Why does vanguard high yield bond NAV decline

[floatingdoc]

Can someone tell me why many people seem to think that the NAV of Vanguard's High yield corporate is destined to continue declining. Obviously, it is correlated closely with stocks and I understand that. The default rate for vheax was 0% for all of 2010 (source: vanguard). The dividend is paid based on the average coupon rate and proportion of bonds owned etc. It is currently yielding 7.6% with is treasury to hy spread of over 400 bp. Is the spread compared to the 5 year treasury or which one? Help please.

 

[veremchuka]

i think the boglehead people just hate junk bonds period. bonds are for safety and stability or if retired income. hy bonds can behave more like equities especially in times of crisis - look at 2008! risk should be taken with equities not in fixed income. vanguard's hycb fund is generally thought of as the better junk bond fund but it's still junk to many. if you held no equities you might use them as you would equities. also iirc they are very tax inefficient but i hold them in a roth so i don't pay attention to that and i may be wrong. i bought a bunch in 2q09 when they were cheap and have nice capital appreciation and they have had a good yield especially initially when they were 13%+.

 

[Surfdaddy]

If interest rates go up, NAV will go down. And the effect is greater the longer the bond maturity. Since interest rates can pretty much only stay the same or go up, the odds are good that this is going to occur (true for all longer term bonds).

 

[ERD50]

And of course, overall performance is more important than NAV.

https://personal.vanguard.com/us/funds/snapshot?FundId=0029&FundIntExt=INT#hist=tab:1

This shows VWEHX performance of $10,000 for ten years to grow to $18,841.

S&P500 treaded water to a measly $10,839.

The bond index however, grew to almost the same ($18,156) and almost a straight line.

I hold a fair amount in a Junk bond fund (switched from Vanguard to Fido a while back to capture some losses w/o a wash). I weight it in my AA as half equity, half bond. Not sure this was a good investment, but it's done OK. Looking at that graph, it might be interesting to see what re-balancing between the two bond funds would have done?

-ERD50

 

[floatingdoc]

So does anyone have an explanation?
Would not a prolonged equity bull market push nav up?
It apparently is not correlated well with interest rate swings as other bond types like long corporates or treasuries. Can anyone help me understand why this seems to be a popular thought here and on bogglehead forum?

 

[FIRE'd@51]

Note that Vanguard says the yield-to-maturity is 6.8%. As you point out, the current yield is 7.6%, so this suggests to me that there are a lot of bonds in the portfolio trading above par, and these bonds will decline to par if held until maturity.

 

[dex]

Can someone tell me why many people seem to think that the NAV of Vanguard's High yield corporate is destined to continue declining.

When you asked those people; what did they say?

It has been up since late 2009. So, from what point are they starting from?

BigCharts - QuickCharts

 

[floatingdoc]

Only mentioned defaults. Is that going to takr down a 350 bond holding fund which had a 0% default rate in 2008 2009 and 2010

 

[Texas Proud]

Only mentioned defaults. Is that going to takr down a 350 bond holding fund which had a 0% default rate in 2008 2009 and 2010

One of the problems with just looking at defaults is.... you can sell a bond before it defaults and still lose value...

Say you own company ABC bond... and some bad news comes out and the bond drops 50%... you sell.. it did not default, but you still lost 50% of your money...

 

[dex]

Only mentioned defaults. Is that going to takr down a 350 bond holding fund which had a 0% default rate in 2008 2009 and 2010

I wouldn't worry about the default aspect. It is a large fund with good quality bonds. If defaults become an issue then companies would be a problem and so would stocks. As you said HYBs trade with stocks.

 

[clifp]

So does anyone have an explanation?
Would not a prolonged equity bull market push nav up?
It apparently is not correlated well with interest rate swings as other bond types like long corporates or treasuries. Can anyone help me understand why this seems to be a popular thought here and on bogglehead forum?

The explanation that I've heard (I think slightly modified) is as follows.

Imagine that instead of being an mutual fund VWEHX was a closed end fund/unit investment. It bought 100 junk bonds with a 5 year maturity, all of the interest was distributed to the shareholders each month. At the end of 5 years 95 bonds were redeemed at par and of the remaining 5 you got $.60 on the dollar. When it comes time to buy the next 5 year bonds, the fund only has $.98 on the dollar. You repeat this process a few times with NAV shrinking 2% each cycle.

Now relatively speaking the loss from default is small compared to fluctuation compared to interest rate. But in a junk bond there will be defaults, even if there weren't any in 2010. For instance right before I bought VWEHX in Nov 2008, it held Chrysler bonds, now it may have sold them before the bankruptcy, but I'm almost certain they lost money on them. More troubling to me than change in the NAV, is the fact that over time the distribution of VWEHX have decreased. Again this is small compared to interest rates fluctuations by if interest rate remain flat as bonds default you have less capital to reinvest.

Now this is NOT important if you strictly look at the total return, but if you buy say 100,000 shares of VWEHX with the intention that it will be paying you a relatively constant $3,500/month in income, I suspect that you will find that income will actually drop over time. At least that is what happen historically over much of the last 20 years.

 

[Gone4Good]

Didn't we answer this question for you a year ago in this thread . . .

Am I crazy, 100% allocation to VG HY Fund

The answer hasn't changed. This is what I said to the NAV question then (which is essentially what clifp is saying above) . . .

Yes there is going to be noise year to year but the overall trend for 30 years running is down. And it trends down for a very good reason. Assume you have a portfolio of 10 bonds each with $1,000 face value and an NAV of $10. If one of those bonds defaults and recovers 50 cents on the dollar your NAV goes down to $9.50. That process is going to happen repeatedly. Remember that most HY bonds are issued at par. Someone is buying those par bonds. And a meaningful fraction of those bonds will never pay par back, which means guaranteed principal loss for the market. That loss is presumably compensated for through coupon payments but if you spend all of your coupons, you'll slowly deplete your principal.

This is the price chart for VG HY bond fund. And as you point out, yields were declining during this entire time (which should cause bond prices to go up)

 

[floatingdoc]

Well what happens when we go to 0
Also capital loss over last 10 y is 1.5% total
Someone mentioned avg 2.5% per annum

 

[ERD50]

Well what happens when we go to 0
Also capital loss over last 10 y is 1.5% total
Someone mentioned avg 2.5% per annum

Please show your math, I get a different answer. - ERD50

 

[floatingdoc]

I donot know how to get the data to display correctly here but it is from the fund info on vanguard site. What did you get?

 

[Gone4Good]

Well what happens when we go to 0
Also capital loss over last 10 y is 1.5% total
Someone mentioned avg 2.5% per annum

If I lose a % of principal every year, I never, ever reach zero. Although I expect that before the NAV gets comically low, the fund will do a reverse share split and reset the price higher.

With respect to the math on the NAV decline, you can't calculate a rate of decline between two points, because the NAV swings wildly around a downward trend due to changes in interest rates and credit spreads. You have to look at the slope of the trend over a period of time to get the correct answer. See the chart above.

 

[ERD50]

I donot know how to get the data to display correctly here but it is from the fund info on vanguard site. What did you get?

You only need two numbers - NAV 10 years ago, NAV today. Try here:

VWEHX Historical Prices | VANGUARD HIGH YIELD CORPORATE F Stock - Yahoo! Finance

-ERD50

 

[floatingdoc]

look under "price and performance" and "historical returns". There is a table of capital return vs. income return from 2000 to present. That is what i am using

 

[Gone4Good]

look under "price and performance" and "historical returns". There is a table of capital return vs. income return from 2000 to present. That is what i am using

What I see is a table that shows annual returns broken out by capital and income. To get the average annual capital return over 10 years, you have to use the sequence of returns (you can't average the annual returns). If I average the annual capital returns over the past decade, I get (1.489)% which isn't correct. If I calculate a beginning and ending capital balance based on the annual returns I get an average annual return of (2.569)%, which is correct.

 

[floatingdoc]

I am lost with this. I think I will forget about capital return and just make a spread sheet using TOTAL annual return with my current starting balance and back track 25 years spending 60% of my dividends and reinvesting 40% and see what happens?

 

[ERD50]

look under "price and performance" and "historical returns". There is a table of capital return vs. income return from 2000 to present. That is what i am using

Also capital loss over last 10 y is 1.5% total

Allow me to repeat myself:

Please show your math, I get a different answer. - ERD50

If you really want answers, you are going to have to do a little work. I've lost interest in taking any unreferenced number you throw out, and trying to reverse-engineer where you got it from. I have no idea where you get your 1.5% number over ten years. I'm getting the impression that is the number you want to believe, so you look until you find it.

I finally found the table here (I had to click through to get to it), copied it to a spreadsheet and added a cumulative capital return calculation. I think you'll see their numbers match the NAV change. A drop of about 15% over ten years.

If you want to challenge this, please show your work and where you got your numbers from.



-ERD50

 

[veremchuka]

erd50 thanks for this chart.

i don't know what the columns are except for the total return and looking at that it seems that 2003, 2009 and 2010 were the only really good years for hycb fund, the others were so so to lousy. but even those good years are NOT THAT good because these were years the equity markets were up huge.

my point is the risk in hy does not look to be well compensated - being in equities is risky too but the returns are better. i bought this fund in the mid $4 range so i'm not doing too bad but this is making me really rethink this allocation to hy in my roth ira! i think we may be fooling ourselves about the wisdom of holding this fund.

 

[Texas Proud]

erd50 thanks for this chart.

i don't know what the columns are except for the total return and looking at that it seems that 2003, 2009 and 2010 were the only really good years for hycb fund, the others were so so to lousy. but even those good years are NOT THAT good because these were years the equity markets were up huge.

my point is the risk in hy does not look to be well compensated - being in equities is risky too but the returns are better. i bought this fund in the mid $4 range so i'm not doing too bad but this is making me really rethink this allocation to hy in my roth ira! i think we may be fooling ourselves about the wisdom of holding this fund.

The thing is that it is still a bond fund... and is not as 'risky' as a stock fund.... the income component is there year in and year out...

I think you are compensated well for the risk... look at the charts comparing it to the S&P (or your favorite stock index) and you will see that even though it might appear to be in lockstep with stocks... its movements are muted because of the income...

Soooo, I think the income componet of it still puts it in the bond category for me...

 

[brewer12345]

But all of this illustrates what I have been saying: there are times to buy junk and sell junk, but just blindly holding it is not a great idea.

The junk market is starting to get really frothy. Realogy just inked a refi deal. This is an overlevered pig that I am amazed managed to stay out of bankruptcy. It is likely just a matter of time before this thing ends up in BK court.

Ditto same for Univision and Freescale, both of which seem to have the junk market approaching them. Foolish, IMO, and a sign to watch junk (especially the more dubious names) from afar.

 

[FIRE'd@51]

But all of this illustrates what I have been saying: there are times to buy junk and sell junk, but just blindly holding it is not a great idea.

While I don't disagree that someone with your expertise may be able to opportunistically time the high-yield market; according to ERD50's table, someone who "blindly held" VWEHX for the past 10 years had a CPAR of 6.4%, considerably better than the S&P 500, which had a CPAR of about 1.5% over the same time period. As you know, there have been successful fixed income managers who strategically carry about a 10% allocation to high yield (BEA Associates comes to mind) in the belief that one is being more than compensated for the risk of default by yield-pickup.