Bond fund question

[Callitaday2022]

I know there are several different categories of bonds, however this question is just generally speaking.
I understand that if you have a bond today, and interest rates go up, your bond is worth less because the new bonds are paying a higher rate.
What I don't understand, is how much less my bond fund would be worth? Obviously I think it would matter if it was short term, intermediate, or long term?
So if I have a total market bond fund that say is $10 per share, and is yielding 3% annually, what would the decrease in value be if the interest rates are increased .5 - 1% over the next year?
Thanks for some education

 

[emi guy]

I believe your answer lies in the duration of the fund. If a fund has a duration of say five years for example and interest rates increase by 1%, the nav of the fund should drop by duration x percent increase (5x1) or 5%.

 

[dallas27]

Yes, google duration, there are formulas that link duration (and mDuration) to the rate changes. Formula only good for small changes.

Also read up on "convexity". Related concept.


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[gcgang]

Advanced Bond Concepts: Duration | Investopedia

Read this and then we will have a test on the Macauley duration equation.

 

[marko]

AFAIK bond funds do not have a duration but instead are more like a conveyor belt with older funds redeemed and newer funds arriving. A bond fund will have hundreds of bonds (and sometimes a few equities) of varying risk, interest and duration that should provide good diversification and buffering.

I've held two TRPrice bond funds (RPSIX and PRHYX (hi yield)) for many many years and have not seen a notable change in monthly payments both before or after the Fed rate went to zero.

 

[Senator]

Assuming you have a 5 year bond. The discount will be enough to make a previous 5-year bond yield the same as a current 5-yield bond. If I am an investor, what would make me buy a 2% bond vs. a 2.25% bond, all other things being equal?

If you have a 5-year bond at 2% and it costs $100. The new rates rise to 2.25%. The bond will be worth $88.90. A 11.1% drop.

A 2.0% bond yielding $2.00 would have to yield the same at 2.25%. It would be discounted to $88.89 to get the same yield. I put in $88.90 to get my $2.00. If I put in $100, I would expect to get $2.25.

Of course time period, bond ratings, etc all factor in. That is why bond funds in the past worked so well, interest rates falling produces the opposite effect.

 

[Senator]

I've held two TRPrice bond funds (RPSIX and PRHYX (hi yield)) for many many years and have not seen a notable change in monthly payments both before or after the Fed rate went to zero.

Payments will be the same. The value/principle will be affected. In the past 10 years, with falling interest rates, the value goes up.

I believe your answer lies in the duration of the fund. If a fund has a duration of say five years for example and interest rates increase by 1%, the nav of the fund should drop by duration x percent increase (5x1) or 5%.

This is not actually true...

 

[marko]

Assuming you have a 5 year bond. The discount will be enough to make a previous 5-year bond yield the same as a current 5-yield bond.

If you have a 5-year bond at 2% and it costs $100. The new rates rise to 2.25%. The bond will be worth $88.90. A 11.1% drop.

A 2.0% bond yielding $2.00 would have to yield the same at 2.25%. It would be discounted to $88.89 to get the same yield. I put in $88.90 to get my $2.00. If I put in $100, I would expect to get $2.25.

Of course time period, bond ratings, etc all factor in. That is why bond funds in the past worked so well, interest rates falling produces the opposite effect.

But in a bond FUND you don't own a particular bond itself but a combination of hundreds and hundreds of bonds of varying yields and durations.

I believe this mitigates a lot of actual NAV movement. I think of it as not buying the bonds themselves but a fund of bonds that's priced differently than actual 1-for-1 movement interest rates.

Over the past 10 years, my RPSIX bond fund price has moved from 11.78 to 12.04 (of course it has fluctuated as low a 9.9 during the crash) and paid a pretty steady 3.5% (or so) interest.

 

[pb4uski]

AFAIK bond funds do not have a duration...

No, virtually all bond funds disclose duration to give investors insight as the the interest rate sensitivity of the fund. I believe that the portfolio duration is the weighted average duration of all the fund's bond holdings (IOW the weight of each bond times that bond's duration).

If the duration is 5 and rates spike 1% then the value of the fund would likely decline by 5%.

 

[pb4uski]

Assuming you have a 5 year bond. The discount will be enough to make a previous 5-year bond yield the same as a current 5-yield bond. If I am an investor, what would make me buy a 2% bond vs. a 2.25% bond, all other things being equal?

If you have a 5-year bond at 2% and it costs $100. The new rates rise to 2.25%. The bond will be worth $88.90. A 11.1% drop.

A 2.0% bond yielding $2.00 would have to yield the same at 2.25%. It would be discounted to $88.89 to get the same yield. I put in $88.90 to get my $2.00. If I put in $100, I would expect to get $2.25.

Of course time period, bond ratings, etc all factor in. That is why bond funds in the past worked so well, interest rates falling produces the opposite effect.

Senator, your math is off. A 0.25% increase in yield would result in a decline in value from $100.00 to $98.83 (a 1.2% decrease in value) not an 11.1% decrease. The bonds value is the pv of the cash flows discounted at the market yield.

0	(100.00)	(100.00)			(98.83)
1	2.00	2.00			2.00
2	2.00	2.00			2.00
3	2.00	2.00			2.00
4	2.00	2.00			2.00
5	102.00	102.00			102.00
Market yield	2.00%	2.25%		IRR	2.25%
Value	100.00	98.83
Rate change		0.25%
Value change		1.17%

 

[Senator]

But in a bond FUND you don't own a particular bond itself but a combination of hundreds and hundreds of bonds of varying yields and durations.

I believe this mitigates a lot of actual NAV movement. I think of it as not buying the bonds themselves but a fund of bonds that's priced differently than actual 1-for-1 movement interest rates.

Over the past 10 years, my RPSIX bond fund price has moved from 11.78 to 12.04 (of course it has fluctuated as low a 9.9 during the crash) and paid a pretty steady 3.5% (or so) interest.

True, but every USD bond, in that fund, will take a hit downward. If there are international bonds in that fund, they may well still be going up as interest rates in the Euroland are still headed down. Some are negative.

If we go back to 'normal' Fed rates of ~4%, the NAV of your bond fund may be interesting.

 

[nun]

If you have individual bonds an increase in interest rates will give you a paper loss, but if you hold to maturity changes in interest rates won't matter. You'll get the interest declared when you bought the bond and your principal back.

The difficulty comes if you need to sell bonds fund or spend their dividends at times of interest rate rises. This forces you to sell at a loss. People expecting to live on the income from bond funds in the next 10 years are faced with the nasty "sequence of returns" problem.

 

[marko]

If we go back to 'normal' Fed rates of ~4%, the NAV of your bond fund may be interesting.

Twenty two years ago (1993) the prime (I think) was about 6% and my NAV was $11.34.

It's $12.04 as of yesterday.

I must be missing something but I tend to look at the long term.

 

[audreyh1]

There isn't just one interest rate. There is a yield curve, and each duration has a different interest rate. The shape of the curve changes over time based on market conditions and economic expectations. Right now it is rising and somewhat steep. The curve can flatten and even invert.

 

[Senator]

Senator, your math is off.

Good catch. That's why I am not a bond manager...

 

[dallas27]

AFAIK bond funds do not have a duration but instead are more like a conveyor belt with older funds redeemed and newer funds arriving. A bond fund will have hundreds of bonds (and sometimes a few equities) of varying risk, interest and duration that should provide good diversification and buffering.

I've held two TRPrice bond funds (RPSIX and PRHYX (hi yield)) for many many years and have not seen a notable change in monthly payments both before or after the Fed rate went to zero.

Bond funds would have a hard to calculate duration. Duration is just the Average time to receive all schedule payments in PV


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[mathjak107]

The problem with duration and counting on getting your money back if nav falls is there are just to many other variables .

funds change their duration midstream . at one time my total bond fund was 7 years , today it is reduced to 5.50 years so clearly rates are lower and my original duration is no more as shorter term bonds replaced the longer term ones i originally had in the fund along with less interest paid . ..

credit up grades and down grades effect the equation as well . managers can alter the types of bonds invested in and that alters your original deal and pay back time . going heavier into treasury's after you took a bigger drop on corporates as an example .

many bond funds loan out security's too in exchange for short term commercial paper . TLT is big with that . depending on how much they loan out the duration changes for you .

at the end of the day it is very difficult to say if you were to come out even . you will get more interest as time goes on but you will always be behind the curve most likely

 

[marko]

The problem with duration and counting on getting your money back if nav falls is there are just to many other variables .

funds change their duration midstream . at one time my total bond fund was 7 years , today it is reduced to 5.50 years so clearly rates are lower and my original duration is no more as shorter term bonds replaced the longer term ones i originally had in the fund along with less interest paid . ..

credit up grades and down grades effect the equation as well . managers can alter th types of bonds invested in and that alters your original deal and pay back time . going heavier into treasuty's after you took a bigger drop on corporates as an example .

many bond funds loan out security's too in exchange for short term commercial paper . TLT is big with that . depending on how much they loan out the duration changes for you .

at the end of the day it is very difficult to say if you were to come out even . you will get more interest as time goes on but you will always be behind the curve most likely

+1 Thanks mathjak, you always put things in a rational and (most times) easy to understand perspective.

 

[LOL!]

So with bond funds up since the FOMC decision to raise rates, what does that mean for all the hand-waving going on in this thread?

 

[audreyh1]

So with bond funds up since the FOMC decision to raise rates, what does that mean for all the hand-waving going on in this thread?

It just shows that Fed moves don't translate exactly to moves out on the yield curve. And that the yield curve can change every day. (Perceived) US economic conditions and global economic conditions dominate in determining the interest rates for intermediate and long duration bonds.

 

[mathjak107]

every time the fed raised the feds funds rate 1% or more in a year bonds actually did well except 1994 .

but all bets are off starting the 2nd year . they then did not do well .

first column is amount feds funds rate went up . next column what intermediate bonds did

 

[Chuckanut]

So with bond funds up since the FOMC decision to raise rates, what does that mean for all the hand-waving going on in this thread?

Obviously, bonds and bond funds are going to crash and probably go to near zero value in a few months. Best to move your money now into those Venezuelan Beaver Cheese Futures that others here have recommended.

Or find some new financial 'product' designed to make you big dollars in a rising interest rate environment.

Or, one could re-balance each year to one's preferred AA, and not worry about it. Just a thought.
.

 

[pb4uski]

Obviously, bonds and bond funds are going to crash and probably go to near zero value in a few months. Best to move your money now into those Venezuelan Beaver Cheese Futures that others here have recommended. ....

Great idea! What is the ticker for those?

 

[Chuckanut]

Great idea! What is the ticker for those?

If I recall correctly - VBCSKR

 

[ArkTinkerer]

Given that next year is an election year I'm trying to figure out how to short hot air and bovine excrement. Not interested in them foreign offerings.