What would a complete bond fund meltdown look like?

[lawman]

Like others here I have suffered deep losses to bond funds. I better understand why that has happened now. Don't know if I'll ever buy a bond fund again but realize for me personally my interest off C.D's and treasuries will be lower than my dividends from my bond funds. I guess I'm willing to make less in order to avoid possible losses to share prices..All this had me thinking just what would it look like if a bond fund was hit with more redemptions from investors than the fund could handle..It seems that someone is going to be the last man standing when the music stops because someone will be left holding very bad bonds. What would that look like for those who choose to ride this out and remain in the funds in the event of a big run on funds?

 

[Bergamo]

Like others here I have suffered deep losses to bond funds. I better understand why that has happened now. Don't know if I'll ever buy a bond fund again but realize for me personally my interest off C.D's and treasuries will be lower than my dividends from my bond funds. I guess I'm willing to make less in order to avoid possible losses to share prices..All this had me thinking just what would it look like if a bond fund was hit with more redemptions from investors than the fund could handle..It seems that someone is going to be the last man standing when the music stops because someone will be left holding very bad bonds. What would that look like for those who choose to ride this out and remain in the funds in the event of a big run on funds?

The yield on the 1 year T bill is higher than the distribution yield on TBM. Are you sure your income from Treasuries or CDs will lower than your dividends from your bond funds?

 

[TheWizard]

How can a legitimate bond fund have more redemptions than it can handle? Not possible.

Now as a fund shrinks down to a few percent of the asset size it used to be, the fund expense ratio would increase.
But at some point, management would either disband the fund or merge it into a similar but healthier one...

 

[lawman]

How can a legitimate bond fund have more redemptions than it can handle? Not possible.

Now as a fund shrinks down to a few percent of the asset size it used to be, the fund expense ratio would increase.
But at some point, management would either disband the fund or merge it into a similar but healthier one...

What are the chances share price would drop say 80% or 90%?

 

[lawman]

The yield on the 1 year T bill is higher than the distribution yield on TBM. Are you sure your income from Treasuries or CDs will lower than your dividends from your bond funds?

Here is a fund I still own..https://www.pimco.com/en-us/investments/mutual-funds/income-fund/inst

Distribution yield is 4.42% and SEC yield is 4.17%

 

[Freedom56]

Bonds are debt instruments between a holder and issuer. The coupon payments are a contractual unless a company defaults.

Bond funds are not proxies for bonds period. Any financial adviser or self proclaimed expert who says otherwise don't understand bonds. A bond in 99% of cases has a finite life and pays a fixed for the term and then the capital is payed back back and it ceases to exist. Bond funds are pooling these bonds with finite lives into perpetual investment vehicles. When bond funds are liquidating, the unusual drops in individual bond prices are temporary and they soon recover while the bond fund may never recover. There are many deep pocketed investors and institutions who are waiting for fund liquidation events to pick up assets at discounts. The problem for bond funds today are:

- The distributions yields are too low relative to CDs and treasuries that have no capital risk
- They are holding too much low coupon debt that they will have to liquidate at steep losses as redemptions occur.
- Money will not flow into these funds until their distribution yields are higher than risk free treasuries and CDs.

Ask yourself why would a sane investor flow money into a fund like VBTLX that has a distribution yield of 2.27% when you can buy a CD or treasury at much higher yields with zero risk to your capital? Since October 2021 though May 22 the distribution yield has only risen from 1.83% to 2.27%. They yield would have to approach 5% to attract fund flows in todays rate environment.

https://investor.vanguard.com/investment-products/mutual-funds/profile/vbtlx

 

[mathjak107]

Here is a fund I still own..https://www.pimco.com/en-us/investments/mutual-funds/income-fund/inst

Distribution yield is 4.42% and SEC yield is 4.17%

Including all interest it is down about 10% ytd.

About half the fund is in BBB OR WORSE

while BBB is still investment grade it is the most riskiest part of the bond market .

It is the last rung of investment grade ..any slip in credit from a downturn and those bonds have to be dumped by every fund , insurer , bank and institutions who can only hold investment grade stuff with few takers .

Be careful with this fund …for a fund with a short term duration figure it has certainly been beat up

 

[mathjak107]

Bonds are debt instruments between a holder and issuer. The coupon payments are a contractual unless a company defaults.

Bond funds are not proxies for bonds period. Any financial adviser or self proclaimed expert who says otherwise don't understand bonds. A bond in 99% of cases has a finite life and pays a fixed for the term and then the capital is payed back back and it ceases to exist. Bond funds are pooling these bonds with finite lives into perpetual investment vehicles. When bond funds are liquidating, the unusual drops in individual bond prices are temporary and they soon recover while the bond fund may never recover. There are many deep pocketed investors and institutions who are waiting for fund liquidation events to pick up assets at discounts. The problem for bond funds today are:

- The distributions yields are too low relative to CDs and treasuries that have no capital risk
- They are holding too much low coupon debt that they will have to liquidate at steep losses as redemptions occur.
- Money will not flow into these funds until their distribution yields are higher than risk free treasuries and CDs.

Ask yourself why would a sane investor flow money into a fund like VBTLX that has a distribution yield of 2.27% when you can buy a CD or treasury at much higher yields with zero risk to your capital? Since October 2021 though May 22 the distribution yield has only risen from 1.83% to 2.27%. They yield would have to approach 5% to attract fund flows in todays rate environment.

https://investor.vanguard.com/investment-products/mutual-funds/profile/vbtlx

Why ?

Because when the economy starts to slip and recession is in the cards watch how long term treasuries soar ….

A one point drop in long term rates can see a 25-30% increase .

If you think stocks are hard to time , try and time your way in to long treasuries

 

[Bergamo]

Here is a fund I still own..https://www.pimco.com/en-us/investments/mutual-funds/income-fund/inst

Distribution yield is 4.42% and SEC yield is 4.17%

High risk also. Look at the holdings. I personally would not hold that fund.

 

[Bergamo]

Bonds are debt instruments between a holder and issuer. The coupon payments are a contractual unless a company defaults.

Bond funds are not proxies for bonds period. Any financial adviser or self proclaimed expert who says otherwise don't understand bonds. A bond in 99% of cases has a finite life and pays a fixed for the term and then the capital is payed back back and it ceases to exist. Bond funds are pooling these bonds with finite lives into perpetual investment vehicles. When bond funds are liquidating, the unusual drops in individual bond prices are temporary and they soon recover while the bond fund may never recover. There are many deep pocketed investors and institutions who are waiting for fund liquidation events to pick up assets at discounts. The problem for bond funds today are:

- The distributions yields are too low relative to CDs and treasuries that have no capital risk
- They are holding too much low coupon debt that they will have to liquidate at steep losses as redemptions occur.
- Money will not flow into these funds until their distribution yields are higher than risk free treasuries and CDs.

Ask yourself why would a sane investor flow money into a fund like VBTLX that has a distribution yield of 2.27% when you can buy a CD or treasury at much higher yields with zero risk to your capital? Since October 2021 though May 22 the distribution yield has only risen from 1.83% to 2.27%. They yield would have to approach 5% to attract fund flows in todays rate environment.

https://investor.vanguard.com/investment-products/mutual-funds/profile/vbtlx

The distribution yield has only risen from 1.83% to 2.27%. Is that because the fund cannot replace the old bonds as quickly as needed?

 

[Bergamo]

Why ?

Because when the economy starts to slip and recession is in the cards watch how long term treasuries soar ….

A one point drop in long term rates can see a 25-30% increase .

If you think stocks are hard to time , try and time your way in to long treasuries

VBTLX is an intermediate term fund not long term Treasury fund.

 

[mathjak107]

Oops ,yes , I was thinking of VGLT .

shows you how little attention I pay to most vanguard stuff

 

[copyright1997reloaded]

What are the chances share price would drop say 80% or 90%?

That's a huge drop and would likely only happen if a large part of corporate America became insolvent. Your bond fund would be the least of your problems.
(ETA/Correction: I suppose this could also be a result of a hyper-inflation happening. I personally do not own any long term bonds with the exception of iBonds/TIPS.)

HOWEVER, as Freedom noted: Bond funds own bonds. If said bond fund gets a lot of redemptions, they MUST SELL bonds to fund the redemptions. Them selling lots of bonds may result in much lower bids (or even in illiquid markets "no-bid" kinds of situations). Thus, if there are lots of redemptions going on across multiple very large bond funds, the prices obtained when they sell will be quite poor (and the NAV will drop to reflect that).

Freedom's method (which I admire and which I wish I were skilled at doing) is to look for these times of craziness where the large bond funds are kicking out positions because they have redemptions...and placing bids for these instruments which would normally be below market value.

 

[Magus]

Like others here I have suffered deep losses to bond funds. I better understand why that has happened now. Don't know if I'll ever buy a bond fund again but realize for me personally my interest off C.D's and treasuries will be lower than my dividends from my bond funds. I guess I'm willing to make less in order to avoid possible losses to share prices..All this had me thinking just what would it look like if a bond fund was hit with more redemptions from investors than the fund could handle..It seems that someone is going to be the last man standing when the music stops because someone will be left holding very bad bonds. What would that look like for those who choose to ride this out and remain in the funds in the event of a big run on funds?

We've had a 40-year downtrend in bond yields so very few today have dealt with the current situation. It basically works like this:

Let's say a US Treasury Bond has a face value of $1000 and has a 1% coupon, and matures in say 30 years. The basic math on that is you'll get $10 a year for 30 years and then in 30 years you'll get your $1,000 back. That works out to a total payment of $1,300. Let's say its trading at par (face value).

Now tomorrow, interest rates have jumped to 3%! All new treasury bonds with 30 year maturities are issued at a face value of $1,000 and a 3% coupon, or $30 a year. That works out to a total payment by the government over 30 years of $1,900 (3% * 1000 = $30 * 30 years + face value).

You can probably tell the situation already even if you can't calculate the value. The new bonds issued today are going to generate $600 more in interest over the next 30 years than your bond. So if you want to sell your bond, you have to sell it a significant discount to face value. In fact, in this example, you'd have to sell for close to $600, or nearly 40% below face value, to keep the yield to maturity at 3%, in line with the new bonds.

The longer the bond duration, the more at risk its principal value is due to fluctuations in interest rates. Shorter duration bonds have less risk and t-bills have extremely little face value risk.

Now - you personally might still be OK sitting on that treasury bond at 1% and just holding it to maturity rather than take a huge loss today. Unfortunately, the bond fund must mark to market. For most of the last 40 years, it's gone the other direction so bond gains were over-stated.

 

[lawman]

That's a huge drop and would likely only happen if a large part of corporate America became insolvent. Your bond fund would be the least of your problems.
(ETA/Correction: I suppose this could also be a result of a hyper-inflation happening. I personally do not own any long term bonds with the exception of iBonds/TIPS.)

HOWEVER, as Freedom noted: Bond funds own bonds. If said bond fund gets a lot of redemptions, they MUST SELL bonds to fund the redemptions. Them selling lots of bonds may result in much lower bids (or even in illiquid markets "no-bid" kinds of situations). Thus, if there are lots of redemptions going on across multiple very large bond funds, the prices obtained when they sell will be quite poor (and the NAV will drop to reflect that).

Freedom's method (which I admire and which I wish I were skilled at doing) is to look for these times of craziness where the large bond funds are kicking out positions because they have redemptions...and placing bids for these instruments which would normally be below market value.

I wish I were knowledgeable enough about corporate bonds that I could confidently buy them by placing bids. All I can do is buy what Schwab offers which is nothing near the YTM that Freedom is able to get on any given CUSIP . Besides that I am unable to know what is low risk and what is high risk. I'm just not comfortable assuming much risk..

 

[Magus]

I wish I were knowledgeable enough about corporate bonds that I could confidently buy them by placing bids. All I can do is buy what Schwab offers which is nothing near the YTM that Freedom is able to get on any given CUSIP . Besides that I am unable to know what is low risk and what is high risk. I'm just not comfortable assuming much risk..

For < under 5 years, the spread between investment grade corp and US Treasury bonds is extremely small - just buy individual US treasury bonds - sweet spot is 6 months to 2 years currently.

 

[lawman]

You can probably tell the situation already even if you can't calculate the value. The new bonds issued today are going to generate $600 more in interest over the next 30 years than your bond. So if you want to sell your bond, you have to sell it a significant discount to face value. In fact, in this example, you'd have to sell for close to $600, or nearly 40% below face value, to keep the yield to maturity at 3%, in line with the new bonds.

QUOTE]

That's why it doesn't seem beyond the realm of possibilities that you could see a fund NAV down a HUGE amount.

 

[Magus]

That's why it doesn't seem beyond the realm of possibilities that you could see a fund NAV down a HUGE amount.

Yes, especially for long duration bond funds. It can go the other direction, though, especially if Freedom is right on deflation concerns coming (I don't think so but it is a possibility depending on how long and deep the fed goes here)

 

[lawman]

For < under 5 years, the spread between investment grade corp and US Treasury bonds is extremely small - just buy individual US treasury bonds - sweet spot is 6 months to 2 years currently.

That's what I have been doing the last two weeks except I've been staying shorter term than that in hopes that as they mature I will have good opportunity to lock in some decent returns for 4 - 5 years.

 

[daylatedollarshort]

That's why it doesn't seem beyond the realm of possibilities that you could see a fund NAV down a HUGE amount.

That is why some of us having been posting about the issues with bond funds for months now, despite the plethora of "market timer" comments.

 

[daylatedollarshort]

Ask yourself why would a sane investor flow money into a fund like VBTLX that has a distribution yield of 2.27% when you can buy a CD or treasury at much higher yields with zero risk to your capital?

This is the the issue at hand in a nutshell.

 

[lawman]

This is the the issue at hand in a nutshell.

I'm new to treasuries..Is it normal for treasuries to have higher yields than investment grade corporates? If no, why is it and will it last?

 

[Magus]

I'm new to treasuries..Is it normal for treasuries to have higher yields than investment grade corporates? If no, why is it and will it last?

Historically no, but when the US lost its AAA rating and some companies that historically had no debt, sitting on massive amounts of cash and generating huge amounts of cash and rates AAA (like Apple), it has happened from time to time in the last decade. Spreads between treasuries and various types and ratings of corp debt is one of the things the bankers give myself and our CFO updates on a lot as we consider our debt stack today and going forward. You can end up with some really unusual circumstances when the bond market has financial distress.

An example is Extended Stay Americas 2025 bonds at 5.25% coupon traded down to about 65 cents on the dollar or 13+% YTM maturity in April 2020 even though it’s debt outstanding was half what the company sold for in bankruptcy in 2010 with much lower peak Ebitda and the company was barely losing cash flow even without cutting capex or opex and still was running 60% occupancy (vs industry at 8%). By August the bonds were back to 98 cents on the dollar and they only had 2 months of negative cash flow and were trading 100 by early the next year. Blackstone financed twice that debt outstanding last summer on their take private at 2.5% fixed with 6 year CMBS with bank swap on libor.

 

[daylatedollarshort]

I'm new to treasuries..Is it normal for treasuries to have higher yields than investment grade corporates? If no, why is it and will it last?

I've usually seen Treasuries lower than everything else. Since Treasuries are considered the safest from default, the private offering yields usually have to be higher for the same maturities. I don't recall ever seeing even FDIC insured CDs being offered at lower yields than Treasuries before. I never bought short term Treasuries until this year.

I believe this is the reason why Treasuries are higher right now: "When Treasury yields are rising, banks are often slow to adjust CD rates, and so they may offer a lower rate than Treasurys,” says Mirabile. Banks use CDs and other deposits to fund loans and investments in Treasurys, so the lower the rate they pay, the more they profit." https://www.forbes.com/advisor/banking/cds/cd-rate-forecast/

Treasuries offered at auction get market rates current as of that hour, while banks have to prepare new CD offerings in advance. Plus old habits die hard. Banks are probably going to make money off people used to buying CDs for some time. You'd have to be a on a forum like this or watch the yield sites to realize Treasuries were paying more now. I don't buy corporate bonds but I suspect the same issues are at play.