How Bond Funds Rolling Down the Yield Curve Help Defend Against Rising Rates

[njhowie]

I agree with you OldShooter.

Additionally, any individual can do the exact same thing as any bond fund, though obviously the individual will have less diversification having a more limited amount of funds. Further, as you point out, at the end of the day, the fund has to also cover their fees - which will likely come as a result of taking on higher risk.

It's my belief (and what I do with my portfolio), once an individual's portfolio gets above a certain point, it is more beneficial to purchase individual bonds. Personally, the draw is that I have total control. I won't employ leverage/margin when I buy. The funds do this to juice their returns. They have to get additional yield to cover the fees. In a low interest rate environment, that could work. However, now that rates are rising, leverage could cause problems for those taking more risk than they should.

When I purchase bonds, I have total control over the types of bonds I will purchase, the maturity, and the quality. The funds, again to juice returns, will have some amount of garbage bonds, again to juice their returns. How many were caught holding Puerto Rico bonds? I won't buy garbage like that.

Similar to Mr._Graybeard, I stick to quality municipal bonds. I manage my maturity/yield curve to meet my personal requirements. I hold to maturity, knowing my yield to maturity and profit the day I make any purchase. Anyone who purchases a fund has no guarantees of anything...besides the greater liquidity.

 

[pb4uski]

...... It's my belief (and what I do with my portfolio), once an individual's portfolio gets above a certain point, it is more beneficial to purchase individual bonds. Personally, the draw is that I have total control. I won't employ leverage/margin when I buy. The funds do this to juice their returns. They have to get additional yield to cover the fees. In a low interest rate environment, that could work. However, now that rates are rising, leverage could cause problems for those taking more risk than they should.

When I purchase bonds, I have total control over the types of bonds I will purchase, the maturity, and the quality. The funds, again to juice returns, will have some amount of garbage bonds, again to juice their returns. How many were caught holding Puerto Rico bonds? I won't buy garbage like that. ....

If someone's portfolio isn't big enough to buy individual bonds or you just don't care to, they could consider a target-maturity bonds fund like those offered by BlackRock or Guggenheim. They select a maturity year and get good diversification, albeit for a fee (10bps for the BlackRock corporate product and 24bps and 40bps for the Guggenheim corporate and high-yield products). Its sort of between individual bonds and a bond index fund.

 

[OldShooter]

If someone's portfolio isn't big enough to buy individual bonds or you just don't care to, they could consider a target-maturity bonds fund like those offered by BlackRock or Guggenheim. They select a maturity year and get good diversification, albeit for a fee (10bps for the BlackRock corporate product and 24bps and 40bps for the Guggenheim corporate and high-yield products). Its sort of between individual bonds and a bond index fund.

Agreed. Remember, too, that the goal of diversification is to diversify away individual issue risk. If a bond buyer sticks to US govvies and agencies, there is no individual issue risk. So even if that buyer can only afford a few bonds in a ladder or just some bills or notes, he can skip the bond funds.

On a related note, some here seem to think that buying individual bonds is intrinsically difficult. IMO it's pretty much the same as individual stocks; you pick your security and then have your broker buy it. The bond desk is happy to help with selection.

With Treasuries it's even easier as you can have your broker buy on the auction. Schwab seems to always waive their fee for me, but IIRC the sticker price for doing that is $25.

 

[brewer12345]

Agreed. Remember, too, that the goal of diversification is to diversify away individual issue risk. If a bond buyer sticks to US govvies and agencies, there is no individual issue risk. So even if that buyer can only afford a few bonds in a ladder or just some bills or notes, he can skip the bond funds.

On a related note, some here seem to think that buying individual bonds is intrinsically difficult. IMO it's pretty much the same as individual stocks; you pick your security and then have your broker buy it. The bond desk is happy to help with selection.

With Treasuries it's even easier as you can have your broker buy on the auction. Schwab seems to always waive their fee for me, but IIRC the sticker price for doing that is $25.

Schwab waives fees on treasury auctions for me as well. Between auctions, new issue CDs, secondary market stuff (which I usually avoid), and the bullet funds offered by Blackrock, it is easy to set up a ladder or stash funds for short or long term with a date certain maturity inside a brokerage account. If you are not dealing with an IRA, you can also easily shop bank and credit union CDs.

 

[OldShooter]

... If you are not dealing with an IRA, you can also easily shop bank and credit union CDs.

I have bought brokered CDs in my Schwab IRA, though I did not research to see if the rates were competitive. I just trusted that they were close enough. I don't think there were any fees, either. YMMV.

 

[brewer12345]

I have bought brokered CDs in my Schwab IRA, though I did not research to see if the rates were competitive. I just trusted that they were close enough. I don't think there were any fees, either. YMMV.

If you buy them new issue, there are no fees. Otherwise you pay a buck per 1000 par to buy or sell CDs. As for rates, they are definitely competitive with secondary market CDs, treasuries and agencies. However, sometimes you can do better by rate shopping retail banks and CUs (e.g. the 2.25% Navy Federal CD special for 15 months).

 

[Luck_Club]

The market value of the assets went down

But I pointed out that your loss was not caused by rising rates. I have no idea how you came to that conclusion.

So the underlying asset value fell as rates were rising. We still got the interest payments, but the net asset value dropped. Since it was a managed account, holding to maturity wasn't being employed by the manager. So the unrealized losses often became realized losses, due to premiums on the bonds that were called or sold.

 

[pb4uski]

Agreed. Remember, too, that the goal of diversification is to diversify away individual issue risk. If a bond buyer sticks to US govvies and agencies, there is no individual issue risk. So even if that buyer can only afford a few bonds in a ladder or just some bills or notes, he can skip the bond funds.

On a related note, some here seem to think that buying individual bonds is intrinsically difficult. IMO it's pretty much the same as individual stocks; you pick your security and then have your broker buy it. The bond desk is happy to help with selection.

With Treasuries it's even easier as you can have your broker buy on the auction. Schwab seems to always waive their fee for me, but IIRC the sticker price for doing that is $25.

I know we are of different views on this but I'm not keen on govvies and even less keen on agencies.. return-free risk as Warren Buffett would say.

On buying individual bonds, my main concern is pricing ... I think the retail bond investor likely gets fleeced whereas I am confident that BlackRock and Guggenheim get fair pricing for bonds that they buy for their target-maturity ETFs and that advantage largely offsets the 10-40 bps fee that I pay.

 

[brewer12345]

I know we are of different views on this but I'm not keen on govvies and even less keen on agencies.. return-free risk as Warren Buffett would say.

Ordinarily, I tend to agree. At the moment, spreads for just about any flavor of corporate you wish to sample have come down so far that I have a hard time seeing value there. I hold my nose and buy some, but with not much extra spread for the risks, I find myself shopping CDs harder and dabbling in treasuries.

 

[43210]

Didn't mean to hijack the thread. It was my comment to how rising rates directly resulted in a huge real loss, that prompted more questions about the specifics.

So even with "Professional Money Managers" mitigating the risks, the laws of economics still apply.

Sorry for.

Apologies for feeding this off-topic strand, but this is so abnormal that I can't let it go. There is absolutely no way that bonds could have any relevance to your portfolio's massive under-performance. An honestly (or un-) managed 50:50 portfolio should have done hugely better than you have portrayed. Either the "management" is much more lucrative for them than you, or else your portrayal of the situation is, inadvertently or otherwise, markedly different from the reality. That's all I have to say about it.

Now back to this informative thread's real topic.

 

[pb4uski]

Ordinarily, I tend to agree. At the moment, spreads for just about any flavor of corporate you wish to sample have come down so far that I have a hard time seeing value there. I hold my nose and buy some, but with not much extra spread for the risks, I find myself shopping CDs harder and dabbling in treasuries.

I actually hadn't needed to buy bonds recently so I haven't been paying attention... my rebalancing has been more to sell stocks and boost cash... but I see your point.... may take a harder look at CDs.

 

[Mr._Graybeard]

Ordinarily, I tend to agree. At the moment, spreads for just about any flavor of corporate you wish to sample have come down so far that I have a hard time seeing value there. I hold my nose and buy some, but with not much extra spread for the risks, I find myself shopping CDs harder and dabbling in treasuries.

Agreed, pickings have been pretty slim lately on the muni bond front too. Most of our muni holdings we acquired in 2013-15. After sitting on cash for a while I finally bought a brokered step-up CD in September that will probably be called as soon as the interest rate bumps up to 2% in early 2019.

 

[njhowie]

On buying individual bonds, my main concern is pricing ... I think the retail bond investor likely gets fleeced whereas I am confident that BlackRock and Guggenheim get fair pricing for bonds that they buy for their target-maturity ETFs and that advantage largely offsets the 10-40 bps fee that I pay.

When purchasing municipal bonds I've had the opposite experience. Because the market is so illiquid, I see two things. Institutional buyers are the ones getting fleeced, because there needs to be another institution willing to sell volume to them. Individual retail buyers get fleeced if they go out for a bid on their 5 or 10 bonds. Then the dealer who fleeced the individual turns around and is looking to quickly unload the 5 or 10 bonds with as minimal a markup as will get them flipped for a profit. No institution will take the 5 or 10 bonds because they don't waste their time acquiring so little at a time. I always get better Muni executions than the institutions when I'm buying.

 

[Mr._Graybeard]

When purchasing municipal bonds I've had the opposite experience. Because the market is so illiquid, I see two things. Institutional buyers are the ones getting fleeced, because there needs to be another institution willing to sell volume to them. Individual retail buyers get fleeced if they go out for a bid on their 5 or 10 bonds. Then the dealer who fleeced the individual turns around and is looking to quickly unload the 5 or 10 bonds with as minimal a markup as will get them flipped for a profit. No institution will take the 5 or 10 bonds because they don't waste their time acquiring so little at a time. I always get better Muni executions than the institutions when I'm buying.

I have had good luck as well with those little bonds, like they're too small for the big boys to mess with. Maybe they're why I was able to beat VWITX over three years.

Not that I'm gloating ...

 

[audreyh1]

Apologies for feeding this off-topic strand, but this is so abnormal that I can't let it go. There is absolutely no way that bonds could have any relevance to your portfolio's massive under-performance. An honestly (or un-) managed 50:50 portfolio should have done hugely better than you have portrayed. Either the "management" is much more lucrative for them than you, or else your portrayal of the situation is, inadvertently or otherwise, markedly different from the reality. That's all I have to say about it.

Now back to this informative thread's real topic.

Part of the problem is the income was taken out, and is not being added back in to determine actual performance. You really can't look at performance without including income received. In looking at bond fund performance you HAVE to look at total return, not the NAV variation.

Given that, if you look at the iShares ETF AGG which tracks a major intermediate bond benchmark, you'll see that NAVs over the past three years swung up and down several times and now is within 0.1% where it was 3 years ago. Meanwhile the total return is 6.36% from three years ago.

 

[audreyh1]

Ordinarily, I tend to agree. At the moment, spreads for just about any flavor of corporate you wish to sample have come down so far that I have a hard time seeing value there. I hold my nose and buy some, but with not much extra spread for the risks, I find myself shopping CDs harder and dabbling in treasuries.

Yeah spreads have really narrowed.

 

[OldShooter]

I know we are of different views on this but I'm not keen on govvies and even less keen on agencies.. return-free risk as Warren Buffett would say.

Yup. Different strokes for different folks, of course, though we do tend to forget that here sometimes.

Buffet is fun to quote and I do it frequently, but I would point out that govvies and agencies are safe, somewhat inflation-resistant, parking places for money and are, for all practical purposes, riskless. That ruins the pithiness of the quotation, however.

I started a thread on this a while back, but I'll repeat: It's a bit of a puzzle to me that we reduce our equity exposure to reduce volatility and risk and then we take the low-risk side of the allocation and immediately go looking for increased volatility and risk, hoping against hope that it is uncorrelated. Seems like just leaving a little bit more on the equity side is just as effective and is easier.

On buying individual bonds, my main concern is pricing ... I think the retail bond investor likely gets fleeced whereas I am confident that BlackRock and Guggenheim get fair pricing for bonds that they buy for their target-maturity ETFs and that advantage largely offsets the 10-40 bps fee that I pay.

True enough. YTM or YTC should tell half the story, anyway. Since I don't do munis or small issue corporates I have really never looked into this. I also have a sort of childlike faith that Schwab does enough bond business that they can intimidate counteparties to not screw Schwab customers too badly.

 

[Luck_Club]

Part of the problem is the income was taken out, and is not being added back in to determine actual performance. You really can't look at performance without including income received. In looking at bond fund performance you HAVE to look at total return, not the NAV variation.

Given that, if you look at the iShares ETF AGG which tracks a major intermediate bond benchmark, you'll see that NAVs over the past three years swung up and down several times and now is within 0.1% where it was 3 years ago. Meanwhile the total return is 6.36% from three years ago.

NOT EVEN CLOSE to 6.3%

There was yield, but the asset reduction in value, ate into the yield severely.

Apologies for feeding this off-topic strand, but this is so abnormal that I can't let it go. There is absolutely no way that bonds could have any relevance to your portfolio's massive under-performance. An honestly (or un-) managed 50:50 portfolio should have done hugely better than you have portrayed. Either the "management" is much more lucrative for them than you, or else your portrayal of the situation is, inadvertently or otherwise, markedly different from the reality. That's all I have to say about it.

It is a RJ managed account. I agree something doesn't smell right in Denmark so to speak. But my simple (I'm a real estate investor after all) back of the envelope math shows a net loss of roughly 10% in asset value all in from Jan 2015 to today. I arrived at that by IIRC Todays Vale /(Jan2015 + Income generate - withdrawals including fees ). Most of the asset decline appears to be in the two bond holdings.

DID THE FA S**K? Yes. Did the FA do anything illegal I don't know. Did the FA act in good faith fulfilling his fiduciary responsibilities, I don't think so.
Did the http://www.eagleasset.com/fixed_performance_taxable.html
Stuff our portfolio with bad trades? maybe?

Sorry to keep feeding the hijack.

 

[pb4uski]

..... Given that, if you look at the iShares ETF AGG which tracks a major intermediate bond benchmark, you'll see that NAVs over the past three years swung up and down several times and now is within 0.1% where it was 3 years ago. Meanwhile the total return is 6.36% from three years ago.

Per Portfolio Visualizer for AGG:

Year	Inflation	iShares Core US Aggregate Bond ETF (AGG)	Total Return	Inflation Adjusted Return	Income	Year End Balance
Annual returns for the configured portfolios
Annual returns for 2017 are based on partial year data
2014	0.76%	6.00%	6.00%	5.20%	2.51% [$251]	$10,600
2015	0.73%	0.48%	0.48%	-0.25%	2.43% [$258]	$10,651
2016	2.07%	2.42%	2.42%	0.33%	2.42% [$258]	$10,908
2017	2.17%	3.06%	3.06%	0.88%	2.12% [$231]	$11,242

 

[43210]

I'll make a comment pertinent to both the on- and off- topic portions of this thread. In any portfolio with a non-small allocation to stocks, the performance of the portfolio will be dominated by the performance of the stocks.