Interest Rates and Bonds

[mathjak107]

Before buying a bond fund, understand the difference between SEC yield and distribution yield. The distribution yield on your fund is 2.94% and the SEC yield is 4.23%. The distribution yield is based on the trailing 12 months distribution (i.e. what you actually receive in your account). SEC yield is an estimate based on the assumption that each bond that the fund holds will be held to maturity (which just won't happen). SEC yield can be extremely misleading. Unlike individual bonds, the distribution of a bond fund is not guaranteed. There also is no return of capital. Bond funds are not bonds period. To me they are complete scams to extract fees from investors and financial community has convinced many investors that they offer portfolio protection. They do not.

bond funds , at least treasuries , which have no credit risk ,do track like individual bonds fairly well .

but you need to stay in the fund at least as long as its duration value .

so hypothetically if you buy a treasury bond fund for 10 bucks and it is paying 5% and has a duration of 5 years :

if rates go up 1% you will get 6% for 5 years , while however nav will fall to 9.50

that extra 5% interest gives you a total return of the original 5% you got the day you bought .

fund fees will effect things a bit but you wont be far off from having kept that 5% individual bond despite being a fund.

but remember you got 5% in a 6% world so either way so you are behind the curve

 

[Mulligan]

Mulligan,



Many companies that issue cumulative are just to "sketchy" for me to even consider buying. When investing in preferred stock, I tend to focus on large money center banks that are well capitalized. The preferred stock universe is littered with too many corpses. I think this year will be another great year to load up on invest grade preferred stocks however unlike the past, the coupons are about 2% lower so they have much further to fall during periods of capitulation. They will also take longer to recover than this time. The same problem exists for corporate bonds. The coupon rates of outstanding high investment grade corporate notes are extremely low relative to the past. Bond funds are holding a lot of this low coupon debt and are in a more precarious position than the past.

Im in total agreement with your thought process, (though my preference is other high quality utility preferreds or profitable junk issuers to trade) but was just explaining why it is that way. Too many people get hung up on cumulative or non cumulative and that really should be one of the last reasons to invest in any specific preferred. As any company can toss in cumulative as a freebee with nothing to lose as cumulative typically means nothing in bankruptcy.
In fact Moodys doesnt even rate differently for the two, because most of the time it just doesnt matter. A few instances do occur though. Pacific Gas and Electric preferreds paid 4 years of deferrals last month as an example.
Utilities typically are as strong as banks and they issue cumulative. I have a couple issues that each have over 100 years of uninterrupted dividend payments. Last years newly issued coupons have been torched. But I was out of those long ago last year. Term dated and live high adjustable with Libor have been my plays and they have done well. Need a bit more roaching of last years fixed issuances to get me in.

 

[Graybeard]

The problem is this investment grade fund (https://advisors.vanguard.com/inves...2GPvRe9GN1qNk1dYmpBoCMFoQAvD_BwE&gclsrc=aw.ds) is now yielding 4.23% ..For me to get bonds paying that I would need to move pretty far down the quality scale..And I don't know what I am doing.

I didn't bother to look at the duration but I suspect it's around 4-5 years. I hold the Short Term Investment Grade fund, it's duration is 1.9 years and I have lost several thousand dollars due to rising rates and decreasing nav. If you want income and don't care about the principal maybe you're OK with the intermediate term version but if the short term is losing this much imagine how much the intermediate term fund has lost..

 

[lawman]

I can tell you when I sold I lost plenty compared to what I could have sold for earlier in the year.. Overall I may have done okay because I held that fund for around 20 years. The long and short term capital gains realized at the time of sale really don't tell you much..It would appear I lost more than I really lost because that doesn't take into consideration all the dividends and capital gains paid out through the years.

 

[Freedom56]

bond funds , at least treasuries , which have no credit risk ,do track like individual bonds fairly well .

but you need to stay in the fund at least as long as its duration value .

so hypothetically if you buy a treasury bond fund for 10 bucks and it is paying 5% and has a duration of 5 years :

if rates go up 1% you will get 6% for 5 years , while however nav will fall to 9.50

that extra 5% interest gives you a total return of the original 5% you got the day you bought .

fund fees will effect things a bit but you wont be far off from having kept that 5% individual bond despite being a fund.

but remember you got 5% in a 6% world so either way so you are behind the curve

Why would any sane person buy a treasury bond fund? What is the risk of owning individual treasury notes or the 30 year treasury bond to maturity? What's next a CD fund? All you do is pay the fund a fee in exchange for market risk and potential loss of capital when there is none with the securities they are holding.

 

[Freedom56]

I can tell you when I sold I lost plenty compared to what I could have sold for earlier in the year.. Overall I may have done okay because I held that fund for around 20 years. The long and short term capital gains realized at the time of sale really don't tell you much..It would appear I lost more than I really lost because that doesn't take into consideration all the dividends and capital gains paid out through the years.

Now run you analysis going back 20 years if you invested in 5 year CDs compounded annually and reinvested your capital and interest every 5 years in another 5 year CD.

 

[mathjak107]

Why would any sane person buy a treasury bond fund? What is the risk of owning individual treasury notes or the 30 year treasury bond to maturity? What's next a CD fund? All you do is pay the fund a fee in exchange for market risk and potential loss of capital when there is none with the securities they are holding.

The ease of rebalancing ….

I own Tlt and when my rebalance bands are hit I can rebalance in seconds in to other assets or other assets in to Tlt .

as well as enter limit orders.

 

[Out-to-Lunch]

Why would any sane person buy a treasury bond fund? What is the risk of owning individual treasury notes or the 30 year treasury bond to maturity? What's next a CD fund? All you do is pay the fund a fee in exchange for market risk and potential loss of capital when there is none with the securities they are holding.

Many sane people have savings in 401(k)-type plans, where they cannot buy individual issues.

 

[COcheesehead]

Many sane people have savings in 401(k)-type plans, where they cannot buy individual issues.

Hmmm, I can at Fidelity.

 

[OldShooter]

Why would any sane person buy a treasury bond fund? What is the risk of owning individual treasury notes or the 30 year treasury bond to maturity? What's next a CD fund? All you do is pay the fund a fee in exchange for market risk and potential loss of capital when there is none with the securities they are holding.

I agree with this. Govvies are so ubiquitous and easy to buy that I see no reason to hire a fund manager to do it.

I think corporates are different at least for individuals because it takes a lot of time and money to assemble a well-diversified portfolio. DW and I are on the investment committee for one of the nonprofits where she's a board member. The nonprofit's FA is running around $3M in bonds and our instructions are that mutual funds are to be used only for very short term cash parking. The bond guy at the FA has done a great job; Very roughly, there are 150 positions well diversified across sectors. Almost all are BBB and we have not found this to be any kind of an issue at all. Typically we have maybe 4 or 5 positions that have been downgraded. Nothing exciting has happened to their prices after the downgrades, in fact lately they seem to be trading at over par. We review the downgrades list every quarter but IIRC we have never sold one. The policy on all bonds is to hold to maturity. (We generally believe in the EMH, so there's little to be gained by selling.)

But 150 bond positions is IMO not something that is feasible for most retail investors to manage. Hence, for retail investors wanting to hold corporates bond funds make sense.

 

[COcheesehead]

I run a muni ladder with about 150 positions in it. I don’t find it hard to manage, but I tip toed into it over a course of about seven years. I even added to it today. There are some interesting deals in bond land.

 

[OldShooter]

 

[Out-to-Lunch]

Many sane people have savings in 401(k)-type plans, where they cannot buy individual issues.

Hmmm, I can at Fidelity.

I concede to not knowing that some plans allow this. So the comma in my original post was in error.

Nonetheless, many sane people have savings in 401(k)-type plans where they cannot buy individual issues. (Comma removed.)

 

[jazz4cash]

I agree with this. Govvies are so ubiquitous and easy to buy that I see no reason to hire a fund manager to do it.

Govvies and corporate bonds are very, very confusing for the average investor. Places like Vanguard have specialized in promoting funds over individual securities to assuage the fears of average investors.

 

[baseman250]

I've been telling myself for years that I need to figure out this "bond" stuff...

Oh well, better late than never. It's not like the warning bells weren't going off about bond funds, but I was so excited about the equity run-up that I just wasn't reading those threads.... ugh.

Not doing too badly overall; down about 8% from highs, but if I wasn't so lazy, it could probably be half that.

Now, back to the bond threads and digging into some of the supplied links (thank you @freedom56)... amazing site and amazing contributors. I just need to pay attention.

 

[daylatedollarshort]

I've been telling myself for years that I need to figure out this "bond" stuff...

I found The Bond Book by Annette Thau very helpful. She was a municipal bond analyst. I felt it was pretty objective about the pros and cons of funds vs. individual bonds, whereas much of the online information is often tilted by parties with vested interests.

 

[sengsational]

I was looking at building a one year, quarterly bond ladder for my mom, as an alternate to her just keeping the funds in the bank. I went into Fidelity's site and I was surprised that I could get a better yield from treasuries than corporates. Am I missing something?

 

[COcheesehead]

I was looking at building a one year, quarterly bond ladder for my mom, as an alternate to her just keeping the funds in the bank. I went into Fidelity's site and I was surprised that I could get a better yield from treasuries than corporates. Am I missing something?

Compared to AA rated corporates that is true, but if you go to lower credit quality like A and lower, corporates are higher yielding. Don’t overlook taxable municipals - they are higher yielding than treasuries and pretty safe, safer than corporates. If taxes matter, muni’s are good too.

 

[jazz4cash]

I remember a debate on this board many, many years ago about bonds vs bond funds. I recall several knowledgeable posters stating adamantly that they were effectively the same. Based on that I took the plunge into my 401k’s bond fund. Pimco Total bond or something like that. For six months or so I cringed every time I looked at it, probably because I didn’t understand. I reasoned that if I had a basket of individual bonds I could selectively sell specific issues if I had an emergency. Also the returns were mediocre but I knew I could not be diversified buying individual bonds. Eventually I dumped the bond fund completely and bought CD’s paying 4-6% and I got lucky. Now I have gained some comfort with buying individual bonds even though I only have a few positions. At this point it seems unlikely I will every buy a bond fund.

 

[lawman]

I remember a debate on this board many, many years ago about bonds vs bond funds. I recall several knowledgeable posters stating adamantly that they were effectively the same. Based on that I took the plunge into my 401k’s bond fund. Pimco Total bond or something like that. For six months or so I cringed every time I looked at it, probably because I didn’t understand. I reasoned that if I had a basket of individual bonds I could selectively sell specific issues if I had an emergency. Also the returns were mediocre but I knew I could not be diversified buying individual bonds. Eventually I dumped the bond fund completely and bought CD’s paying 4-6% and I got lucky. Now I have gained some comfort with buying individual bonds even though I only have a few positions. At this point it seems unlikely I will every buy a bond fund.

I'm right there with you..Just bought my first corp., tax free muni's, muni's,C.D's and treasuries last week..If interest rates were high now I would be going back into funds but I never want to get caught in the trap I found myself in this Spring. My primary reservation is my belief that anything I might save by eliminating the chance of lower share prices is that in the end I will not draw nearly as much interest on my bonds as I would dividends from a bond mutual fund..I just don't have the access to the bonds a fund manager has and I'm not willing to go down on quality.. I also don't know the ins and outs of selling bonds before they mature to increase my returns like bond managers do....In the long run I still think that for me personally I would do better in a fund than buying my own bonds and holding til maturity..I just am not willing to see that drastic drop in share price should rates take another sharp increase..

 

[COcheesehead]

I remember a debate on this board many, many years ago about bonds vs bond funds. I recall several knowledgeable posters stating adamantly that they were effectively the same. Based on that I took the plunge into my 401k’s bond fund. Pimco Total bond or something like that. For six months or so I cringed every time I looked at it, probably because I didn’t understand. I reasoned that if I had a basket of individual bonds I could selectively sell specific issues if I had an emergency. Also the returns were mediocre but I knew I could not be diversified buying individual bonds. Eventually I dumped the bond fund completely and bought CD’s paying 4-6% and I got lucky. Now I have gained some comfort with buying individual bonds even though I only have a few positions. At this point it seems unlikely I will every buy a bond fund.

I agree completely - I buy almost exclusively individual bonds. I did, however play the bounce with a closed end muni that went up 10% in less than two weeks.

 

[daylatedollarshort]

I just am not willing to see that drastic drop in share price should rates take another sharp increase..

Powell said in an interview last week that they would not stop the rate hikes until inflation starts coming down to 2%. The last CPI numbers were 6.3%, so that's a ways to go yet.

 

[DawgMan]

Ok, following this thread and trying to learn from strangers on the internet... mama always said don't talk to strangers!

Having recently retired, I have made a decision to bond ladder up to 10 years worth of spend and then letting the rest roll in equities. Effectively, a 2 bucket approach which has moved my previous 60/40 AA closer to 70/30. The thought being, let my equities take the brunt of the return risk, but try and secure some level of "reasonable" yield without giving up unnecessary risk in my bonds. Currently, I have 5 yrs worth of bonds in treasuries that are maturing between July and Jan (the balance in short term bond ETFs for now), with plans to start looking further out (maybe 2 years) as some of these roll considering some higher quality corporates. So here's my question to the experts, how should you compare (or should you) a certain rating/maturity on a corporate bond to a individual preferred stock of a "large money center bank that is well capitalized"? Assuming it has the same maturity, should we be comparing a AAA corporate here? Just trying to understand the risk/reward and how much one should reach for yield here in the strategy as noted?

Ok, I will hang up and listen...

 

[pb4uski]

....Assuming it has the same maturity, should we be comparing a AAA corporate here?...

There are only two AAA rated companies left in the US... JNJ and MSFT... and 3 AA+... APPL, GOOG and FNMA... and 4 AA rated US companies... CVX, XOM, WMT, BRK.

So only 9 US sompanies that are AA or better.

 

[DawgMan]

There are only two AAA rated companies left in the US... JNJ and MSFT... and 3 AA+... APPL, GOOG and FNMA... and 4 AA rated US companies... CVX, XOM, WMT, BRK.

So only 9 US sompanies that are AA or better.

So, for those who might be laddering bonds with the noted similar strategy, how far down the rating scale do you go?? I realize everyone has their own risk tolerance and the % of defaults increase as you move down, but curious as to where most draw the line on ratings relative to risks? Also, in underwriting a lower rated bond with a shorter term maturity (say 1 year or less), assuming you do some DD and the company should "make it" during that period, should not assume that is a reasonable risk to take, assuming you are getting a premium (as opposed to say a 5 year maturity)?

Still curious about how/if individual preferreds should be in the ladder.