Bond Funds or Bonds?

[bmcgonig]

“It got the rest of the money by selling a bunch of its bond portfolio: At the end of September it had $11.4 billion of bonds, $8.3 billion of them “available-for-sale” (an accounting term meaning that Silvergate had to mark them on its books at their fair value) and others “held-to-maturity” (meaning that Silvergate could mark them at cost and not worry about changes in market value). At the end of December, it had just $5.7 billion of bonds, all of them available-for-sale. It had sold the rest.”

This is an interesting quote from an email sent out by Bloombergs Matt Levine talking about the run on the bank at Silvergate bank. It seems there’s an accounting term for both sides of this debate here. Some people consider bonds “available for sale” and wish to see bonds marked to market, and others consider them “held-to-maturity” and as the article says, “not worry about changes in market value”

Both sides can be correct at least as far as a CPA is concerned.

 

[Montecfo]

These terms of course are not applicable to individual investors.

The reality is the market is constantly valuing all securities.

Those values can be ignored but they are reality.

 

[daylatedollarshort]

“It got the rest of the money by selling a bunch of its bond portfolio: At the end of September it had $11.4 billion of bonds, $8.3 billion of them “available-for-sale” (an accounting term meaning that Silvergate had to mark them on its books at their fair value) and others “held-to-maturity” (meaning that Silvergate could mark them at cost and not worry about changes in market value). At the end of December, it had just $5.7 billion of bonds, all of them available-for-sale. It had sold the rest.”

This is an interesting quote from an email sent out by Bloombergs Matt Levine talking about the run on the bank at Silvergate bank. It seems there’s an accounting term for both sides of this debate here. Some people consider bonds “available for sale” and wish to see bonds marked to market, and others consider them “held-to-maturity” and as the article says, “not worry about changes in market value”

Both sides can be correct at least as far as a CPA is concerned.

The snippet you posted supports what has been posted in this thread recently by youbet on opportunity costs and the Fidelity chart on principal preservation. It isn't a both side issue. The difference in the article between the two bond groups' book values is one is being held to maturity and the other is not intended to be held to maturity. The principal does change on bonds sold prior to maturity or intended to be sold prior to maturity. This is noted in the Fidelity chart. Per Investopedia, Available-for-sale securities are reported at fair value. Bonds intended to be held to maturity are kept on the books at principal values, since that is what they will be redeemed for. It isn't a personal choice of how to value them from the CPA. If they are being put up for sale the company has to accept the market rates at the time of the sale.

 

[Hank]

YTM does NOT reset as the fair value of bonds change. So the only way that a fund can get a big discrepancy between coupon and YTM is to buy bonds at a significant discount.

Would holding a lot of Zero Coupon bonds influence this ?

 

[pb4uski]

I think this applies to your question:

"Are realized gains or losses recorded for held-to-maturity debt securities?

If a debt security is classified as held-to-maturity, then the security holder intends to hold the debt security until it matures. Examples of held-to-maturity debt securities includes government securities, corporate bonds, or certificates of deposit (CD). Held-to-maturity debt securities are reported at cost and amortized over the life of the security. Any unrealized gains or losses would not be recorded to the income statement or balance sheet for held-to-maturity debt securities since fair value measurement is not applicable."
Source:https://www.universalcpareview.com/...ecorded-for-held-to-maturity-debt-securities/

The way this applies to this thread is some have stated that the principal value keeps changing when market rise on individual bonds with maturity dates. The market values do change, but the principal values on nominal bonds with maturity dates that are held to maturity do not change in your brokerage statements or on your taxes. On a TIPS bond, the principal changes with the CPI adjustment factor only. On bond funds without maturity dates, the principal values (based on the NAV price) do change daily. On the Fidelity chart in the prior post, they describe this for bond funds, under "principal preservation and liquidity", as "Unlike individual bonds, most bond funds do not have a maturity date, so your principal will fluctuate."

Nah, it doesn't really apply to my question. I'm very familiar with FAS 115 HTM accounting as I ran the investment accounting shop for a life insurer during my career.

And actually, realized gains and losses would be recorded if a HTM security was sold but more importantly, a single sale, no matter what the reason, would taint management's assertion that they intend to hold securities to maturity and require the registrant to reclassify all HTM securities to AFS and mark-to-market through AOCI (Accumulated Other Comprehensive Income).

 

[pb4uski]

“It got the rest of the money by selling a bunch of its bond portfolio: At the end of September it had $11.4 billion of bonds, $8.3 billion of them “available-for-sale” (an accounting term meaning that Silvergate had to mark them on its books at their fair value) and others “held-to-maturity” (meaning that Silvergate could mark them at cost and not worry about changes in market value). At the end of December, it had just $5.7 billion of bonds, all of them available-for-sale. It had sold the rest.”

This is an interesting quote from an email sent out by Bloombergs Matt Levine talking about the run on the bank at Silvergate bank. It seems there’s an accounting term for both sides of this debate here. Some people consider bonds “available for sale” and wish to see bonds marked to market, and others consider them “held-to-maturity” and as the article says, “not worry about changes in market value”

Both sides can be correct at least as far as a CPA is concerned.

Yes, as I alluded to in my prior post, there are two different accounting for bonds, HTM which are held at amortized cost and AFS which are held at fair value. What probably happened with Silvergate is that once they sold a single HTM security they had no choice but to change the accounting for all HTM securities to AFS because the sale of just one HTM security taints the entire HTM portfolio.

So they may not necessarily have sold all their HTM securities at the end of December, but were just no longer eligible to use HTM accounting for any debt securities.

 

[pb4uski]

Would holding a lot of Zero Coupon bonds influence this ?

It might in that there would be less cash flow from coupon payments to make income distributions.

 

[daylatedollarshort]

This site sourced below explains the difference between held-to-maturity debt securities, trading debt securities, and available-for-sale debt securities.

"Held-to-maturity debt securities are reported at amortized cost. This is due to the securities being held to collect contractual cash flows. As such, it would not be appropriate for an investor to recognize interim fluctuations in fair value through a fair value model since those fluctuations will not be realized by the investor."

"Debt securities classified as trading are reported at fair value, with unrealized gains and losses recorded in net income each period."

"Debt securities classified as available for sale are reported at fair value..."

Sources: Accounting for debt securities, https://viewpoint.pwc.com/dt/us/en/...accounting__1_US/34_accounting_for_de_US.html

Seems pretty clear to me and matches what the Fidelity chart states regarding principal values relating to individual bonds and bond funds.

ETA: Posted second link on the subject from an accounting book specifically because pb4uski stated my first link on the subject didn't answer the question of bonds held to maturity having unrealized gains or not.

 

[pb4uski]

Is there a way to put someone on Ignore using the Android app?

 

[daylatedollarshort]

I think that the investopedia article is poorly worded. The decline in the price/value of bonds when interest rates rise is because the bond's contractual cash flows are discounted at a higher discount rate. It's that simple.

I don't view it as having anything to do with opportunity cost, but one might be able to stretch it that far.

Opportunity cost pertaining to rising rates seems to be pretty standard terminology: "Interest rate risks are the risks that the prices of fixed-income securities, such as bonds, will decline when interest rates rise. This is due to the opportunity cost of missing a more favorable investment. The inverse is also true – bond prices may increase when interest rates fall."Source: Interest Rate Risks: Investment Guide, https://smartasset.com/investing/interest-rate-risks-investment-guide

 

[big-papa]

Is there a way to put someone on Ignore using the Android app?

Yes. Find a post from that person. Click on their username. Their profile will appear. Click on the 3 dots on the upper righthand corner. Ignore/Block appears for you to click to then ignore that individual.

Cheers,
Big-Papa

 

[pb4uski]

Yes. Find a post from that person. Click on their username. Their profile will appear. Click on the 3 dots on the upper righthand corner. Ignore/Block appears for you to click to then ignore that individual.



Cheers,

Big-Papa

Thanks, that may come in handy. [emoji4]

 

[daylatedollarshort]

The big bogeyman of 2022 was not the question of Bond Funds or Bonds(?). It was duration of securities held.

Low duration bonds and bond funds did not get killed.

High duration bonds and bond funds did. Yes, including TIPS. They were actually hurt worse than comparable treasuries due you low coupons.

So the best strategy was to avoid duration. This kept any losses to an absolute minimum. No need to mitigate by holding to maturity or waiting to get back to par.

This article lays out the math on how an individual TIPS protects your principal, and makes a nice return, in a rising rate environment with inflation, compared to how an equal investment in a TIPS ETF would lose money. This contradicts your statements regarding TIPS in this post and others in this thread. Both positions can't be correct, so if you think the math in the article is wrong, please explain where the article author has erred in his calculations.

TIPS Funds Vs. A Ladder: "Fund investors have been punished as the 10 year real TIPS rate went from -1% to the current 1.6%. As a result, the TIP ETF is down YTD 12.2%. Since its duration is 6.94, for each 1% point rise in rates, TIP would decline by about 7%. Some of that loss was offset by the real interest earned and the inflation principal adjustments. However, individual TIPS bonds held to maturity protect against principal loss in the event of rising real rates. To demonstrate, let’s look at an example....". Then the article author goes on to to show the math calculations on how equal investments in an individual TIPS bought in the secondary market and a TIPS ETF, one year later, could result in total returns of -.07% for the TIPS ETF and 6.5% for the individual TIPS., https://seekingalpha.com/article/4567020-tips-funds-vs-ladder

If you can't access the Seekingalpha article, there is a good overview at Tipswatch, TIPS funds vs. TIPS ladder: An investor weighs in, https://tipswatch.com/2023/01/08/tips-funds-vs-a-tips-ladder-an-investor-weighs-in/.

 

[pb4uski]

 

[Montecfo]

What say we move on from this repetition and instead cover the pros and cons of bonds and open and closed-end bond funds?

I think there is wider interest there.

 

[daylatedollarshort]

What say we move on from this repetition and instead cover the pros and cons of bonds and open and closed-end bond funds?

I think there is wider interest there.

TIPS and TIPS funds are types of bonds and bond funds and the same principles generally apply, except nominal bonds do not have the inflation factors. You specifically asked me to post this discussion here in the Golden Period thread. You also said I was spreading misinformation on individual TIPS returns along with quite a few insults I won't bother to repeat. I'd like to keep this discussion polite and focus on the math and factual difference between individual TIPS / bonds and the funds.

I've posted very detailed articles from Tipswatch and Seekingalpha that support what I've stated about TIPS returns last year being similar to I bonds, TIPS having increasing principal during times of inflation, etc.

Are these articles factually and mathematically accurate or not?

 

[pb4uski]

... Are these articles factually and mathematically accurate or not?

The articles seem to be accurate, but your interpretation of what they mean is not accurate. You are still chosing to ignore that in claiming that individual bonds (TIPS or nominal) have performed better than bond funds/ETFs (TIPS or nominal) for specific periods of time that you are comparing apples (amortized cost) and oranges (fair value for funds/ETFs). Funds operate under different accounting rules and cannot chose to use amortized cost accounting, but individuals or companies that intend to hold-to-maturity can choose to carry bonds at amortized cost subject to strict constraints under generally accepted accounting principles.

One of the many articles that you referenced stated:

... As Wakerly notes. “This was painfully evident this year. Fund investors have been punished as the 10 year real TIPS rate went from -1% to the current 1.6%. … However, individual TIPS bonds held to maturity protect against principal loss in the event of rising real rates.”

At a time of rising real yields, TIPS funds are going to suffer. But an individual TIPS will stay on its course to maturity, where it will pay par value + inflation accrual (or at the very least, par value). If you hold a TIPS in a brokerage account, it can be painful to see the loss in “market value” because that is how the broker will report it each day. But in reality, your TIPS is actually holding its principal value (unless deflation strikes), and rising with future inflation. Wakerly says:

In my opinion, this is the most important advantage of buying individual bonds in a ladder versus a fund. This is especially important for retirement investors who want predictable income and cash flow.​

The thing is that if you hold individual bonds rather than a bond fund then you can choose to ignore market value fluctuations since you plan to hold individual holdings to maturity, a choice that a bond fund/ETF investor doesn't have since the fund is required to mark-to-market daily. But that doesn't mean that that the investor in individual bonds doesn't have an economic loss, just that they can chose to ignore it.

You seem to be totally ignoring the FACT that if you had two identical portfolios of bonds and one was owned by an individual and the other was owned by a fund/ETF that the economic performance (ignoring fees) for any particular period of time would be identical since by definition economics is based on exit pricing for any discrete period... the author acknoledges this where he says:

If you hold a TIPS in a brokerage account, it can be painful to see the loss in “market value” because that is how the broker will report it each day.

 

[pb4uski]

What say we move on from this repetition and instead cover the pros and cons of bonds and open and closed-end bond funds?

I think there is wider interest there.

Looks like that isn't going to happen so let's just close down the thread.

 

[daylatedollarshort]

Looks like that isn't going to happen so let's just close down the thread.

You've stated my posts were inaccurate without quoting any of my actual posts and instead making up things I didn't post. The articles are correct as is what I have posted in this and the Golden Period thread, especially regarding the difference in principal values on bonds and bond funds when market rates rise. On bonds your principal doesn't change for nominal bonds and only changes for TIPS with CPI changes. On bond funds your principal changes daily as market rates change. This is the key difference between bonds and bonds funds. Bond funds are priced like equities and may not preserve your principal. It is summarized in the Fidelity chart regarding capital preservation, "Unlike individual bonds, most bond funds do not have a maturity date, so your principal will fluctuate." Market rate changes can cause one to lose their principal, or original investment, in bond funds but not individual bonds, unless those bonds are sold prior to maturity.

I'm not the one spreading misinformation.

ETA: Changed "the principal" to "your principal"

 

[pb4uski]

I'm convinced that you will never see where you are wrong, so let's agree to disagree.

I'm also convinced that you have some strongly held misconceptions and misunderstandings, but let's focus on a couple inaccuracies in the very last post.

... On bond funds the principal changes daily as market rates change. ...

For bond funds/ETFs the principal does NOT change daily. Technically, the bond fund/ETF doesn't have principal or par value or face value, however the bond portfolio owned by the bond fund/ETF would have par or face value, which is sometimes referred to as principal. The fair value or market value of a bond portfolio changes daily when the markets are open whether that portfolio is owned by an individual, a financial institution or a bond fund/ETF, but the principal (aka par value or face value) of the individual bonds or the aggregate principal for the bond portfolio does NOT change daily (unless there happen to be purchases or sales of bonds that day).

... This is the key difference between bonds and bonds funds. ...

Since your previous statement that the principal changes daily is incorrect, the above statement that that is the key difference between bonds and bond funds can't possibly be correct.

When you are referring to a bond fund or ETF, you are really talking about shares of ownership in an entity that owns a bond portfolio. Like other equity investments if you own a bond fund/ETF you have cost/basis and NAV (and market value for closed-end funds). The NAV and market value for closed-end funds changes daily when the market is in session and that is about it. Now the underlying bond portfolio has par value, maturity dates... and also market values that change daily, etc... but par value does NOT change unless there are purchases or sales that day.

You don't own 1/n th of each bond, you own 1/n th of the entity that owns the bond portfolio.

 

[MichaelB]

<mod note> Everyone has made their point - multiple times and quite explicitly - no views are changing, and readers are free to choose. Let’s just move on.

 

[daylatedollarshort]

<mod note> Everyone has made their point - multiple times and quite explicitly - no views are changing, and readers are free to choose. Let’s just move on.

I hope it is okay to post that I was incorrect in how I stated that particular post. I agree with pb4uskis's point that I should have stated with bond funds, "the principal" doesn't change daily, I should have stated it as "your principal" may change daily. I meant the principal in your account. On the Fidelity chart this is written as, "your principal will fluctuate."

 

[pb4uski]

I hope it is okay to post that I was incorrect in how I stated that particular post. I agree with pb4uskis's point that I should have stated with bond funds, "the principal" doesn't change daily, I should have stated it as "your principal" may change daily. I meant the principal in your account. On the Fidelity chart this is written as, "your principal will fluctuate."

I found the piece on Fidelity that you were referring to... it says:

Unlike individual bonds, most bond funds do not have a maturity date, so your principal will fluctuate. Funds can be bought and sold daily.

Unfortunately, it's wrong or at best, very poorly worded. I'm not sure what they are trying to say. Maturity date and principal don't have anything to do with each other. Even perpetual preferred stocks don't have maturity dates but still have stated values that don't fluctuate. Perhaps they meant to say that the value fluctuates rather than principal, because that would be correct. With a bond fund, like a stock fund, there's really no such thing as principal.

For both bond and stock funds, you have cost or basis, which I guess is conceptually similar to principal... but that doesn't change daily. In fact it doesn't change at all unless you buy or sell shares. So if the Fidelity chart says "your principal will fluctuate" then it is wrong because neither the par or face value aka principal nor the fund holders cost will fluctuate absent purchase or sale transactions.

For bond funds/ETFs the NAV will fluctuate daily based on changes in fair value of the underlying bond portfolio just like the NAV of a stock fund/ETF will fluctuate daily based on changes in the fair value of the underlying stock portfolio.

 

[daylatedollarshort]

I found the piece on Fidelity that you were referring to... it says:

Unfortunately, it's wrong or at best, very poorly worded

Already covered here - https://www.early-retirement.org/forums/f28/bond-funds-or-bonds-117033-15.html#post2903700. Schwab uses the same terminology - https://www.schwab.com/learn/story/bonds-vs-bond-funds-which-is-right-you, " One key difference between individual bonds and bond funds is that with bond funds, there's no guarantee that you'll recover your principal at a specific time, particularly in a rising-rate environment." According to Investopedia, "in the context of investing, principal is the original sum committed to the purchase of assets (independent of any earnings or interest)." Whether you buy a $1K bond at par or invest $1K in a bond fund, "your principal" starts out the same.

 

[Alan]

Thanks for the interesting discussion.