Bond Funds

[oldman]

For those of you already in retirement and using a core bond fund for some of monthly income, which fund are you holding? I noticed that the funds that use lehman Aggregate as the index are heavily into government securities and mortgages, so last week was not a good week.
Do you stick with your fund or trade into another fund as the market changes. Seems its not a good time to be in treasury's. Corporates are doing much better. Interest rates are going to continue to increase, so where do you want to be for yield?

 

[mickeyd]

which fund are you holding?

Nothing fancy for me. I divide my bond part (all in IRA~long term) into two equal parts~1/2 Vanguard Intermediate Term Index and the other 1/2 in VG TIPS. I also stash about 1/2 of my cash reserves in the Vanguard ST Bond fund.

 

[oldman]

Vanguard Intermediate-Term Investment-Grade Fund Investor Shares (VFICX) does not have alot of government/agency's so that's good now, but not good last year.

 

[oldman]

BERIX or FSICX

These are 2 funds that have good yield and total return. Anything better than these over different time periods?

 

[clifp]

My two core bond funds are Vanguard GNMA and Vanguard High Yield Corporate (i.e. junk bonds). At times I have held BND the Vanguard Total Bond ETF.

 

[Zoocat]

My two core bond funds are Vanguard GNMA and Vanguard High Yield Corporate (i.e. junk bonds). At times I have held BND the Vanguard Total Bond ETF.

I have a substantial position in Vanguard GNMA and a very minor position in Vanguard High Yield Corporate, also in my ROTH Vanguard Intermediate Fund.

Does anyone want to offer an opinion about the future of GNMA funds in this environment of rising interest rates? I don't want to lose much principal, so maybe I'm in the wrong fund?

Also, I view the Vanguard High Yield Corporate as part of my equity holding. But I'm not sure how to judge the risk there. Anyone care to clue me about that?

 

[Moemg]

Also, I view the Vanguard High Yield Corporate as part of my equity holding. But I'm not sure how to judge the risk there. Anyone care to clue me about that?

I've had Vanguard High Yield since 1999 and last year was the only truly down year and that was 8.18% as compared to the SP500 drop of 32.40%.

 

[clifp]

Well here are my thoughts FWIW (a bit more than you pay me but only a tiny bit.)

Eyeballing the chart VFIIX prices has been $10 +/- $.50 for ~90% over the last 25 years. (The first few years of the fund were a roller coaster).
The price has remained stable despite some dramatic shifts in the benchmark 10 yr T-Bond (in 1984 is 12.5% and last year it dropped to 2.5%) .

Of course over the last 6 months it has remained above the 10.50 level but only marginally. The relatively high price of VFIIX coupled with the juicy yields was the reason I switched roughly 1/2 my bonds to High yield. The trader testosterone also kicked in. Of course, I left my mom's much larger position in VFIIX intact cause at 83 she doesn't need to take additional risk.

So under normal circumstances I'd say as long as you can stand to see a 10% paper drop in your position (10.5x to 9.50) it should fine. More over even if the price drop the yields will increase and the monthly distributions should remain relatively constant, I spend the interest and the distributions haven't changed a lot (down 10% year over year).

Now obviously if interest rates rise (and most folks think they will) than any bond fund price will drop. The stability if GNMA price is enhanced because in normal environment the increased economic activity means that as more people move, more mortgages are paid of early, and the new mortgage pay higher rate. In a falling interest rates environment people don't even need to move just refinance which hurts the distributions of the fund.

Now all of my analysis is based on normal circumstances, which unfortunately probably excludes today's economy.

So I see 3 probable outcomes for VFIIX

1. Continued recession interest rates remain low, fund price remains high and at 4.2% the yield is way higher than any other safe investment.
2. Normal recovery, modestly higher interest rate, but demand for houses increases so fund distributions increase, and price drop modestly but total return is still positive.
3. A severe bear market in US Government (backed) bonds. Concerns about the safety and reliability of US debt increase causing significant drop in the fund price. The big area of concern, I have with GNMAs, is while GNMA in theory are backed by the full faith of the US Government, it is important to remember that the first line of defense as GNMA bond holder is the assets which back them. This means a bunch of mortgage on US homes. How many of these home owners are underwater is a question which I don't think anybody knows. At what point will the US government stop pouring money into GSE to cover their massive losses is another unknowable questions.

I don't want to sound alarmist, and 1 year ago I would have laughed at a posted picture of tinfoils hats to anyone who suggested than GNMA were anything but the safest investment on the planet, but times have changed. I think #3 is very unlikely but no longer impossible.

 

[LOL!]

We have owned the Vanguard GNMA fund now for awhile and the Vanguard short-term investment grade bond fund in our IRAs. We don't really add much money to them, but just let them sit. For example, no new money has gone into VFSUX in over 2 years, while GNMA has received some Roth contributions. We reinvest all dividends back into the funds.

My 401(k) gets contributions to an intermediate bond fund, but rebalancing has moved half of that position back into equities.

As far as performance, we haven't made any money in bonds, but we haven't lost any either.

The short-term investment grade lost 10% in 2008 but has gained that back this year, so we are even.

The GNMA fund was the highest performing Vanguard fund in the last 12 months with a return of about 8%. It is continually dissed at the Bogleheads forum despite its outstanding performance. Good arguments can be found in this thread: Bogleheads :: View topic - Vanguard GNMA Read it to get a much more detailed and contentious take on GNMAs than clifp just wrote.

The intermediate-term fund in the 401(k) lost about 15% in 2008, but has recovered those losses and is about breaking even.

We didn't really own any Treasuries last year, when they were cooking. We don't own them this year when they aren't doing well.

Now I do trade between the GNMA fund and the Vanguard TIPS fund based on the "real yield" of TIPS. Since the real yield of the 10-year does not average above 2.5%, I am out of TIPS and into GNMA. Other than that, my bond fund strategy is to be patient and ignore moves even up to 15% in them.

 

[FIRE'd@51]

One thing to consider when contemplating an investment in mortgage funds is the asymmetry in price volatility. The price volatility to the downside tends to be greater than the upside. This occurs, of course, because more people tend to pay off their mortgages when interest rates drop (to refinance at the lower rate) than when they rise. When rates rise the only folks who pay off their mortgages are those who have to move.

 

[clifp]

The GNMA fund was the highest performing Vanguard fund in the last 12 months with a return of about 8%. It is continually dissed at the Bogleheads forum despite its outstanding performance. Good arguments can be found in this thread: Bogleheads :: View topic - Vanguard GNMA Read it to get a much more detailed and contentious take on GNMAs than clifp just wrote.

.

Excellent thread thanks for the link. BTW, over the long term the highest returns for any Vanguard bond funds are GNMA, followed closely by High Yield. (Note not an apples to apples comparison since the bond funds started at different times).

What I found most surprising in the thread is that nobody mentioned that investors (especially foreign ones) might not value the bonds back by the "full faith and credit of the AAA rate US government" as highly as they once did.

In essence what I am suggesting MIGHT happen is situation similar to what we saw last fall in the Muni bond market.

The largest insurers of Muni bonds (e.g. MBIA and AMBAC) got themselves in trouble by writing insurance on Mortgage back securities and other CDOs. It looked like there was a good chance the insurers would go out of business, making the insurance policy they wrote on muni bonds pretty much worthless. At which point Muni bonds, took a real beating as people
had to price them on the value of the underlying credit worthiness of the bond issuer, rather than on the AAA credit rating of the insurance company.

What I find interesting is that market priced in a lot of things that didn't actually happen. The price of muni bonds fall dramatically, eventhough the insurers still had AAA credit ratings. Eventually the credit agency cut the ratings of the insurers to junk levels. The actual defaults of muni bonds is still quite low, although smart folks like Warren Buffett are warning the risks are rising.

Obviously there are differences between Muni bonds market, and GNMAs market. The good news is I value the insurance backing of the US government far more than the silly bond insurance companies like MBIA. The bad news is that I bet that mortgage is at least 10 times and maybe as much as 100 times more likely to default as a muni bond.

The cautionary note is that GNMA price could drop severely if investor no longer have confidence that Uncle Sam will actually pay back all the interest and principal of many many trillions of MBS now being guarranteed.

Finally, I loved this quote from the Booglehead board

Diligent reading of this forum would suggest that virtually every possible investing plan is so fraught with risks, misconceptions, egregious failures to optimize and so on that we are all doomed to failure no matter what we do.

There is an occasional ray of light that says most plans are good enough, that there are many roads to Dublin, that the enemy of a good plan is a perfect plan, and so on.

I would prefer to emphasize the latter.

 

[LOL!]

I certainly remember that last year about this time Fannie Mae and Freddie Mac had problems. Unlike GNMAs, at the time the bonds from these agencies were not backed by the full faith and credit of the United States. Furthermore, it was pretty clear that lots of folks think that GNMAs are mortgage-backed securities or MBSs. This caused a dip in the fund value last year. In reality, they are government-backed. When sane folks figured this out, the NAV went back up. And of course, the government had to step in and make Fannie and Freddie government-backed as well.

So the 8% 12-month return of GNMAs is not because GNMAs performed well - it is simply because of the big temporary negative blip at about this time last year.

Also, there is really not a lot of refinancing going on. Mortgage rates were lower 3 years ago when we refinanced. Anybody who could, already refinanced 3 years ago. I don't see any more than normal rash of refinancing happening nowadays that would affect GNMAs.

The biggest risk is that general interest rates go up and that will affect ALL bonds. The Vanguard GNMA fund has an abnormally low duration at the present time, so the fund managers seem to be doing their job by keeping maturities relatively short for this fund. That's probably all one can hope for.