Is The Carnage Mostly Over For Bond Funds?

[Midpack]

VBLTX (broad example) paid dividends throughout, looks like the NAV bottom was last Nov, and has significantly outperformed Treasuries, CDs and most bonds 4Q22 and 1Q23. Same is true for ST & IT Invest Grade and IT Tax Exempt (I used to own them all). Wonder if the worst of it is over?

 

[statsman]

I bailed on our long-held bond funds in the middle of the 3rd quarter in 2022. It appears the bond funds have recovered close to the point where we exited the funds (when including the dividends). We're still ahead a bit because of the move to money markets and treasuries for the last 7+ months, but I sense that advantage may not hold for much longer.

I would have loved to have bought back in during the dip in November, but my nerves were shot. Add to that our only child's wedding in early January, and I figured we had enough on our plate to deal with.

 

[Freedom56]

As long as the yield curve remains inverted, bond funds will perform poorly. Look at distributions paid by short to long term bond funds versus cash. The distribution yields are still pathetic relative to cash in a money market fund. Even the shortest duration bond funds have not been able to increase their distributions to keep pace with short term CDs, treasury bills, and money market funds or even FDIC insured savings account deposits at banks. If many banks are sitting on losses due to investments in coupon debt, why would anyone buy a fund bloated with similar debt or worse? A bank can hold the debt to maturity and recover face value of the bank, but the bond fund will sell that debt at a loss when there is a liquidity issue due to redemptions. This is not too different from the SVB faced when it sold bonds at a 10% loss to meet liquidity requirements.

 

[Markola]

It’s undeniable that VBTLX price has been improving for 5 months now. No one knows if the worst is over, of course, but one painful way the yield curve could normalize, helping VBTLX NAVs further, unfortunately, is because the Fed pivots and slashes short term yields to combat a recession.

 

[pb4uski]

As long as the yield curve remains inverted, bond funds will perform poorly. Look at distributions paid by short to long term bond funds versus cash. The distribution yields are still pathetic relative to cash in a money market fund. Even the shortest duration bond funds have not been able to increase their distributions to keep pace with short term CDs, treasury bills, and money market funds or even FDIC insured savings account deposits at banks. If many banks are sitting on losses due to investments in coupon debt, why would anyone buy a fund bloated with similar debt or worse? A bank can hold the debt to maturity and recover face value of the bank, but the bond fund will sell that debt at a loss when there is a liquidity issue due to redemptions. This is not too different from the SVB faced when it sold bonds at a 10% loss to meet liquidity requirements.

Doesn't

...This is not too different from the SVB faced when it sold bonds at a 10% loss to meet liquidity requirements.

Disprove

...A bank can hold the debt to maturity and recover face value of the bank....

?

SVB was a bank and could not hold the debt to maturity and recover face value to meet liquidity requirements caused by a spike in withdrawals.

OTOH, an individual investor can control withdrawals where a bank or bond fund can't. If my bond fund gets a flood of redemptions in excess of new money they will need to sell bonds at a loss to satisty the redemptions and I participate in that loss whether I want to or not.
Whereas with a ladder I would not incur that loss unless I have a liquidity event and need the money and need to sell. I prefer the control of the bond ladder all else being equal.

 

[Exchme]

If my bond fund gets a flood of redemptions in excess of new money they will need to sell bonds at a loss to satisty the redemptions and I participate in that loss whether I want to or not.

This would show up as tracking error vs. the index. I've never thought to look for such data, I'd be interested to know where did you find it and how big were the tracking errors?

 

[pb4uski]

I didn't find anything... but if for a period redemptions exceeded new money and liquidity then the fund would have to sell to honor the redemptions, would they not? That's sort of what happened with SVB, right?

 

[Exchme]

I didn't find anything... but if for a period redemptions exceeded new money and liquidity then the fund would have to sell to honor the redemptions, would they not? That's sort of what happened with SVB, right?

Here's an interesting article, apparently there was a bit of a liquidity crunch bond funds in March of 2020.

https://www.etf.com/sections/features-and-news/did-corporate-bond-etfs-exacerbate-panic

 

[big-papa]

I think it's amusing that on the same forum, we can have two different threads: One which discusses the carnage in bonds and the other that discusses how we're in a golden age for bonds.

And of course both are true. It depends on whether the investor is concerned at any point in time about bond/bond fund returns or the interest thrown off by bonds



Cheers

 

[audreyh1]

If my bond fund gets a flood of redemptions in excess of new money they will need to sell bonds at a loss to satisty the redemptions and I participate in that loss whether I want to or not.

This would show up as tracking error vs. the index. I've never thought to look for such data, I'd be interested to know where did you find it and how big were the tracking errors?

Outsized error is not there for 2022. It’s easy to compare bond index funds against their published benchmark and thus how closely they track. Example, FXNAX versus the index benchmark it tracks, the Bloomberg US Aggregate Bond Index. FXNAX has a 0.025% expense ratio and seems to stay within ~+/-0.25% compared to the index performance and ironically for 2022 it’s almost 0. Morningstar table which I had posted on another thread earlier this year.

 

[Out-to-Lunch]

If my bond fund gets a flood of redemptions in excess of new money they will need to sell bonds at a loss to satisty the redemptions and I participate in that loss whether I want to or not.

I think this may not be correct. Isn't it only the ones that cashed out their shares that participate in the loss?

Stupidly simple example: My 2 brothers and I have a bond mutual fund, with three people holding shares. The mutual fund owns only 9 bonds of a particular GE issue. After the value of those GE bonds tanks, one brother panics, and asks to redeem all of his shares. So the fund sells 3 GE bonds, and settles it liability with the brother. The other two brothers are indifferent to what just happened.

Note that this is not the same as the complaint about funds often mentioned here about redemptions and purchases being made in order to keep the duration constant. I don't dispute that.

 

[Chuckanut]

I think this may not be correct. Isn't it only the ones that cashed out their shares that participate in the loss?

Stupidly simple example: My 2 brothers and I have a bond mutual fund, with three people holding shares. The mutual fund owns only 9 bonds of a particular GE issue. After the value of those GE bonds tanks, one brother panics, and asks to redeem all of his shares. So the fund sells 3 GE bonds, and settles it liability with the brother. The other two brothers are indifferent to what just happened.

Note that this is not the same as the complaint about funds often mentioned here about redemptions and purchases being made in order to keep the duration constant. I don't dispute that.

When the bonds go down they go down. The fact they are not sold at that moment is irrelevant. They are still down. If the other two brothers must unexpectedly sell at that time they get the lower price.

My house went down in 2008. I did not sell it and realize the loss but it still was worth less. The county assessor even agreed and knocked $80,000 of the taxable value.

This isn’t like quantum mechanics where an electron can spin clockwise and counter clockwise at the same time. [emoji16]

 

[jazz4cash]

I think this may not be correct. Isn't it only the ones that cashed out their shares that participate in the loss?

Stupidly simple example: My 2 brothers and I have a bond mutual fund, with three people holding shares. The mutual fund owns only 9 bonds of a particular GE issue. After the value of those GE bonds tanks, one brother panics, and asks to redeem all of his shares. So the fund sells 3 GE bonds, and settles it liability with the brother. The other two brothers are indifferent to what just happened.

Note that this is not the same as the complaint about funds often mentioned here about redemptions and purchases being made in order to keep the duration constant. I don't dispute that.

Each bond in the fund's portfolio is owned by all three brothers. If the fund sells a bond at a loss, all shareholders get their portion of the loss. There is no way for the fund to allocate the loss to a particular shareholder. The loss is only recognized when a shareholder sells so that does permit other shareholders that have not sold to ignore the loss, but it is still there.

 

[pb4uski]

It's a little of both since NAV is based on market values. The day before the sale all brothers have unrealized losses because of the decreased value of the bonds reflected in the NAV. When one brother sells, the fund has to sell some bonds to raise the money for the redemption request and the fund realizes the loss and distributes the proceeds to the brother who is redeeming. Assuming no other changes in the bond's fair value that day, the NAV is unchanged as a result of the redemption. Assuming that the bonds are held to maturity and recover then the unrealized loss reverses as the value of the bonds converge to par.

So for the other two brothers... IF they sell then they would have a loss just like the first brother, but if they stay then the unrealized loss will reverse.

The problem is with a real bond fund you have people comming and going all the time.

 

[COcheesehead]

I think this may not be correct. Isn't it only the ones that cashed out their shares that participate in the loss?

Stupidly simple example: My 2 brothers and I have a bond mutual fund, with three people holding shares. The mutual fund owns only 9 bonds of a particular GE issue. After the value of those GE bonds tanks, one brother panics, and asks to redeem all of his shares. So the fund sells 3 GE bonds, and settles it liability with the brother. The other two brothers are indifferent to what just happened.

Note that this is not the same as the complaint about funds often mentioned here about redemptions and purchases being made in order to keep the duration constant. I don't dispute that.

This would be an interesting concept, if only it were true. Sellers lose. Owners win.

 

[RunningBum]

Just because a fund sells a bond doesn't mean that sale is a loss.

 

[foxfirev5]

As time goes by I still see my LMP bond ladder marching in lockstep with my bond funds of similar duration. I force myself to look at market values even though I plan to hold to maturity for my individual bonds. I'm not some big bank that can arbitrarily designate these as HTM - hold to maturity. I actually feel sorry for those who sold funds at a loss to build a ladder for no other reason than a fear of bond fund carnage. But actually it probably doesn't matter that much either way.

FWIW, my bond funds are a small percentage of my FI holding. Like all my holdings they serve a purpose. Currently to rebalance into equities and in the future, as I unroll the ladders, to build a holding that my heirs can manage with little effort.

 

[pb4uski]

Just because a fund sells a bond doesn't mean that sale is a loss.

Probably is a loss these days though... lost of unrealized losses in bond funds.

 

[pb4uski]

As time goes by I still see my LMP bond ladder marching in lockstep with my bond funds of similar duration. I force myself to look at market values even though I plan to hold to maturity for my individual bonds. I'm not some big bank that can arbitrarily designate these as HTM - hold to maturity. I actually feel sorry for those who sold funds at a loss to build a ladder for no other reason than a fear of bond fund carnage.

FWIW, my bond funds are a small percentage of my FI holding. Like all my holdings they serve a purpose. Currently to rebalance into equities and in the future to build a holding that my heirs can manage with little effort.

Actually, if you were doing personal financial statements you could designate certain positions as HTM and account for them at amortized cost just like a business does... the same accounting principles apply.

If someone sold their funds at a loss and used to proceeds to build a similar quality and duration ladder then they should be indifferent... but they are a bit ahead because they have more control. In fact, if it was a taxable account then they would be ahead because of the tax benefit of the loss somewhat offset by higher income going forward.

 

[Out-to-Lunch]

I do not understand many of the reactions.

There may be some semantics about what pb4 meant by "participate" in the loss. My claim is that owners of shares in the fund are unharmed by other owners buying and selling shares. Is this not true?

(They are, of course, harmed by the change in value of the assets that the fund holds, but that is not what I or pb4 were addressing.)

 

[foxfirev5]

Actually, if you were doing personal financial statements you could designate certain positions as HTM and account for them at amortized cost just like a business does... the same accounting principles apply.

If someone sold their funds at a loss and used to proceeds to build a similar quality and duration ladder then they should be indifferent... but they are a bit ahead because they have more control. In fact, if it was a taxable account then they would be ahead because of the tax benefit of the loss somewhat offset by higher income going forward.

So... it probably doesn't matter much either way. I might add that control is only needed if your plan requires it. That's why I have both a ladder and funds. But I do appreciate your highly detailed input.

 

[sengsational]

My claim is that owners of shares in the fund are unharmed by other owners buying and selling shares. Is this not true?

I have maintained that the effect is rather small, but there is an effect that comes from forced selling. When the one brother panics out of his position, the market is hostile to selling, so a little more selling is needed to get him his money. That leaves the other brothers who stay the course with slightly less in the pot. If the timing of the sale was not coincident with a load of other similar activity, there would be no effect of this type, but if suddenly a bunch of people flee to cash, then there aren't enough buyers and the fund isn't getting a good deal when they sell, so, again, need to sell just a smidge more than otherwise in a more balanced market. That's how I think of the disadvantage, anyway.

 

[Freedom56]

Why not look at the 10 year performance of these funds? That should give you a total picture of the "loss sharing" absorbed by many passive index funds.

 

[Rianne]

Why not look at the 10 year performance of these funds? That should give you a total picture of the "loss sharing" absorbed by many passive index funds.

This is why we sold our bond funds. The performance has been dismal for over 10 years. Originally, back in 2013, the thought was 60/40 AA long-term with passive bond funds as a hedge in the tIRA. With 20/20 hindsight, treasury yields were in the 2% range and that's approximately what our bond funds yielded, lower at times. But since the beginning of 2022, it was clear treasuries and CDs were the better choice. Very small loss with the bond fund sell-off and our ladder will easily make up for that and more. Our ladder will take us out for about 5 years at good rates. We'll see from there.

Based on our IRR performance record.

 

[sengsational]

10 years is a somewhat arbitrary duration. I haven't done it, but I would suggest that the analysis is sensitive to the starting point and duration. Maybe find an interest rate curve in history that matches the recent curve, and use that as the starting point.