recommended bond portfolio

[brewer12345]

Hmm, I see total return YTD of 2.88% as of yesterday. Not blazing a trail to the moon, but not terrible either. Could you be missing some of the fund distributions (interest)?

 

[donheff]

Hmm Morningstar shows 1 year 3.68 but Schwab shows 1.4 (NAV).

 

[donheff]

Hmm Morningstar shows 1 year 3.68 but Schwab shows 1.4 (NAV).

And what is the difference between NAV and MKT in these ratings? Hustle Brewer we expect instant answers

 

[JohnEyles]

Hmm, I see total return YTD of 2.88% as of yesterday. Not blazing a trail to the moon, but not terrible either. Could you be missing some of the fund distributions (interest)?

I was looking at yahoo-finance, so it was as of 8/31; I see the 2.88% at Morningstar.
I still don't see why that is not way worse than MM/CD/T'Bill. That's probably because
I don't understand the relationship between the yTD return and yield. I've tried to
read some primers on it, but it still does not make sense to me.

 

[modlair]

Hmmm. It sounds like the bond advocates are making a case for an asset with appreciation potential as the source of superiority over an equivalent maturity CD.

This sounds like either:

1) Asking investors to time not just stocks for purchase, but also bonds -- or

2) Trying to time neither, being a buy-and-holder of both asset classes and relying on the non correlative aspects of the two asset classes to provide appreciation in one when the other is depreciating.

Well, I have a problem with this. Yes, no question, a non correlated asset class will smooth the performance of a portfolio that holds some other asset class, but if the two asset classes are non-correlated there is no reason that both cannot collapse at the same time. If the goal is to smooth the collapse of one asset class, why not hold a CD as your other asset class -- since it never collapses.

In this context, firecalc suggest better performance when one picks the 5 yr bond vs LT bonds. Don't know if this counts or not.

 

[magellan_nh]

That's probably because I don't understand the relationship between the yTD return and yield.

YTD return - The percentage of the starting balance that you would have gotten in total return (price appreciation + interest paid) had you owned the investment since the begining of the year and sold it yesterday (or at the end of the period used for the calculation).

Yield - The rate of interest that the instrument is currently paying as a percentage of the price. You can think of this as the "instantaneous rate of return", but stretched into an annualized rate.

Jim

 

[magellan_nh]

There's one other cool feature of CDs compared to bonds and bond funds. This one is definitely a reach, but...

If you're in a high tax bracket in one year and expect to be in a lower bracket the next year, you can buy a CD that matures in the next year (up to 12 months away), and defer the interest payment and taxes until next year. That allows you to push the income into the lower tax year.

Jim

 

[JohnEyles]

YTD return - The percentage of the starting balance that you would have gotten in total return (price appreciation + interest paid) had you owned the investment since the begining of the year and sold it yesterday (or at the end of the period used for the calculation).

Yield - The rate of interest that the instrument is currently paying as a percentage of the price. You can think of this as the "instantaneous rate of return", but stretched into an annualized rate.

Jim

Thanks ! Welcome to Bonds 101.

So the reason that AGG has a YTD rtn of only 2.88%, even though the yield
is 4.5% and the share price is almost flat (within a fraction percent) is that
the yield was much lower earlier in the year, or because the YTD rtn is not
annualized, or both ?

 

[JohnEyles]

Unless you really want to fiddle, I would stick with funds and treasuries. I take it you are at Schwab? If so, I would take 2/3 of the money and buy AGG (or possibly PPT if you want to play the game a bit), and use the rest to buy a 5 year TIPS at auction in a few weeks. Schwab will let you participate in treasury auctions for no cost/no fee.

Good simple answer, thanks ! Yes, at Schwab.
But shouldn't I have some short-term bond exposure, and
some junk-bond (FAGIX) ?

 

[AltaRed]

Thanks ! Welcome to Bonds 101.

So the reason that AGG has a YTD rtn of only 2.88%, even though the yield
is 4.5% and the share price is almost flat (within a fraction percent) is that
the yield was much lower earlier in the year, or because the YTD rtn is not
annualized, or both ?

Think we have to wait for brewer to answer the last question (my view is it is not annualized).

Regarding first question, yield was lower early this year as the mix of bonds in the index was still catching up to increased ST rates imposed by the Fed. However, I don't know what it was for AGG for example in Jan 06.

brewer also mentions AGG as his choice for a broad index bond fund.... Would like to understand the rationale behind that. I've been watching AGG for awhile (Canadians can't access US domiciled CDs for 5+%) looking to buy in once the yield curves on MMFs I currently own are about to cross AGG yield, and I also have interest in LQD on Corporate bonds. Would like brewer to comment on LQD as well when he has a chance.

 

[magellan_nh]

So the reason that AGG has a YTD rtn of only 2.88%, even though the yield
is 4.5% and the share price is almost flat (within a fraction percent) is that
the yield was much lower earlier in the year, or because the YTD rtn is not
annualized, or both ?

I'm not sure what the yield was before, but from what I can tell the price drop on AGG was around 1.1% since Jan 1 (price was 100.64, now it's 99.53). Also, as you indicated, the 2.88% ytd return is not annualized. If you annualize it (divide it by 9/12), it comes out to around 3.4%. Then, if you add back in the 1.1% price drop, you're up to 4.5% annualized.

If my math is correct, that means that the yield hasn't changed very much since the beginning of the year. This kind of math is hard to do with intraday values since the ytd return of 2.88 was probably calculated a few days ago when the price was different. Anyhow, it gives you an idea at least...

Jim

 

[magellan_nh]

Actually, I'm all wet already...

First - 2.88% / .75 = 3.84% (not 3.4 as I said)

Then, I realized that according to yahoo finance at least, the 4.5% yield is ttm (trailing 12 months as of aug 31) and it's not clear if the ytd return is annualized or not. It seems to depend on the source.


Jim

 

[brewer12345]

Thanks ! Welcome to Bonds 101.

So the reason that AGG has a YTD rtn of only 2.88%, even though the yield
is 4.5% and the share price is almost flat (within a fraction percent) is that
the yield was much lower earlier in the year, or because the YTD rtn is not
annualized, or both ?

Its not annualized. Yields haven't changed much this year.

I would perhaps forgo junk now. You don;t have access to VG's junk fund, and junk is, in any case, no bargain right now.

 

[mathjak107]

If rates drop i dont have to sit on a LONG TERM cd to get all my gains. I can sell my bond early and reap some gains up front. Since long term bonds change just based on perecption rates dont even have to change to get additional gains just the preception that they will.

 

[mathjak107]

Bond funds arent very different from individual bonds. Individual bonds vary in value every day if you sell early. IF held to maturity the bonds will pay a fixed amount and all the while you collect a fixed rate of interest.

Bond funds have a maturity too,its called duration. As long as you stay in the fund for the duration value you pretty much will get very close to the same deal. The interest rate varies on a bond fund unlike a fixed bond and as rates rise your rate rises too although a drop in nav will follow the increase in rate.

So heres the deal. take a fund that cost 10.00 bucks a share and pays 5 % the day you buy in..
if the funds duration value is say 5. than it means the fund will drop 5% in value for every point rates rise

so if rates go to 6% your nav drops to 9.50 . but you will get 6% interest

the extra 1% for 5 years offset the 5% decline in nav giving you your origional return of 5% again.

Only high quality bond funds carry a duration value as you cant have any market risk in order for the value to hold true and so you wont find a duration value on hi-yielld or lower quality corporate bond funds.

 

[AltaRed]

Only high quality bond funds carry a duration value as you cant have any market risk in order for the value to hold true and so you wont find a duration value on hi-yielld or lower quality corporate bond funds.

Maybe not, but Barclay's Corporate LQD does list a duration of 6.02 yrs.
http://www.ishares.com/fund_info/detail.jhtml;jsessionid=TR1E2HOKBVVDMRJUMTCBBGSFGQ0EOD50?symbol=LQD

As an aside, their AGG carries a current yield of 5%. Question is whether that is sufficient return over 5 years (5 yrs duration), or whether there is a bit of CG upside here in event Feds start dropping short term rates. I believe MMFs are already starting to show fractional decline.

Seems to me a mixture of CDs and AGG (or LQD) is not a bad way to hedge Fixed Income.

 

[mathjak107]

As long as there is default risk its hard to have a time on the duration value . Credit risk can change the effective interest rate big time.

remember a bond fund is nothing more than a big bunch of laddered bonds . they behave no different than if you bought individual bonds yourself and sold some early and kept some ..

Dont forget even individual bonds may cost you more than par or less than par if they arent newly issued. You can pay 1050.00 for a 1,000 dollar bond if it pays a higher rate of interest than the market is at giving you a higher interest rate but a loss in capital when you get 1,000 bucks for a bond at maturity thatyou paid 1050.00 for

CD or bonds?

a cd or money market is a bet that rates will stay the same or rise at maturity

bonds unless very short term are a bet rates will stay the same or fall

 

[saluki9]

Bond funds have a maturity too,its called duration. As long as you stay in the fund for the duration value you pretty much will get very close to the same deal. The interest rate varies on a bond fund unlike a fixed bond and as rates rise your rate rises too although a drop in nav will follow the increase in rate.

I would be careful about using duration as a measurement of time. It's best and most common use is as a measurement of sensitivity to changes in interest rates.

Holding a fund for the "length" of it's duration is no guarantee that you will not see a loss in the principal value.

 

[saluki9]

I also wanted to add per the discussion of using the Lehman Ag vs LQD or some other ETF for your fixed income portfolio.

I (along with some other more famous people) do not like corporate bonds. IMHO you are taking on all the the risk of stockholders and getting instead a limited and fixed return. In addition, for doing so you get much much less of the diversification benefit that you would from other fixed income sources.

To prove my point I just ran a correlation matrix of (Vanguard Funds) S&P 500, Total Stock market index, Total bonds market index, High yield Corporate, and Intermediate Treasury Fund. Sadly I'm having trouble now printing it to a pdf so I will Summarize.

Compared to the total SM index over the last 5 years, the correlations have run as follows. (For novices high correlations (closer to 1) are bad, negatives are good for asset allocation purposes)

High yield corporate = .56

Total Bond Mk Index = -.27

Intermed Treasury = -.45

You can now see why when I am constructing a portfolio I

1. Do not add corporate fixed income securities

2. Favor US treasury securities over broader indexes.

 

[magellan_nh]

I (along with some other more famous people) do not like corporate bonds. IMHO you are taking on all the the risk of stockholders and getting instead a limited and fixed return. In addition, for doing so you get much much less of the diversification benefit that you would from other fixed income sources.

saluki9,

Thanks for working up this data. It is interesting indeed. However, I'm hesitant to change my thinking about asset allocation based on 5 years of correlation data.

To me, correlation data is a reasonable thing to consider in figuring out an asset allocation stratgey. However, I think we (the world!) place way too much stock in the recent correlation data in making allocation decisions. Making investment decisions based on 3-7 years worth of correlation data is a lot like making them based on 3-7 years worth of returns data. In short, recent correlations may not be a good predictor of future correlations.

So while I certainly pay attention to correlation data and the output of optimizers, I pay more attention to the underlying "return generating process" of each asset class (I got this phrase from indexinvestor.com)

The idea is to think about the forces that generate returns for each asset class in your portfolio. Are those forces similar or different between asset classes? Are the risks similar or different? Are there structural reasons to believe the relationships or the underlying return generating processes have changed or will change?

For example, IMHO corporate bonds are fundamentally different animals from government bonds in terms of the risks and the return opportunities that underly the two investments. They have different return generating processes and bacause of that are unlikely to be (or stay) correlated over the long haul.

Also, I would bet a large sum of money (in fact I guess I am) that corporate bond returns will not stay correlated to stocks over the next 30-40 years. For example, after a 25% market crash, if investor psychology fundamtentally shifts away from equities (which it does from time to time), demand for stocks is likely to fall vs demand for bonds, and hence their respective returns will be different.

So while I could accept (or at least consider) a market timing argument that the risk of corporate bonds is mispriced by the market right now, I'd disagree with an argument that corporate bonds and stocks have similar return generating processes and therefore are likely to move in lock-step.

I know this thinking is controversial and many respected people disagree with me, but hey, sometimes it's fun to buck the conventional wisdom...

Jim

 

[saluki9]

saluki9,

Thanks for working up this data. It is interesting indeed. However, I'm hesitant to change my thinking about asset allocation based on 5 years of correlation data.

To me, correlation data is a reasonable thing to consider in figuring out an asset allocation stratgey. However, I think we (the world!) place way too much stock in the recent correlation data in making allocation decisions. Making investment decisions based on 3-7 years worth of correlation data is a lot like making them based on 3-7 years worth of returns data. In short, recent correlations may not be a good predictor of future correlations.

So while I certainly pay attention to correlation data and the output of optimizers, I pay more attention to the underlying "return generating process" of each asset class (I got this phrase from indexinvestor.com)

The idea is to think about the forces that generate returns for each asset class in your portfolio. Are those forces similar or different between asset classes? Are the risks similar or different? Are there structural reasons to believe the relationships or the underlying return generating processes have changed or will change? ...

I know this thinking is controversial and many respected people disagree with me, but hey, sometimes it's fun to buck the conventional wisdom...

Jim

I can list the factors that go into corporate bond returns. Why don't you try the same, and ten tell me how they aren't related to stocks.

There is bucking the trend, and then there is lacking common sense. I will hold back my opinion on yours.

BTW: The correlation between the S&P 500 and the High yield fund is EXACTLY THE SAME when you go out 15 years. In addition, correlations change every day. When doing research of asset classes most believe you are better served by looking at recent correlation data rather than older data because many of those factors don't even exist anymore.

Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

 

[magellan_nh]

I can list the factors that go into corporate bond returns. Why don't you try the same, and ten tell me how they aren't related to stocks.

My thinking is that relative demand for equities vs stocks bonds has historically ebbed and flowed over the years driven largely by investor psychology. Following the 30s, the average investor considered equities a lot like betting at the race track and considered bonds as the more sensible investment. I'm not claiming that investor sentiment is about to change tomorrow, only suggesting that it may repeat patterns from the past and this may cause returns from the two asset classes to diverge.

When doing research of asset classes most believe you are better served by looking at recent correlation data rather than older data because many of those factors don't even exist anymore.

Yeah, this is the challenge I commented on before. The short term correlations don't have enough history to them and the long term correlations don't hold anymore. The correlations are likely to stay the same until they change, and no one knows when that will happen.

Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

Ouch! Looks like I struck a nerve, sorry. I didn't mean to challenge your belief system, only to ask you to consider another view.

Jim

 

[saluki9]

Ouch! Looks like I struck a nerve, sorry. I didn't mean to challenge your belief system, only to ask you to consider another view.

Jim

But what is there to consider?

Treasury securities are the safest, most liquid security the world has. The only risks that they run into are interest rate risk and inflation risk.

Corporate securities on the other hand are subject to interest rate risk + liquidity risk, downgrade risk, credit spread risk, event risk, and default risk.

To imply that somehow liquidity risk, credit risk, and default risk is going to provide you a correlation benefit as compared to the same issuers as the stocks is just plain silly.

 

[brewer12345]

You can now see why when I am constructing a portfolio I

1. Do not add corporate fixed income securities

2. Favor US treasury securities over broader indexes.

Heh, so what do you think of SPIAs?

I don't think much of LQD as a bond allocation, in part because of the factors Saluki mentioned and in part because of the fact that credit spreads are at historically low levels.

 

[Nords]

Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

Aw, c'mon, I can't pass up a slow pitch.

Technically the earth isn't round, it's a skewed ellipsoid. And it's changing too, just like correlations!