Total Bond) with actual bonds in my retirement accounts. This is about $1.4M. The thought was to save the small amount of fee which adds up over time. This would be a DIY project with support from Fidelity rep. Has anyone undertaken such a philosophy? Was it relatively easy to set up and maintain? Did it really save money?

thanks,

Marc

 

[audreyh1]

My Fidelity rep recommended that I consider replacing my two low cost bond funds (Fid Corporate Bond and Fid Total Bond) with actual bonds in my retirement accounts. This is about $1.4M. The thought was to save the small amount of fee which adds up over time. This would be a DIY project with support from Fidelity rep. Has anyone undertaken such a philosophy? Was it relatively easy to set up and maintain? Did it really save money?

thanks,

Marc

BTW - those are not particularly low-cost bond funds. The Fidelity bond index funds are far, far cheaper.

Personally I'm not interested in managing my own bond portfolio.

 

[Marc]

Yes, bond index is cheaper but too heavily weighted towards government bonds; found FTBFX vs bond index higher (net) return over time (at least when I made my decision a while back).

 

[audreyh1]

Yes, bond index is cheaper but too heavily weighted towards government bonds; found FTBFX vs bond index higher (net) return over time (at least when I made my decision a while back).

I disagree. It's not too heavily weighted towards government bonds. If you have a large allocation to equities, you want a heavy weighting in very high quality bonds such as government bonds. So I see that as a benefit of the bond index funds. Due to that high quality weighting, they perform much better than the average managed bond fund when equities get hit hard. That's exactly when I want my bond funds for defense.

Personally I don't believe in seeking out higher performing bond funds because that usually means taking on more risk. If you want higher overall returns, increase your equity allocation instead.

 

[ER Eddie]

This doesn't sound like a very good basis for making an investment decision, nor does asking SGOTI what he thinks.

I will of course do additional research, but I like starting here. I've gotten plenty of good advice from ER.org over the past 5 or 6 years. I don't consider them equivalent to SGOTI.

In that same visit, in fact, my CPA commented that I'd done "really well" with my money, and he repeated it with emphasis. I replied that I felt very fortunate. And I do. I also realized how much of that good fortune was due to the fact that I listened to people here on ER.org.

I'm not going to swallow any advice unthinkingly -- that's not my style at all -- but I've always found this forum a great source of input on just about any financial or retirement issue.

 

[audreyh1]

You have to ask yourself what is your goal for owning bonds in your asset allocation. Why even have an AA and rebalance? Why not be 100% stocks to maximize your long-term returns?

Is it because you want to reduce your short-term volatility? If so, IMO, you should choose bond funds that are less correlated with stocks, not choose bond funds based on returns or yield.

 

[davebarnes]

You have to ask yourself what is your goal for owning bonds in your asset allocation.

Well, our goal at ages 70.2 and 61.1 is to have enough in bonds (short term) and cash to cover our “needs” for 5+ years.
For us, this means 75% stock index funds and living with the drag from 25% cash.
If the market goes up, then the cash % will shrink.

 

[audreyh1]

Well, our goal at ages 70.2 and 61.1 is to have enough in bonds (short term) and cash to cover our “needs” for 5+ years.
For us, this means 75% stock index funds and living with the drag from 25% cash.
If the market goes up, then the cash % will shrink.

Since you aren’t rebalancing to a target AA but instead intend to let your stocks run, you probably don’t care about asset correlation or managing volatility.

 

[davebarnes]

Since you aren’t rebalancing to a target AA but instead intend to let your stocks run, you probably don’t care about asset correlation or managing volatility.

You are correct because I don’t understand the points.
Cash does not move. It sits there as dead weight.

 

[audreyh1]

You are correct because I don’t understand the points.
Cash does not move. It sits there as dead weight.

Not completely dead weight. It is earning something. And when your equities get a sudden 10%-20% haircut suddenly that cash is king! And you can even use some of it to buy downbeaten equities if you are especially brave.

Cash is trash until cash is king!

 

[Freedom56]

I currently have an AA of 65/35, with the 35% in low-cost, index bond funds (mostly intermediate term or total bond index), with Vanguard and Fidelity. The CPA who does my taxes suggested that I look into managed bond funds. He said that they can provide better returns than index bond funds, assuming you get a good manager and a fund with a track record.

He wasn't trying to sell me anything. He explained that bond funds are different, because they're distorted by the way the US government both prints the bonds and buys the bonds. A good manager understands those distortions and can use them to effect. He admitted that he was not an expert in the area, but he had read a fair amount suggesting that managed bond funds might be a good idea. I have a significant amount of money in bond funds, and I do feel as if it's just sitting there collecting dust, keeping up with inflation but not doing much else besides being a source of diversification and security against a crash (which I admit is no small thing).

So, any thoughts about managed bond funds? Pros and cons? Things to watch out for?
Suggested funds? I know that I'll be trading a low-cost fund for one with a higher management fee, and that'll be the big difference. I also know that this group is typically DIY, anti-management. But it's also my go-to source for financial advice.

Thanks in advance for any insight.

I have been managing our own bond ladder for just over 30 years now. Our current allocation is 80% corporate bonds, 10% QDI investment grade preferred stocks and 10% CD/money market. Twenty to thirty years ago, we were heavily weighted to CDs, government bonds, and treasury notes. But as treasury and CD yields contracted, we shifted to corporate bonds/notes. We invest for income and preservation of capital. This strategy has paid off as we continued to compound our investment through several major market corrections over the past 30 years and our portfolio continued to grow. We are at a point where a 6.8% average coupon in our portfolio is a serious amount of money. Bond interest is contractually guaranteed whereas dividends are not. Your capital is returned when the bond matures or is called. If you buy below par, you realize a gain. A bond fund does not guarantee preservation of capital and the yields are horrible. You are better off buying CDs than a bond fund. Even a money market account or fund makes more sense now. I also don't want to hold bonds in loser sectors such as retail, malls, oil and gas, and mining sectors which most funds do. These sectors have not only been painful for equity investors, but also fixed income investors. Timing and discipline is everything when investing in fixed income. You research the companies you want to invest in and wait for market sell-offs to buy. Passive bond funds don't do that. You can easily achieve a yield of 6-7% managing your own portfolio and much higher if you time your purchases as I do. Don't assume that financial representatives know what they are doing. Most are just sales people working on a base salary and incentive commissions. Passive bond and equity funds are managed by software algorithms that issue buy and sell orders on their holding based on weightings and fund inflows and outflows. If your aren't comfortable managing your own bond ladder and want some allocation in fixed income, I would select a non-leveraged closed end fund (CEF) with a good track record. You can find these at:

www.cefconnect.com

Buy CEFs during market corrections as their yields become more attractive.

 

[foxfirev5]

My Fidelity rep recommended that I consider replacing my two low cost bond funds (Fid Corporate Bond and Fid Total Bond) with actual bonds in my retirement accounts. This is about $1.4M. The thought was to save the small amount of fee which adds up over time. This would be a DIY project with support from Fidelity rep. Has anyone undertaken such a philosophy? Was it relatively easy to set up and maintain? Did it really save money?

thanks,

Marc

My Fido rep recommended the same thing about 3 years ago. However he was trying to sell me on Fido managing the individual bonds. With a fee. I took another path and simply set up a large CD ladder for this portion. Expenses - nil.

In the future I'll continue to evaluate but will probably use some of the maturing CD's to DCA into FXNAX total bond fund with an ER of .025. If you want to juice the returns simply add in a small amount (10-15% total) of high yield and emerging market funds and you'll match the managed funds such as FTBFX. Vanguard has a couple relatively low cost managed funds in these categories.

 

[DrRoy]

I buy my own bonds.

 

[ER Eddie]

You have to ask yourself what is your goal for owning bonds in your asset allocation. Why even have an AA and rebalance? Why not be 100% stocks to maximize your long-term returns?

My goal in owning bonds is to provide diversification and thus asset protection in case of a stock market crash. If equities go down, bonds go up (I know that's an oversimplification).

Why not 100% stocks, you ask? Because I plan to start withdrawing money from mutual funds in a few months. If I were 100% stocks, I'd be too much at the mercy of the market. If the market tanked, I would have to sell stocks at a big loss. Having 35% in bonds gives me the option to sell bonds instead and wait for the equity market to recover.

So, my primary reason for owning bonds is mostly a protective one -- a counter-balance to the risk associated with the equity investments.

At the same time, though, I would like to make that money perform as best it can, without sacrificing the protective function I just described. It is, after all, a significant chunk of money, so I want to make sure it's well-placed.

I take it from your earlier answer that don't think managed funds will preserve the protective function, because they are associated with lower-quality bonds and thus higher risk. And also you mentioned that when the equity market bottoms out, they don't do as well as index bond funds.

 

[ER Eddie]

I buy my own bonds.

I'm not well-versed in investing in bonds, but I'm a quick learner. Maybe I'll look into that option. If you have any tips or reading suggestions, let me know.

 

[BigMoneyJim]

I currently have an AA of 65/35, with the 35% in low-cost, index bond funds (mostly intermediate term or total bond index), with Vanguard and Fidelity.

Pssst: Wellington.

I'm spread across three different companies, but I have about half my assets in Vanguard Wellington Admiral shares at 0.17% ER. Their bonds are more corporate and their stocks are value than a cap-weighted index which leans Treasury and growth.

I actually just rebalanced out of Wellington-copycat-but-much-higher-ER funds in my other accounts and briefly fretted about cheap index versus managed. I concluded that I'm getting enough reasonably-priced managed value stocks and corporate bonds through my VWENX assets so went with the dirt-cheap-ER index stock and bond funds elsewhere.

And Wellington is about 65/35 AA, anyway, so it should be right up your alley.

Edit: Wellesley is very much like Wellington but 35/65-ish if you need a more bond-heavy fund. And "Pssst...Wellesley" is a long-held tradition here.

 

[ER Eddie]

Yeah, I held some in Wellington, in the very beginning. However, to buy into that now, using bond funds, would screw my AA up, since all-bond money would go 65% into stocks. I'm looking to take some of my bond money and put it into a pure bond fund. That way, my AA stays 65/35. So I need a bond fund, not a mixed fund. But thanks for the suggestion.

 

[Spanky]

For taxable accounts, is Vanguard Intermediate Tax Exempt bond fund a good substitute for the total bond market fund? Obviously, it is as diversified. Any other recommendation?

 

[audreyh1]

My goal in owning bonds is to provide diversification and thus asset protection in case of a stock market crash. If equities go down, bonds go up (I know that's an oversimplification).

Why not 100% stocks, you ask? Because I plan to start withdrawing money from mutual funds in a few months. If I were 100% stocks, I'd be too much at the mercy of the market. If the market tanked, I would have to sell stocks at a big loss. Having 35% in bonds gives me the option to sell bonds instead and wait for the equity market to recover.

So, my primary reason for owning bonds is mostly a protective one -- a counter-balance to the risk associated with the equity investments.

At the same time, though, I would like to make that money perform as best it can, without sacrificing the protective function I just described. It is, after all, a significant chunk of money, so I want to make sure it's well-placed.

I take it from your earlier answer that don't think managed funds will preserve the protective function, because they are associated with lower-quality bonds and thus higher risk. And also you mentioned that when the equity market bottoms out, they don't do as well as index bond funds.

Looking at past history, index funds have usually behaved better than managed core bond funds when stocks are hit hard for the very reason they are often criticized - holding “too much” in government bonds. In 2008 some well respected managed core bond funds were creamed. Many folks concluded that bond funds in general don’t protect you during a credit crisis/nasty bear, but if you look for which bond funds did do well, the highest credit quality bond funds did much better and many of these were index funds.

So if your goal is to hold a low correlation asset to equities, I think bond index funds based on a high quality index like AGG are a better choice.

 

[audreyh1]

For taxable accounts, is Vanguard Intermediate Tax Exempt bond fund a good substitute for the total bond market fund? Obviously, it is as diversified. Any other recommendation?

No, it’s not diversified. It’s just muni bonds which is just one segment of the bond market. It’s not a substitute. But you could always hold some in muni bond fund because I don’t think the total bond index fund holds munis.