Question about Bond Funds

[audreyh1]

Fed rate moves don't directly control ANYTHING except overnight lending to FED member banks, but does IMPACT a lot of things.

https://investor.vanguard.com/insights/bond-fund-basics-duration

For bond funds, the impact "rule of thumb" is duration x rate increase = decline in fund value. I would not want to take much of this "interest rate" risk (duration = 5 for the fund in question given:

"Yellen has tentatively sketched out a path of three rate hikes per year until the Fed get interest rates to 3% in 2019." - MarketWatch

That doesn't mean intermediate bond funds are going to go up exactly the amount that the Fed funds rate goes up (which would be 2.25% over 3 years from the current 0.75% rate to meet that projection). Even less that the Fed will do three rate hikes of 0.5% in 2017 - 0.25% are the much more likely moves, and no one, including the Fed, knows how many of them will occur this year because the Fed evaluates the current economic conditions at each meeting. In addition, no one knows how the yield curve will behave as it all unfolds.

If you look at the past performance of various bond funds over periods where interest rates rise, you'll get a much better idea of the impact of rising rates on total return during those years. In the real world it's not a simple formula.

 

[mathjak107]

no one really knows what is next .

since the election my investment strategy has changed because of more uncertainty than i ever saw in my life .

trump-mania has increased inflation perception and interest rate perceptions .

since the election sell off i added not only gold ,which has been my best performer so far but i added TLT to my equity positions .

i use a barbell of 50% of the bond budget in TLT 50% in pimco mint/shy

that gives the duration of an intermediate term bond fund interest rate wise but with a lot more lifting power on those down days .

the longer you go out the more fear ,greed and perception are added to the interest rate mix so swings can be far stronger than rate perceptions alone can imply in a flight to safety or risk off scenario . .

my feeling is if things do not pan out inflation wise than these longer term bonds will be the place to be . so i have a portfolio now that tries to profit from uncertainty and not just hope for prosperity and lower rates

 

[big-papa]

I generally invest in Treasury bond index funds as they have tended to do a little better during stock market stresses than total bond funds do as investors flee to safety. At Fidelity, I use FIBAX and at Vanguard, it's VFIUX. I also have some shorter duration treasuries in the mix as well at both mutual fund houses. However, I have other accounts like my current 401K where treasury bond funds aren't available - in both of them I use FSITX.

As others have noted, when interest rates rise, the NAV of bond funds will drop. Ultimately, the total returns will catch up to where the interest rates are, depending on the duration of the fund. For many, bond funds are mostly about ballast against the stock market fluctuations as they have near zero long term correlation against stocks and often have negative short term correlation during times of market stress. For others, it's about the dividends thrown off.

 

[mathjak107]

keep in mind total return catches up to your original yield when you bought in but it is always going to be behind the curve .

a bond fund at 10 bucks a share and 5% yield with a duration of 5 would fall to 9,50 if rates jumped to 6% so for 5 years you would get an extra 1% interest for 5 years making up for your 5% loss .

but that only brings you to a 5% total return in a 6% world . higher rates usually equate to higher inflation so whether you care about the 1% is a different issue than your purchasing power . both can be behind the curve .

 

[hesperus]

In a rising rate environment, a fund like FSITX with its 5.83 Years duration, could see its NAV drop in the coming year. If chair Janet and the Fed boys move up half a pct 3 times, your net return (interest - loss of NAV) will be in the red.

+1
go with a bond ladder

 

[bw5972]

+1
go with a bond ladder

I'd have no issues with bonds or a bond ladder. It's bond FUNDs that will be at issue as rates rise.

 

[photoguy]

I'd have no issues with bonds or a bond ladder. It's bond FUNDs that will be at issue as rates rise.

Your individual bond will take the exact same hit as the bond fund. After all the bond fund is just composed of individual bonds. Bond funds only seem worse because they are marked to market (you see the price everyday).



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[audreyh1]

I'd have no issues with bonds or a bond ladder. It's bond FUNDs that will be at issue as rates rise.

No difference. Just an illusion.

 

[bw5972]

Your individual bond will take the exact same hit as the bond fund. After all the bond fund is just composed of individual bonds. Bond funds only seem worse because they are marked to market (you see the price everyday).

There is a difference. An individual bond is a date certain instrument. A six year bond bought today has a duration of 6. Interest rate risk is mitigated as time passes i.e., after 4 years, the duration is 2.

A bond FUND bought today with an effective duration of 6 may still have an effective duration of 6 even after 4 years as the component bonds are retired, new bonds purchased etc...

They are not the same and are not subject to the exact same interest rate risk.

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[haha]

Cash flow is king.

Sometimes.

Ha

 

[COcheesehead]

There is a difference. An individual bond is a date certain instrument. A six year bond bought today has a duration of 6. Interest rate risk is mitigated as time passes i.e., after 4 years, the duration is 2.

A bond FUND bought today with an effective duration of 6 may still have an effective duration of 6 even after 4 years as the component bonds are retired, new bonds purchased etc...

They are not the same and are not subject to the exact same interest rate risk.

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This^^^ This is correct. Individual bonds, IF HELD FOR THE DURATION, have less risk than a bond fund.

 

[audreyh1]

There is a difference. An individual bond is a date certain instrument. A six year bond bought today has a duration of 6. Interest rate risk is mitigated as time passes i.e., after 4 years, the duration is 2.

A bond FUND bought today with an effective duration of 6 may still have an effective duration of 6 even after 4 years as the component bonds are retired, new bonds purchased etc...

They are not the same and are not subject to the exact same interest rate risk.

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The discussion concerned a bond ladder, where one also buys new, longer duration bonds as the older bonds mature. No shortening of average duration for in this case either.

 

[bw5972]

Original Post

I'm looking for clarification of Fidelity's Bond Fund nomenclature, and the general types of Bond Funds.

They have FSITX, a Total US Bond Index Fund Premium Class.
There was also some talk about a Total US Bond Fund (not Index).

Does anybody have any experience with these Funds ?? What exactly is the difference ?? Is a Bond Index better that a straight Bond Fund ??

I'm thinking about increasing my Bond Allocation within my IRA.

The discussion concerned a bond ladder, where one also buys new, longer duration bonds as the older bonds mature. No shortening of average duration for in this case either.

The OP and my responses related to question about bond funds.

 

[audreyh1]

Original Post
The OP and my responses related to question about bond funds.

Your post specifically mentioned bond ladders.

I'd have no issues with bonds or a bond ladder. It's bond FUNDs that will be at issue as rates rise.

 

[photoguy]

A few comments:

First, as mentioned, a bond ladder is exactly the same as a fund. It's just self managed instead of managed by a fund company.

Second, bond funds are not exactly like an individual bond due to the declining maturity issue. However the risk is exactly the same and here's why: If the bond fund declines due to an interest rate rise, you can sell it and buy the individual bond which has also declined in price.

Third, there are defined maturity bond funds: https://personal.vanguard.com/pdf/ICRDMB.pdf . These are a small part of the market (less than 1%) but they do exist and can be bought.

 

[COcheesehead]

A few comments:

First, as mentioned, a bond ladder is exactly the same as a fund. It's just self managed instead of managed by a fund company.

Second, bond funds are not exactly like an individual bond due to the declining maturity issue. However the risk is exactly the same and here's why: If the bond fund declines due to an interest rate rise, you can sell it and buy the individual bond which has also declined in price.

Third, there are defined maturity bond funds: https://personal.vanguard.com/pdf/ICRDMB.pdf . These are a small part of the market (less than 1%) but they do exist and can be bought.

Ouch. So much bad info in this post.

 

[hesperus]

Ouch. So much bad info in this post.

+1

 

[mathjak107]

This^^^ This is correct. Individual bonds, IF HELD FOR THE DURATION, have less risk than a bond fund.

except individual bonds get whacked in purchasing power . as an example, a 30 year bond that repays 1k at maturity can buy 1/2 or less of what it did .

on the other hand bond funds have a value change but as rates rise their interest rises .

an individual bond has a fixed interest rate and a fixed "share price " at maturity . a bond fund has a variable interest rate and a variable share price that changes with rates .

with the bond fund it's value fluctuates , with the individual bond its purchasing power fluctuates .

in the end if rates and hence inflation rise both are going to feel pain about the same . .

 

[COcheesehead]

except individual bonds get whacked in purchasing power . as an example, a 30 year bond that repays 1k at maturity can buy 1/2 or less of what it did .

on the other hand bond funds have a value change but as rates rise their interest rises .

an individual bond has a fixed interest rate and a fixed "share price " at maturity . a bond fund has a variable interest rate and a variable share price that changes with rates .

with the bond fund it's value fluctuates , with the individual bond its purchasing power fluctuates .

in the end if rates and hence inflation rise both are going to feel pain about the same . .

A bond fund's rates may rise in a rising interest rate environment, but the NAV drops, leaving you where? A bond held for the duration pays issuing face value, no drop, leaving you where?
Your caps key is broke by the way.

 

[mathjak107]

the rising rates you get as interest as older bonds are replaced offset some of the nav drop . rates never stop rising in the bond fund so while you are always behind the curve it is about the same as the purchasing power lost in the regular bond since that interest never changes and goes up .


take a 10 buck a share bond fund with a duration of 5 paying 5%. if rates jump to 6% the bond fund gets an extra 1% interest for 5 years offsetting the 5% drop in nav . yes , you got your 5% you signed on for when you bought in the bond fund but it is in a 6% world .

no worse than your 5% individual bond .

it is close for both at the end of the day.

my cap key isn't broke . my fingers are . i have diabetic nueropthy in my finger tips and type with 1 finger left handed only .

the cap key is not even on the radar as far as me using it .

 

[TuborgP]

There is a school of thought that suggests a managed bond fund can adapt better to a rising rate environment. The question is does that hoped for better return exceed the additional increase in cost.

 

[COcheesehead]

the rising rates you get as interest as older bonds are replaced offset some of the nav drop . rates never stop rising in the bond fund so while you are always behind the curve it is about the same as the purchasing power lost in the regular bond since that interest never changes and goes up .


take a 10 buck a share bond fund with a duration of 5 paying 5%. if rates jump to 6% the bond fund gets an extra 1% interest for 5 years offsetting the 5% drop in nav . yes , you got your 5% you signed on for when you bought in the bond fund but it is in a 6% world .

no worse than your 5% individual bond .

it is close for both at the end of the day.

my cap key isn't broke . my fingers are . i have diabetic nueropthy in my finger tips and type with 1 finger left handed only .

the cap key is not even on the radar as far as me using it .

Sorry about my snarky caps comment. That was out of line.

 

[photoguy]

Ouch. So much bad info in this post.

Thanks for the courteous reply. I have no problems with people disagreeing with me, and in-fact I expect it. But your comments adds nothing to the discussion so on my ignore list you go.

For anyone else still interested in this topic, I'm not the only one who thinks that the safety of individual bonds over a bond fund is fiction. Vanguard thinks this as well:

https://advisors.vanguard.com/iwe/pdf/ICRIBI.pdf

Holding an individual bond to maturity primarily confers an emotional, rather than economic, benefit

A bond’s price is inversely related to changes in interest rates: When interest rates rise, the bond’s price falls. This is because a bond’s coupon payments are typically fixed at issuance, leaving the price as the only variable that can be adjusted to make the bond’s yield competitive with that of newly issued bonds. When interest rates change, the price of each bond shifts so that comparable bonds with different coupon rates provide the investor with the same yield to maturity.

This price adjustment punctures the common myth that holding an individual bond to maturity will provide an economic benefit to the investor. Absent transaction costs, when interest rates are rising, the total return and present value of the cash flows will be equal from that point forward, regardless of whether the bond is held to maturity or sold at a loss prior to maturity with the proceeds reinvested in a bond with a comparable maturity date, but a higher coupon. Therefore, the fact that an investor is able to get principal back at a specific maturity date adds no economic value compared to a mutual fund that does not have a specific maturity date.

The hold-to-maturity myth typically surfaces only when interest rates are expected to rise. Reversing the expectation may underscore the flaw in the myth. When interest rates fall, an existing individual bond can be sold at a premium, which would lock in the gain in principal. On the other hand, holding the bond to maturity would bring the investor only the par value, with no gain in principal. But selling the bond specifically to get the premium has no economic benefit, because the investor will be reinvesting the proceeds in lower-coupon bonds— which leaves him or her with the same yield to maturity in either case.

emphasis mine

 

[COcheesehead]

Thanks for the courteous reply. I have no problems with people disagreeing with me, and in-fact I expect it. But your comments adds nothing to the discussion so on my ignore list you go.

OK, maybe I can state it another way. What you said is wrong.

A ladder and a fund are very different. Fees and control of maturities being two of the major differences and no loss of NAV if held to maturity being the other.

Your comment about selling a fund and buying the bond if it declines is confusing at best. A fund is a group of bonds. What bond would you buy to replace it? See the problem?

 

[mathjak107]

There is a school of thought that suggests a managed bond fund can adapt better to a rising rate environment. The question is does that hoped for better return exceed the additional increase in cost.

it could since depending on the types of bonds pro's tend to do better spread wise as well as assessing credit worthiness . a good fund manger who has an eye for bonds with good up grade potential in rating can add alpha .