Bond vs Bond Fund

[Phroig]

I don't think it is necessarily a wash in the long run but my main point is that the fair value of individual bonds have dropped in this period rising rates so both bond fund investors and individual bond investors have seen declines in portfolio value in 2022.

So a case could be made for holding bond funds when rates stabilize, rather than bonds. Bond fund holders can be more nimble; many here sold in January and avoided the decline in their PVs. Holders of individual bonds, OTOH, would have messed up their ladders.

I realize that an individual bond will pay the par value upon maturity. However, a bond holder could have sold 100 bonds priced at $108 in January and bought back 108 of the same bonds priced at $100 in June. In fact, the need to maintain their ladders probably induced some folks to buy bonds in January.

Just a thought. I completely agree that for someone investing right now, a ladder makes more sense than a fund.

 

[Freedom56]

^^^^ I’m lost. BND is a total bond index ETF. There is no active manager to be “dumb”, just a computer tracking 10,121 bonds of AA credit or better.

You must be lost. Only two of the top ten holdings of BND are rated AA. The rest are lower. Ally financial is rated BBB-. The whole idea of a market weighted bond index is just dumb given that corporations that have issued the most debt have the highest weighting. This is counter-intuitive given that corporations with the highest level of debt have higher credit risk. Yes bots are used to buy and sell bonds based on inflows and outflows but there are some humans involved in deciding what issues to buy as bonds/notes have a finite life.

 

[daylatedollarshort]

So a case could be made for holding bond funds when rates stabilize, rather than bonds. Bond fund holders can be more nimble; many here sold in January and avoided the decline in their PVs. Holders of individual bonds, OTOH, would have messed up their ladders.

Why would an individual bond holder, holding to maturity, have sold at all in January?

 

[Phroig]

Why would an individual bond holder, holding to maturity, have sold at all in January?

I’m suggesting they wouldn’t, so they didn’t avoid the decline in value that fund holders did.

 

[RunningBum]

I’m suggesting they wouldn’t, so they didn’t avoid the decline in value that fund holders did.

Instead they continued to get the lower than current market rate payments.

 

[COcheesehead]

Instead they continued to get the lower than current market rate payments.

Maybe… I have a ladder and continued to roll over maturing bonds, doubling the yield of the ladder in a very short time. Rates over 5 years dropped quickly since mid June, so some of the ladder has already locked in the higher yields which are no longer available at this time.

The whole idea of a ladder is to take advantage of longer rates/higher yields as bonds mature which is a hedge to increasing rates while still preserving capital if held to maturity.

 

[Markola]

You must be lost. Only two of the top ten holdings of BND are rated AA. The rest are lower. Ally financial is rated BBB-. The whole idea of a market weighted bond index is just dumb given that corporations that have issued the most debt have the highest weighting. This is counter-intuitive given that corporations with the highest level of debt have higher credit risk. Yes bots are used to buy and sell bonds based on inflows and outflows but there are some humans involved in deciding what issues to buy as bonds/notes have a finite life.

Are we talking about the same Vanguard BND ETF? You’re making some claims that I can’t verify. Vanguard says there are zero BBB- rated bonds in the fund. And do you have evidence that humans are doing something nefarious or “dumb” or even significant in this fund, in which computers simply track an index?

 

[daylatedollarshort]

I’m suggesting they wouldn’t, so they didn’t avoid the decline in value that fund holders did.

Individual bonds held to maturity get redeemed at par, so that is avoiding the decline in value. When you sell a bond fund there is no maturity date, so you can make more or less than what you bought it for. That is the whole point of avoiding the funds when rates are rising and prices dropping.

 

[daylatedollarshort]

Instead they continued to get the lower than current market rate payments.

People can have bonds in a ladder bought at all different times in the last 30 years, so I don't understand why that would be true. Interest rates are currently far from all time highs -10 Year Treasury Rate - 54 Year Historical Chart | MacroTrends.

 

[RunningBum]

People can have bonds in a ladder bought at all different times in the last 30 years, so I don't understand why that would be true. Interest rates are currently far from all time highs -10 Year Treasury Rate - 54 Year Historical Chart | MacroTrends.

In that case, those bonds could have been sold for a profit. Carrying them to maturity brings the value down to par value.

And btw, bond funds are holding some of those older bonds too, so if someone has been holding bond funds for awhile, they are doing fine too.

I'm tired of this. I hope others reading this thread understand that a bond fund is comprised of individual bonds. And if you have multiple bonds yourself, you essentially have your own bond fund. Rate increases and declines affect both similarly, though not identically. There is no magic about holding a bond to term that somehow makes it superior. The overall value of a bond or bond fund is based on how much you pay, how much interest you get over time, and how much you sell when you sell or keep it to maturity, all considering time value of the money in these events. You're not finding an extra pot of gold at the end of the bond term.

I'm out.

 

[Freedom56]

Are we talking about the same Vanguard BND ETF? You’re making some claims that I can’t verify. Vanguard says there are zero BBB- rated bonds in the fund. And do you have evidence that humans are doing something nefarious or “dumb” or even significant in this fund, in which computers simply track an index?

 

[Phroig]

Individual bonds held to maturity get redeemed at par, so that is avoiding the decline in value. When you sell a bond fund there is no maturity date, so you can make more or less than what you bought it for. That is the whole point of avoiding the funds when rates are rising and prices dropping.

You are missing the opportunity cost of holding on to the individual bond. Both the bond fund and the individual bond declined in market value from (say) $100 to $92 over Jan-June. If the bond fund holder sold in Jan, she has $100 in June. If the owner of the individual bond didn’t, he has a $92 investment in June. If he instead sold 1 bond for $100 in Jan, he could buy 1.09 of the same bond @ $92 in June and be better off.

 

[Freedom56]

Individual bonds held to maturity get redeemed at par, so that is avoiding the decline in value. When you sell a bond fund there is no maturity date, so you can make more or less than what you bought it for. That is the whole point of avoiding the funds when rates are rising and prices dropping.

Another reason is what they buy for the sake of "diversification". Look at Vanguard's number three holding in a portfolio of over 9500 bonds in their BND ETF, Aercap Ireland. Putin has seized 113 of their aircrafts and the Russian airlines have suspended lease payments for those aircrafts. They are already taking a hefty loss on their holding of Aercap and it will be much worse when they are downgraded below investment grade.

 

[COcheesehead]

In that case, those bonds could have been sold for a profit. Carrying them to maturity brings the value down to par value.

And btw, bond funds are holding some of those older bonds too, so if someone has been holding bond funds for awhile, they are doing fine too.

I'm tired of this. I hope others reading this thread understand that a bond fund is comprised of individual bonds. And if you have multiple bonds yourself, you essentially have your own bond fund. Rate increases and declines affect both similarly, though not identically. There is no magic about holding a bond to term that somehow makes it superior. The overall value of a bond or bond fund is based on how much you pay, how much interest you get over time, and how much you sell when you sell or keep it to maturity, all considering time value of the money in these events. You're not finding an extra pot of gold at the end of the bond term.

I'm out.

Except a bond fund has management expenses, forced redemptions, no par and no set duration. So… they really are different as much as you try to make them the same.

 

[Freedom56]

Except a bond fund has management expenses, forced redemptions, no par and no set duration. So… they really are different as much as you try to make them the same.

You forgot to mention the hidden trading fees which are not even included in their expense ratio.

 

[Markola]

Take a look at the top ten holdings for BND

https://investor.vanguard.com/investment-products/etfs/profile/bnd#portfolio-composition


Number ten is Ally Financial which used to be rated BB+ (High Yield) but was upgraded to BBB- a couple of years ago. There are many other Baa3/BBB- such as Aercap Ireland which is their third largest holding. That company has 113 aircraft leased to airlines in Russia and is facing not only financial distress but also a credit downgrade below investment grade which will force BND to unload their third largest holding for a big loss.

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C933917&symbol=ALLY5047166

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C1002026&symbol=AER5286241

So Vanguard not only hides their paltry distribution yields but also misrepresenting their portfolio composition.

You’re seeing conspiracies where there are none. That is not the top ten holdings of the fund. That is just the first ten that start with the letter A out of 10,000 bonds. Keep scrolling.

 

[Freedom56]

You’re seeing conspiracies where there are none. That is not the top ten holdings of the fund. That is just the first ten that start with the letter A out of 10,000 bonds. Keep scrolling.

Look at the column that indicates "% of Fund". It declines as you move to the following pages. You should keep scrolling and find bonds/notes from American Airlines that are rated B (lower tier of junk bonds) and this one from Charter Communications that is rated high yield (junk) on page 54:

https://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C695587&symbol=CHTR4513437

So your statement that BND has bonds rated AA is clearly not true. They are holding many junk bonds in their portfolio and losing money on them at the same time. These are facts for anyone to see if they are willing to look. Also consider that ETF management companies allow you to download their entire holdings to analyze. Vanguard does not. I wonder why?

 

[tulak]

Also consider that ETF management companies allow you to download their entire holdings to analyze. Vanguard does not. I wonder why?

Sure they do: https://advisors.vanguard.com/investments/products/bnd/vanguard-total-bond-market-etf#portfolio

Select “Export full holdings” under “Holding details.”

Nothing hidden here…

 

[sengsational]

Except a bond fund has management expenses, forced redemptions, no par and no set duration. So… they really are different as much as you try to make them the same.

You forgot to mention the hidden trading fees which are not even included in their expense ratio.

This is a nice set of observations. I don't know the magnitude of the hidden trading fees, and I could deal with no par, no set duration. The fact that when fund holders panic out of the fund during flights to cash, is the issue for me.

It seems clear to me in the following example that a bond fund acts in a less than profitable way: A specific issue is sold because someone is panicking out. It's sold for $98. Now, the panic is over, that same issue is added back to the fund, but costs $100. The individual bond holder would not have panicked out, so been 2% better off on that issue.

Again, I don't know the magnitude of this effect, but I have no doubt it exists.

 

[Freedom56]

Sure they do: https://advisors.vanguard.com/investments/products/bnd/vanguard-total-bond-market-etf#portfolio

Select “Export full holdings” under “Holding details.”

Nothing hidden here…

You are correct and if you download the spreadsheet and sort on holdings you will find all those high yield bonds/notes from American Airlines, Charter Communications, Diamondback Energy and others. So the myth propagated by others that BND is tracking AA rated and higher bonds is completely false.

 

[tulak]

This is a nice set of observations. I don't know the magnitude of the hidden trading fees, and I could deal with no par, no set duration. The fact that when fund holders panic out of the fund during flights to cash, is the issue for me.

It seems clear to me in the following example that a bond fund acts in a less than profitable way: A specific issue is sold because someone is panicking out. It's sold for $98. Now, the panic is over, that same issue is added back to the fund, but costs $100. The individual bond holder would not have panicked out, so been 2% better off on that issue.

Again, I don't know the magnitude of this effect, but I have no doubt it exists.

+1. This is my concern too.

I suspect if you held a bond fund for it’s average duration, you’ll get about the same as a portfolio with individual bonds minus fees with the same duration. The difference is probably small enough that it’s easier to stick with a bond fund instead of building your own bond fund.

The problem is forced liquidation of bonds in the fund. I’m also curious to know how much that affects overall performance.

 

[all4j]

This is a nice set of observations. I don't know the magnitude of the hidden trading fees, and I could deal with no par, no set duration. The fact that when fund holders panic out of the fund during flights to cash, is the issue for me.

It seems clear to me in the following example that a bond fund acts in a less than profitable way: A specific issue is sold because someone is panicking out. It's sold for $98. Now, the panic is over, that same issue is added back to the fund, but costs $100. The individual bond holder would not have panicked out, so been 2% better off on that issue.

Again, I don't know the magnitude of this effect, but I have no doubt it exists.

Regarding sections I bolded...

Best source for expense is the annual/semi-annual report. It will show both the hypothetical, but actual expense for a previous time period.

I'm curious as to why an individual would hold an individual bond that went down in value, but not a bond fund. I would have thought someone who watched the ups/downs & couldn't take the risk would react the same in either case. Can someone help me see the distinction?

Keep in mind that part of the drag with funds is having some 'cash' to handle redemptions. Actually when a market such as bonds is falling, it isn't a drag but a help. Some funds handle 'forced' sales better than others as a result.

But I think there are some key points missing. I'm not at all sure that the bond would be bought back, but assuming it was it doesn't seem to fit the scenario. By the price going up, the yield would go down...but situation is supposedly rising rates? And depending upon how much time has passed, it will be at a different place on yield curve anyway & so not really same risk, etc. Also, how much was paid for it originally? When sold, it would have incurred a cap gain/loss that needs to be factored in....

Both bonds & bond funds right now are locking in losses in terms of real return; so I'm not touting either. Whether distributions are re-invested or not matters to overall results.

Point being that details matter & clearly there is lots of confusion on details!

 

[daylatedollarshort]

In that case, those bonds could have been sold for a profit. Carrying them to maturity brings the value down to par value.

And btw, bond funds are holding some of those older bonds too, so if someone has been holding bond funds for awhile, they are doing fine too.

I'm tired of this. I hope others reading this thread understand that a bond fund is comprised of individual bonds. And if you have multiple bonds yourself, you essentially have your own bond fund. Rate increases and declines affect both similarly, though not identically. There is no magic about holding a bond to term that somehow makes it superior. The overall value of a bond or bond fund is based on how much you pay, how much interest you get over time, and how much you sell when you sell or keep it to maturity, all considering time value of the money in these events. You're not finding an extra pot of gold at the end of the bond term.

I'm out.

The people that sold their bond funds early in the year avoided up to 11% losses and may be making 3% or more on one year Treasuries with no further principal loss. One can always rebuy the bond fund if rates go down lower than the bond fund yields and be able to buy more shares than those that stayed in the funds. It is simple math, explained in The Bond Book by Annette Thau regarding bond funds lack of maturity dates and addressed in the Kiplinger link earlier in the thread. I've laid out the math previously with Investor A and Investor B examples in previous threads and to date no one has provided a math counter example, including this thread.

 

[Freedom56]

Regarding sections I bolded...

I'm curious as to why an individual would hold an individual bond that went down in value, but not a bond fund. I would have thought someone who watched the ups/downs & couldn't take the risk would react the same in either case. Can someone help me see the distinction?

The same reason why a CD investor holds a brokered CD if the price falls. The coupon is fixed and it pays back 100% at maturity. Bonds are not stocks. Bonds have a par value. Bond funds don't have a choice when they sell a bond at a loss to satisfy redemptions. Also most individual bond investors would not buy a 5 year note\bond with a coupon of 0.55% at or above par. However bond funds (like BND) do just that. In fact, if you look at the holdings of BND you will find the Apple 0.55% 2025 notes in the portfolio. The BND ETF is holding so much low coupon debt, that it is doomed in a rising rate environment.

 

[OldShooter]

... Best source for expense is the annual/semi-annual report. ...

The most important trading expense is sometimes called "market impact." You won't find it written down anywhere. As soon as a whale starts taking a position, there is the near-certainty of front runners. Also, simple supply and demand causes the price paid or price received to move negatively for the whale. There's really no way to know the magnitude of market impact cost but clearly it is there and the bigger the fund, the bigger the positions, and the bigger the cost. High turnover hurts, too, of course. For equities I have seen it estimated at 1 or 2 percent.

I can't find it now but I remember reading a description of DFA's trading strategy. Basically it is to move in and out of positions oportunistically over relatively long periods, like weeks. They nibble away at the position, trying to hide the fact that a whale is involved. It makes a good story. How well it works, only DFA knows.