Managed Bond Funds rather than Index Bond Funds?

[ziggy29]

When there's a flight to cash, bond funds must sell low, right? Like Freedom and others, I'm not a fan of bond funds. After the bond fund in my 401k didn't zag when the market zigged, I called BS on that whole idea and haven't held a bond fund since.

That was the conventional wisdom, that bonds "diversify". For the most part, in the near-meltdown of 2008, that didn't happen much; at best bond funds simply fell *less* than equities. The exception, of course, was funds which exclusively held Treasuries, which rallied. But corporates were deeply in the red.

 

[audreyh1]

That was the conventional wisdom, that bonds "diversify". For the most part, in the near-meltdown of 2008, that didn't happen much; at best bond funds simply fell *less* than equities. The exception, of course, was funds which exclusively held Treasuries, which rallied. But corporates were deeply in the red.

Your “at best” statement is not true. There were bond funds that went up quite a bit during the 2008 crisis - the bond funds that held a lot of very high quality credit such as funds that held mostly treasuries like VFIUX.

I know a lot of people got the impression that all bond funds went down in 2008, but that is simply not true. Sure, quite a few well respected core bond funds did go down. But there were funds that behaved well because they held a lot of government backed debt, bond index funds among them. VBMFX is a good example.

The moral of the story is: if you want your bond fund to behave well during a crisis, then invest in one that holds very high quality bonds. People tend to drift away from these types of bond funds because they don’t yield as much overall. But you are sacrificing a small amount of yield for safety. Make the choice consciously - don’t just be seduced by the highest yielding bond fund.

 

[samclem]

The moral of the story is: if you want your bond fund to behave well during a crisis, then invest in one that holds very high quality bonds. People tend to drift away from these types of bond funds because they don’t yield as much overall. But you are sacrificing a small amount of yield for safety. Make the choice consciously - don’t just be seduced by the highest yielding bond fund.

There are even folks who adjust the types of bonds/bond funds they hold in response to the stock market valuations (P/E10, etc). Historically, when stocks are "highly valued" (or "overpriced"), when they eventually fall there is frequently a "flight to quality" that helps bid up the price of govt bonds. When stocks are more moderately priced and the dips are less severe, quality corporate bonds are sufficient diversifiers and the higher interest they pay is worth getting.
Adjusting the types of bonds in my (slim) bond holdings based on stock valuations is more trouble than I'd want to take, but some folks do it and history shows it does improve risk-adjusted returns. Not every time, or even every decade, though.

 

[ziggy29]

There are even folks who adjust the types of bonds/bond funds they hold in response to the stock market valuations (P/E10, etc). Historically, when stocks are "highly valued" (or "overpriced"), when they eventually fall there is frequently a "flight to quality" that helps bid up the price of govt bonds. When stocks are more moderately priced and the dips are less severe, quality corporate bonds are sufficient diversifiers and the higher interest they pay is worth getting.

Yes. To a very large degree, even high quality corporates fell, often considerably, in 2008. But in just about all other bear markets I can recall, they rallied along with Treasuries. In most bear markets, unless the bear is accompanied by significantly rising interest rates, it's junk bonds that suffer.

 

[audreyh1]

There are even folks who adjust the types of bonds/bond funds they hold in response to the stock market valuations (P/E10, etc). Historically, when stocks are "highly valued" (or "overpriced"), when they eventually fall there is frequently a "flight to quality" that helps bid up the price of govt bonds. When stocks are more moderately priced and the dips are less severe, quality corporate bonds are sufficient diversifiers and the higher interest they pay is worth getting.
Adjusting the types of bonds in my (slim) bond holdings based on stock valuations is more trouble than I'd want to take, but some folks do it and history shows it does improve risk-adjusted returns. Not every time, or even every decade, though.

IMO that type of timing is too difficult. IMO - flights to quality tend to be sudden and sharp.

Most folks are rebalancing anyway. So if the bond fund is lagging a bit while stocks are running up - no matter, when you rebalance you'll buy a bit more of your "safety net".

Personally, if I want to be a bit more aggressive about my total return, I thinks it's better to hold a bit more in equities than try to hold higher yielding bond funds.

 

[audreyh1]

Yes. To a very large degree, even high quality corporates fell, often considerably, in 2008. But in just about all other bear markets I can recall, they rallied along with Treasuries. In most bear markets, unless the bear is accompanied by significantly rising interest rates, it's junk bonds that suffer.

I know that a lot of people like high quality corporates and may choose to hold only them for the higher yield. But one of the things that happens during a harsh bear market is that spreads widen, so corporates don’t see the rally that treasuries do, and may even be punished like they were in 2008. 2002 had a “credit crunch” type financial crisis as well due to several corporate accounting scandals. You never know. 2008 was definitely the worst, but I think it was a good lesson in terms of what behaves well versus poorly when TSHTF.

 

[Freedom56]

When there's a flight to cash, bond funds must sell low, right? Like Freedom and others, I'm not a fan of bond funds. After the bond fund in my 401k didn't zag when the market zigged, I called BS on that whole idea and haven't held a bond fund since. That was 18 years ago. And I was working, so the bond percent was small. Since then, I've owned individual bonds, mostly tips. And now I've got the bond portion in a guaranteed income fund. What I realize is that a lot of what happens on the bond side is about what the custodian offers.

Investors buy bonds in companies with a future, for stable, reliable income, and they want to know that they'll get their principal back. You don't get that with bond funds, and you pay ongoing expenses. People are going to soon realize the risks associated with bond funds , especially passive ones. CDs are a better alternative to passive bond funds.

The next few years will be like navigating through a minefield as many corporations have to de-leverage at the expense of equity holders. Many companies will default as their operating income will not cover their interest income (primarily energy, and retail sectors). Passive equity and bond funds will not protect investors from those risks.

This is coming from the guy that stated one year ago that the economy would slow down and rates would begin to invert.

I have attached some data that I monitor from Moody's Analytics with respect to CDS (Credit Default Swaps).

 

[scrabbler1]

Back in late November of 2008, just after I retired and bought a huge number of shares in a corporate bond fund at rock-bottom prices, I came across an article in the WSJ which I happened to save in a Word file. The author, Michael Aneiro, explained that a big reason for the big drop in bond prices was the huge decline in investor demand, as opposed to the credit worthiness of the issuers. While the article was mostly about the muni bond market and its effects on state and local governments, a lot of it pertained to the bond market in general.


This decline in investor demand was a huge break for me as I began my ER because I was able to buy about 25% more shares of my chosen (managed) bond fund, and those added shares have been paying me an extra monthly dividend every month for the last 10 years.


The bond market recovered in 2009 as market conditions, including investor demand, improved.


(The article is about 1,000 words. Is it too large to post?)

 

[statsman]

Back in late November of 2008, just after I retired and bought a huge number of shares in a corporate bond fund at rock-bottom prices, I came across an article in the WSJ which I happened to save in a Word file. The author, Michael Aneiro, explained that a big reason for the big drop in bond prices was the huge decline in investor demand, as opposed to the credit worthiness of the issuers. While the article was mostly about the muni bond market and its effects on state and local governments, a lot of it pertained to the bond market in general.

This decline in investor demand was a huge break for me as I began my ER because I was able to buy about 25% more shares of my chosen (managed) bond fund, and those added shares have been paying me an extra monthly dividend every month for the last 10 years.

The bond market recovered in 2009 as market conditions, including investor demand, improved.

(The article is about 1,000 words. Is it too large to post?)

Attachment?

 

[scrabbler1]

Attachment?

I don't know how to include an attachment to a post here, sorry.

 

[friar1610]

Before I retired I decided that I was not going to buy any individual stocks/securities except the occasional CD, Treasury or iBond which are super easy.

This was simply because I was not interested in doing and maintaining the research during retirement. I wanted my retirement portfolio to be very low maintenance, one that I could ignore for a whole year if I wanted to. Just occasionally rebalance, preferably no more than annually: run off and enjoy retirement and ignore investments for months at a time.

I certainly understand that many folks do like buying individual securities and managing their own individual stocks and bonds. I just had a different goal.

We have more than the "occasional" CD/I-Bond in the fixed income allocation
of our retirement portfolio but, those aside, I totally agree with the index fund approach to bond investing. At 73, I'm becoming more and more convinced of the wisdom of a liability matched portfolio composed of CDs, I-Bonds and a mix of VG Total Bond Index and VG Short-Term Index funds to cover X years of living expenses over and above my pension and our SS. In addition, my wife, although very smart, was not blessed with the investment gene. Having VG handle the bonds will make life easier for her if I precede her in going to that great bond market ine sky. Paying their low expense ratios is worth evert cent to me.

 

[Spock]

Observations that keep me out of bond funds:
* rate skews/compression by central banks actively manipulating markets and creating financial zombies.

* I've seen way too many companies leverage up on debt just to pay the dividends and to do share buy backs. Smart for while rates are low, but neither of which is an investment that will generate future income to pay back those bonds.


* "Investment grade" means nothing any more. After the financial crisis all of the rating agencies copped out in front of congressional hearings stating "our rating is an opinion protected by free speech" they can't be held accountable if the rating is wrong. And the 2008 crash showed just how wrong the ratings were.

* Just about every supposedly non-junk bond fund I peek at has something like an Illinois or GE or PG&E splattered some where in the top holdings. The music stops faster than the rating agencies dance.



* Way too many articles on "IG" grade companies that are hair width away from junk ratings in the next recession... none of which is reflected in the rating outlook.

* and it not just perma-bear biased sites

https://www.cnbc.com/2018/10/07/things-getting-stormier-for-investment-grade-bonds.html

Investment grade is also not what it used to be. There is widespread concern that the sheer volume of debt issued by investment-grade companies since the financial crisis could be a problem when the economic cycle turns. Corporate investment-grade bonds now total roughly $6 trillion, versus just $2 trillion before the financial crisis. Some of that is a result of economic growth, but corporate leverage by all measures is much higher than it was in the last cycle.
...
The ratings distribution of the market is also far more skewed to the lower end of the scale. There are only two corporate issuers in the United States — Microsoft and Johnson & Johnson — rated AAA, and bonds rated BBB, the lowest rating of the investment-grade market, account for 50 percent of the Bloomberg Barclays investment-grade bond index, versus 38 percent prior to the financial crisis.

Let that soak in... only TWO AAA corp bond issuers in the US??


https://www.nytimes.com/2018/07/13/business/riskier-to-own-high-quality-corporate-bonds.html

The other noteworthy shift in investment-grade corporate bonds is a deterioration in overall quality. In 2007, 27 percent of the total value of bonds issued by companies in the Standard & Poor’s 500-stock index were rated BBB, the lowest rung of investment grade. Today, 50 percent of the market value of S.&P. 500 bonds have that rating.

I guess at the end of the day I've probably become too cynical to have much trust in the markets any more. 11 years post crisis and the economy still has a heart attack when rates get much above 0... ECB is still NIRP!. Until the economy does some laundry, I'll just sit here under my rock wearing the cleanest dirty shirt in the hamper: USTs and CDs.

 

[COcheesehead]

The deflault rate on high investment grade bonds is close to 0.1% a year. High yield or junk is close to 4.22%. Stay out of junk and you’ll do fine. Buy the bond, not a fund. There is no free lunch. Diversify and have a cushion. If risk bothers you, buy CD’s.

 

[OldShooter]

I don't really have a dog in the fight, but to observe that "In 2007, 27 percent of the total value of bonds issued by companies in the Standard & Poor’s 500-stock index were rated BBB, the lowest rung of investment grade. Today, 50 percent of the market value of S.&P. 500 bonds have that rating." may be more indicative of rating agencies getting tougher than of a deterioration of credit quality. The agencies got shot up pretty bad for overly-optimistic ratings after 2007 and a normal human reaction would be to tighten up. CYA IOW.

 

[Marc]

My Fido rep recommended the same thing about 3 years ago. However he was trying to sell me on Fido managing the individual bonds. With a fee. I took another path and simply set up a large CD ladder for this portion. Expenses - nil.

In the future I'll continue to evaluate but will probably use some of the maturing CD's to DCA into FXNAX total bond fund with an ER of .025. If you want to juice the returns simply add in a small amount (10-15% total) of high yield and emerging market funds and you'll match the managed funds such as FTBFX. Vanguard has a couple relatively low cost managed funds in these categories.

Met with my FIDO rep and he recommended the same; not a path I want to take. A question about creating a bond ladder. Most descriptions of setting up bond (or CD) ladder involves establishing a number of rungs (e.g., five) of varying durations and then replacing each of the rungs with bonds or CDs of the longest duration when each matures. In my situation I have over 1.4M in a couple of fidelity bond funds. What if I took $100K out and purchased 10 different 10 year bonds (diversifying both over companies and industries). Then, a year from now, I again take $100K out and buy 10 more bonds; and so on. Why take our $1M now putting 20% of it in very short term bonds when I am already diversified in a total bond and corporate bond fund?

BTW, the $1 fee for fidelity bond funds is really only true for new bonds; I imagine additional fee will be found in the spread on bonds purchased on secondary market.

thanks,

Marc

 

[COcheesehead]

Met with my FIDO rep and he recommended the same; not a path I want to take. A question about creating a bond ladder. Most descriptions of setting up bond (or CD) ladder involves establishing a number of rungs (e.g., five) of varying durations and then replacing each of the rungs with bonds or CDs of the longest duration when each matures. In my situation I have over 1.4M in a couple of fidelity bond funds. What if I took $100K out and purchased 10 different 10 year bonds (diversifying both over companies and industries). Then, a year from now, I again take $100K out and buy 10 more bonds; and so on. Why take our $1M now putting 20% of it in very short term bonds when I am already diversified in a total bond and corporate bond fund?

BTW, the $1 fee for fidelity bond funds is really only true for new bonds; I imagine additional fee will be found in the spread on bonds purchased on secondary market.

thanks,

Marc

It’s a $1 per bond no matter what at Fido. You can decide if the spread is to your liking. You can also enter an ask of your choice and see if it fills.

 

[Montecfo]

The standard investment advice is to take risk on the equity side, not fixed income.

Which is easier to follow currently since there seems to be little premium for investment-grade corporate vs. government.

So following this theory do you invest your bond allocation in US government bonds only?

 

[Spock]

I don't really have a dog in the fight, but to observe that "In 2007, 27 percent of the total value of bonds issued by companies in the Standard & Poor’s 500-stock index were rated BBB, the lowest rung of investment grade. Today, 50 percent of the market value of S.&P. 500 bonds have that rating." may be more indicative of rating agencies getting tougher than of a deterioration of credit quality. The agencies got shot up pretty bad for overly-optimistic ratings after 2007 and a normal human reaction would be to tighten up. CYA IOW.

Quite possible.
But IF I'm reading this right, it sounds as though the IGs are "in it" (net leverage) a lot deeper than they used to be. (the graphs in the article speak better than the quoted txt). Again I could be reading it wrong, but if anything it sounds from this 1 article, the rating standards have gone down, not up.

https://www.pimco.com/en-us/insight...-grade-credit-be-actively-aware-of-bbb-bonds/

Back in 2000, net leverage of BBB rated nonfinancial corporates was 1.7x on average; in 2017, net leverage for these companies was 2.9x ...<snip>
This suggests a greater tolerance from the credit rating agencies for higher leverage, which in turn warrants extra caution when investing in lower-rated IG names, especially in sectors where earnings are more closely tied to the business cycle.
The higher leverage among U.S. investment grade issuers should also be seen in context: Back in 2010, only 6.6% of the IG nonfinancial market had net leverage greater than 4.0x, but as of 2017, that share increased to 19% (see Figure 2). In addition, only 26% of IG nonfinancial debt is leveraged less than 2.0x as of 2017, compared with 55% in 2010.

 

[OldShooter]

Agreed. From the graphs in the article it looks like my speculation is not a good guess. But there is some arm waving in the text, too, that I'm really not interested in working to parse. After all, it's a piece of sales literature, as everything below "Beware fallen angel risk" makes clear.

Would someone else have emphasized the safety represented by the interest coverage ratios and would someone else have graphed the more comforting average net-debt-to-enterprise values? I also wonder what graphs of debt-to-book (is that "enterprise value?") and debt-to-market cap would look like. I'm too lazy to figure it out, though.

The credo of their sales pitch is that buying riskier fixed income instruments makes fund management more important has always made sense to me. Junk and foreign debt come to mind as justifying fees. Buying US govvies does not. But since I avoid significant risk on the fixed income side of our AA, I don't need the managers. Mostly we're in TIPS, but a few months ago we did bail out of a leveraged loan fund that had been quite successful until recently, based on Janet Yellen's and The Economist's advice that these loans were getting risky.

Thanks for the link. I've never been much of a bond guy but hanging around here is helping.

 

[Montecfo]

In my view you want management of your bond portfolio, not an index tied to the AGG. A bond index is very different than a stock index. A stock index usually is composed of high quality, successful companies primarily, and is usually capitalization-weighted. So the more valuable a company, the heavier the weighting in the index.

Debt indexes, OTOH, are composed of obligations of the largest debt issuers. it is really the opposite of finding the best value. And over time the index drifts typically to longer duration and lower credit quality. I do not want to passively be buying lower quality, larger issuers and variable duration, particularly late in the cycle.

Within my bond/FI portfolio, I have treasuries, CDs, short and mid-term bond funds. My mid-term bond funds have beaten the AGG over virtually all periods. Check out DODIX and DLNTX. I also hold a unique short-term bond fund, RPHIX.

The best thing to own in a market swoon is US treasuries. They will usually rally then but lag badly at all other times. But if protection in a market swoon is your 100% priority, then I would suggest s treasury ladder.