Vanguard: Total Bond Market Index (VBMX) or Intermediate Term Treasury Fund (VFITX)

[ZMAN]

We have a very substantial part of our stash (the "safe part") in Vanguard Total Bond Index (VBMX). Performance has been fine given the insanity. It is valued well within its traditional parameters, and has not suffered from the bond fund melt downs discussed in the WSJ. It is only down a bit this year inclusive of distributions. In looking at its holdings though you see corporate bonds and lots of FNMA, GNMA etc.

WSJ is full of stories about current and more pain in the bond market which has me looking again at this part of the remaining portfolio.

My question: Does the Total Bond Index remain safe enough in the current environment. Should I move the bond stash into the Intermediate Term Treasury Fund (VFITX). I recognize I canot avoid the interest rate risk. What I am seeking to avoid is too much risk in the meltdown of the various obligors within the fund. I am not seeking fool proof safety, only to avoid say a 10%-20% drop in this part of our investments.

One other point. I see that VFITX is up over 7% this year as people flee to treasuries. Does that in itself add to the risk of the switch?

Thanks for the collective help!

Zman

[hankster]

VBMX is the only substantial bond option available in my 401k, other than the bond component of the Wellington fund. I'll be staying with these for the bond portion of my AA until I get more options next year by starting my Roth IRA.

[. . . Yrs to Go]

Quote:

Originally Posted by ZMAN One other point. I see that VFITX is up over 7% this year as people flee to treasuries. Does that in itself add to the risk of the switch?

It's hard for me to yell loudly enough, but here goes . . . YES!!!!

Treasuries are the richest investment on the planet right now. Short-dated bills can be used as a tool for capital preservation (although with likely negative real returns) but longer-dated treasuries have fairly meaningful downside risk, in my view. Unless you are expecting a serious bout of deflation, I'd avoid them. And even at the short-end of the curve, much better yields can be found in bank CDs, which are essentially US government risk (as long as you abide by the investment maximums).

[ZMAN]

Thanks YRS. I am concerned about preservation being a pessimist at heart. What do you see as the % down side on the Treasury Fund and what do you think of the obligor risk in the Total Bond Index.

Zman

[. . . Yrs to Go]

As far as the VFITX goes, I'd say a complete retrace of the 7% gain this year is possible if credit markets get back to normal in the next 12 months. There is a huge arbitrage opportunity between treasuries and high quality corporates that someone will eventually want to exploit. The US may also add $1 trillion in new treasury supplies next year which can't help that market. Of course, I'm more optimistic than most that risk markets are currently oversold. If I'm wrong, the flight to quality could continue.

With respect to the default risk embedded in the Total Bond Market Index, I haven't a clue. But the index is almost 74% Treasuries and Agencies which won't default. So if every other security went bankrupt and we assumed zero recovery (an absurd set of assumptions), the portfolio loss from that would be 26%. With a portfolio duration of 4.7 years, I'd say you're wearing more interest rate risk in the Index than you are default risk.

Personally I've been moving money out of the index recently into high grade & high yield corporates. TIPs look interesting too, but I don't own any. I recently moved my "safe" money from a single state tax-exempt money market fund to a Treasury MM. I'll probably move a big chunk of that to some kind of laddered CD scheme, but haven't had time as of yet.

[ZMAN]

Thanks again YRS.

Any thoughts out there on "the default risk embedded in the Total Bond Market Index", as I think that is the focus of the WSJ pessimism on the Bond Funds. At least it is the focus to the extent it results in the selling or overselling of that market. And that gets back to my other point. Why has VBMX held up fairly well while other bond funds have suffered?

[. . . Yrs to Go]

Quote:

Originally Posted by ZMAN Thanks again YRS. Any thoughts out there on "the default risk embedded in the Total Bond Market Index", as I think that is the focus of the WSJ pessimism on the Bond Funds. At least it is the focus to the extent it results in the selling or overselling of that market. And that gets back to my other point. Why has VBMX held up fairly well while other bond funds have suffered?

Hey Z, I added some comments to my previous post that might help on the Index.

As to why the Index has held up, it is because the gains from the large Treasury and Agency component have offset declines in CMBS, finance, asset backed & other. Diversification at work.