Whither goes bonds?

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roger r

Recycles dryer sheets
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I've in the process of doing some reorganizing of finances, and I just don't quite understand recent bond fund performance. I'd always thought that in times of falling interest rates, that the NAV of bond funds would go up, but it seems like the opposite has happen? My funds are what I would think of as higher quality, such as VBIIX, some muni funds, and TIPS funds.

I know that market timing even for bonds may not be the best strategy, but normally I might hold off in buying more funds when interest rates seem to be near a historic low. If we are looking at some new rules for this, is there some possibility that NAV will rise when there seems to be some economic recovery, even if interest rates eventually tred upward? Any other best guesses on bond fund prices for intermediate term?

Thanks for the thoughts.
 
roger r said:
I've in the process of doing some reorganizing of finances, and I just don't quite understand recent bond fund performance. I'd always thought that in times of falling interest rates, that the NAV of bond funds would go up, but it seems like the opposite has happen? My funds are what I would think of as higher quality, such as VBIIX, some muni funds, and TIPS funds.
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I am not familiar with your funds. But many bond funds have been falling becasue of credit issues with the underlying securities. In the case of TIPS, they have lost price because of other factors- maybe technical trading factors, maybe changes in real interest rate (although to me that seems a stretch considering how well fixed treasuries have performed.)

Look at each of your funds and try to determine why it has fallen. Then you will have a better understanding of what might happen to it going forward.

Ha
 
Thanks, Roger. I've been meaning to post the same question.

For the purposes of this discussion, consider the VG total bond index fund.
 
There are some great deals in munis. Also, I see a rally in high yield in the next 1-2 years..........
 
My best guess in trying to get a handle on things is that high yields have been pretty beat up due to the risk of defaults? Is this a real risk for future consideration.
 
roger r said:
My best guess in trying to get a handle on things is that high yields have been pretty beat up due to the risk of defaults? Is this a real risk for future consideration.
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Yes, they can be scary. However, once the credit markets unfreeze, there will be some opportunities.
 
I think that many bonds have suffered from the flight to quality we have seen this year. This is a fear-driven process, so trying to rationalize it might be a bit difficult, but I'll try.

If you look at VG bond funds for example, Treasuries and GNMA held up best (both fully backed by the US government), while bonds that have or are perceived to have a higher credit risk, such as corporates and munis, have been hit pretty hard. The fund which was hit the hardest has been the high yield corporate fund (VG's bond fund with the lowest credit rating), down 23% in 1 year, even tough as far as I can tell this fund has not actually reported massive defaults to date. So perception of possible defaults has been the driver here. That fund also has a pretty short duration (4.5 years), so it reinforces my view that credit risk and not duration has been the key factor affecting bond prices this year.

I have a different theory for TIPS. TIPS had done really well this year despite the credit crunch until about 1 month ago. I believe that they have been hit hard by forced selling AND what is looking more and more like a potentially deflationary outlook.

I think that once the credit market unfreezes, we will see rallies in high-quality corporate and muni bonds. There are good deal to be had in both categories. I also think that TIPS will recover as soon as deflation expectations recede. I expect high yield bonds to recover more or less when stocks do.
 
roger r said:
I'd always thought that in times of falling interest rates, that the NAV of bond funds would go up...
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This is only true if nothing else that might affect the perceived value of a bond has not changed. In the last month or two, this hasn't been the case. The overall flight to lower-risk assets and forced liquidations by hedge funds may drive down valuations regardless of interest rate concerns. Mutual funds report the value of their bond portfolios based on recent trade prices, and like any other actively traded security, more sellers than buyers will drive down prices.

Munis appear to have stabilized (at least for the time being), thank goodness. So-called investment grade bonds appear to still be under pressure. I'd like to see some stabilization in this market, too. :)
 
It is possible that some turmoil in the bond market is caused by hedge funds selling to return cash to investors. Business Week recently had an article on this issue.
 
Thanks for the thoughts. I especially thought the Moningstar article was helpful. Sounds to me like, as best as I can figure, the decline in bonds has been mostly driven by the fear of defaults in the investment grade and high yields, by the prospect of deflation in TIPS, and by hedge fund dumping in the muni market. So it's complicated. I wonder if the stability of high quality bond values will be re-written in the textbooks of tomorrow? I think I understand a little better now, but it also seems like the future of bond asset value is more in the the hands of a stabilizing economy than the fluctuations of interest rate for the short run. So it's almost falling into the same realm as equities. It does seem like munis are running on a different set of rules that I'm not quite getting, so maybe the better prospect.
 
Let's talk about who determines what's "high quality"... the credit rating agencies! Standard & Poor's, Moody's, Fitch... I think we all know these agencies have not had a great amount of foresight. The obvious recent example is the high quality ratings they were assigning to subprime mortgages, but of course there are countless others. On the flipside, the rating agencies have tended to rate munis pretty poorly relative to corporations, but how often do you hear about a municipality going bankrupt? I think we all know how often corporations go bankrupt.... Investors are fleeing into Treasuries which is helping make munis an overlooked but extremely attractive investment.

The other thing I'd ask you to consider: stop investing in bond funds! These funds buy and sell and you suffer from price fluctuations due to interest rate fluctuations. Why not buy the bonds themselves? On a 20 term you're looking at rates around 5.35% which are exempt from taxes. The equivalent taxable rate is 7.64%. Why not buy and hold until maturity? You are locking in a great return a extremely low risk!
 
Dreamweaver said:
Let's talk about who determines what's "high quality"... the credit rating agencies! Standard & Poor's, Moody's, Fitch... I think we all know these agencies have not had a great amount of foresight. The obvious recent example is the high quality ratings they were assigning to subprime mortgages, but of course there are countless others. On the flipside, the rating agencies have tended to rate munis pretty poorly relative to corporations, but how often do you hear about a municipality going bankrupt? I think we all know how often corporations go bankrupt.... Investors are fleeing into Treasuries which is helping make munis an overlooked but extremely attractive investment.

The other thing I'd ask you to consider: stop investing in bond funds! These funds buy and sell and you suffer from price fluctuations due to interest rate fluctuations. Why not buy the bonds themselves? On a 20 term you're looking at rates around 5.35% which are exempt from taxes. The equivalent taxable rate is 7.64%. Why not buy and hold until maturity? You are locking in a great return a extremely low risk!
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Uhm.. because my tax deferred accounts don't allow for purchasing individual bonds...

DD
 
Dreamweaver said:
Why not buy the bonds themselves? On a 20 term you're looking at rates around 5.35% which are exempt from taxes. The equivalent taxable rate is 7.64%. Why not buy and hold until maturity? You are locking in a great return a extremely low risk!
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I agree with everything you say other than the "extremely low risk part." How can it be low risk to lend money for 20 years? It wouldn't take much inflation to wipe out that yield completely.

The funds are no better- IMO it is not low risk to make long term loans, even to God.

Ha
 
haha said:
I agree with everything you say other than the "extremely low risk part." How can it be low risk to lend money for 20 years? It wouldn't take much inflation to wipe out that yield completely.

The funds are no better- IMO it is not low risk to make long term loans, even to God.

Ha
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I'm not saying no risk, just low risk. Municipalities usually are not fly-by-night operations. They tend to stick around, even for 20 years. And they tend to pay back their loans. Especially if the loan is backed by general property taxes, because they'll tax whatever they need to in order to pay back that loan.

Inflation is a risk, no doubt about it, but how many investments are offering 5% - 7% low-risk returns right now?
 
cyclone6 said:
Are you referring to individual munis, mutual funds or CEFs? Any suggestions?
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Individual. I like "general obligation" (GO) bonds because they are safer. These days who knows if the bond ratings are real or fake........:p
 
FinanceDude said:
Individual. I like "general obligation" (GO) bonds because they are safer. These days who knows if the bond ratings are real or fake........:p
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I agree 100%!

Ever hear of capital appreciation general obligation bonds? If you don't mind bullet maturities, they are a really great deal because you earn interest on the principal plus interest on the interest! And the interest rates tend to be 0.5% to 1% higher.
 
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