Let's Talk Bond Funds

[daylatedollarshort]

okay someone here please correct me if I am wrong but it seems to me like if I buy a bond fund on Jan. 1 2022 with a 7 year duration yielding 3% that theoretically if I hold that fund for 7 years I will realize 3% dividends based on whatever the price was on Jan.1, 2022...I realize there will likely be different share price but assuming I do not sell I would still have realized a 3% annual yield.. Am I wrong?

In an open ended bond fund, the bond fund managers are actively selling and buying bonds at prevailing interest rates, which may be higher or lower than 3%, as shares get bought and redeemed and interest rates change over time.

 

[sengsational]

The selloff might affect share price but not the dividends..

Imagine this scenario: a flight to cash happens (that part should not require imagination). Fund managers forced to sell into a soft market because they need enough cash to pay people who want cash. They sell bond X for $98. The week before, they would have been able to get $100 for that same bond. Ok, now time passes, people are no longer fleeing to cash. The fund manager buys back the same bond sold earlier, but he pays $101 for it because bonds are in demand again. You don't need to complicate it with interest rate moves...the beginning and ending points are the same: bond X is held by the fund. The difference is that in order to pay the flight to cash, the fund took a hit. If you held the bond yourself, didn't panic out, you'd be ahead of those who held the fund.

 

[accountingsucks]

okay someone here please correct me if I am wrong but it seems to me like if I buy a bond fund on Jan. 1 2022 with a 7 year duration yielding 3% that theoretically if I hold that fund for 7 years I will realize 3% dividends based on whatever the price was on Jan.1, 2022...I realize there will likely be different share price but assuming I do not sell I would still have realized a 3% annual yield.. Am I wrong?

You can't look at the yield but you can look at the 'yield to maturity' or ytm and yes all things being equalled that is the return you will get including dividends if you held the bond fund or etf from day 1 to the end of 7 years or whatever the average duration is for the fund.

How much lower can bond funds go? Right now there are about 8 rate hikes priced in to a mid duration bond fund (about 8 years). Do you think the Fed will raise more than 8 times (25 basis points each) before they stop hiking? If yes, then bond funds will continue to fall. If no, then you should be bullish on bonds. I have no idea so stick to my 30% bond allocation and yes it is painful but remember we will get higher yields at the end of this "normalization"

 

[Out-to-Lunch]

Imagine this scenario: a flight to cash happens (that part should not require imagination). Fund managers forced to sell into a soft market because they need enough cash to pay people who want cash. They sell bond X for $98. The week before, they would have been able to get $100 for that same bond. Ok, now time passes, people are no longer fleeing to cash. The fund manager buys back the same bond sold earlier, but he pays $101 for it because bonds are in demand again. You don't need to complicate it with interest rate moves...the beginning and ending points are the same: bond X is held by the fund. The difference is that in order to pay the flight to cash, the fund took a hit. If you held the bond yourself, didn't panic out, you'd be ahead of those who held the fund. [emphasis added]

Wait, there is another factor. It is not clear that the FUND took the hit.

Why did the fund manager re-buy the bond? S/He did so because someone was purchasing shares of the fund. And they were paying the going rate. Obviously, if the cost of the typical bond is back to $101, the NAV is similarly up 3% compared to when that bond was selling for $98. It isn't the case that the fund sold at $98, held the cash, then rebought at $101. Instead, the fund sold at $98, disbursed the cash, then later took in $101, and rebought at $101. I don't see where the other fundholders were harmed.

 

[pb4uski]

You might look into the Invesco BulletShares. They are a series of bond-fund ETF's, but that contain bonds of a certain maturity date. Thus, you can set up a ladder of maturities, but each rung is spread out over thousands of companies.


https://www.invesco.com/us/en/solutions/invesco-etfs/bulletshares-fixed-income-etfs.html

There is also a similar series from BlackRock: https://www.ishares.com/us/strategies/bond-etfs/build-better-bond-ladders

I'm somewhat of a fan of these and have invested in them in the past, but to keep it real it is hundreds of companies, not thousands. I downloaded the 2023 Corporate fund portfolio and it was 353 different issuers.

 

[garyt]

If you're an active trader/market timer, Motley Fool might be a helpful guide, their audience is not long term investors. Many/most retirees are long term investors.

Motley Fool is definitely for long term investors. They say be willing to hold any of their picks for at least 5 years and they very seldom sell a pick. They definitely aren't churners.

 

[pb4uski]

I'm not sure how this differs from any other bond fund. That they group bonds by maturity date seems not to prevent the holders from bailing out at an inopportune time, forcing the sale of bonds before maturity. When the flight to cash happens, as it will from time to time, unless you hold individual bonds yourself, you're going to get a little bit shorter end of the stick. Also, as an individual bonds holder, you can actually be on the smart side of that trade!

sengsational, these target maturity bond ETFs are like holding a portion of a portfolio if individual bonds... because the bonds all mature in a stated year the portfolio will receive the par value of the bonds in the portfolio as the bonds mature. In December of the target year, the ETF makes a terminal distribution of the cash to its investors and then that specific ticker ceases to exist because there are no assets left.

Different from a bond fund that has a perpetual life and is constantly reinvesting the proceeds from maturing bonds in new bonds.

So these target maturity bond ETFs are more similar to owning individual bonds than a bond fund. The portfolio is marked to market daily just like a portfolio of individual bonds are.

 

[daylatedollarshort]

okay someone here please correct me if I am wrong but it seems to me like if I buy a bond fund on Jan. 1 2022 with a 7 year duration yielding 3% that theoretically if I hold that fund for 7 years I will realize 3% dividends based on whatever the price was on Jan.1, 2022...I realize there will likely be different share price but assuming I do not sell I would still have realized a 3% annual yield.. Am I wrong?

Here is an explanation from Wikepedia regarding open bond funds - - Bond fund - Wikipedia - Bond funds typically pay periodic dividends that include interest payments on the fund's underlying securities plus periodic realized capital appreciation.......Disadvantages over individual bonds....Variable Dividends: Bond fund dividend payments may not be fixed as with the interest payments of an individually held bond, leading to potential fluctuation of the value of dividend payments.....Net Asset Value (NAV)of a bond fund may change over time, unlike an individual bond in which the total issue price will be returned upon maturity (provided the bond issuer does not default).

If you look at the dividend history of the Fidelity Total Bond Fund in this link, it changes every month - https://www.dividend.com/funds/ftbfx-fidelity-total-bond-fund/


You can also look at the holdings. The individual bond yields are all over the map from the manager buying and selling at different yields and durations over the years.

 

[pb4uski]

okay someone here please correct me if I am wrong but it seems to me like if I buy a bond fund on Jan. 1 2022 with a 7 year duration yielding 3% that theoretically if I hold that fund for 7 years I will realize 3% dividends based on whatever the price was on Jan.1, 2022...I realize there will likely be different share price but assuming I do not sell I would still have realized a 3% annual yield.. Am I wrong?

Yes, you're wrong. Because a bond fund is continually having bonds mature and buying new bonds at current interest rates, your dividend will not be 3% for the entire 7 years unless interest rates were unchanged. If rates are rising then your dividends will increase but if rates are declining your dividends will decline as current holdings mature and new holdings are purchased at higher or lower interest rates.

Now if you buy a portfolio of 3% yielding bonds on Jan 1, 2022 that mature on Dec 31, 2027 then you would get a 3% yield (assuming no credit defaults).

If interest rates go up 1%.. from 3% to 4%, then the value of the fund will go down 7%. Or if interest rates spike 2%... from 3% to 5%, then the value of the fund would go down 14%.

And it will take 7 years for the new, higher yields on bonds purchased with the proceeds of maturing bonds to recover the decline in value.

https://www.blackrock.com/us/indivi...measured in years,drop as interest rates rise.

 

[Out-to-Lunch]

I'm somewhat of a fan of these and have invested in them in the past, but to keep it real it is hundreds of companies, not thousands. I downloaded the 2023 Corporate fund portfolio and it was 353 different issuers.

Thanks for the friendly correction!

 

[target2019]

Motley Fool is definitely for long term investors. They say be willing to hold any of their picks for at least 5 years and they very seldom sell a pick. They definitely aren't churners.

Many investors here use "forever" as their synonym for long-term. This makes MF and their 5-year yardstick rather short when compared to forever.

 

[mrfeh]

For weeks I've listened to people talk about what a bad investment bonds are now. I realize that as interest rates go up bond prices go down..So what? If you are invested for long term who cares about bond price? I care about default risk, inflation and interest rates..I want rates to go up..Have wanted higher rates for many years. To the extent investors are able to time bond prices I attribute that to luck. Bond traders have so much more knowledge and information available that I do not have. I continue to believe contrary to some that investment grade bond funds are safer and more predictable than equities and perhaps maybe even more important for investors today than in the recent past...Tell me what I'm missing..

You aren't missing anything.

In fact, you are part of the minority that clearly understands the situation.

 

[audreyh1]

For weeks I've listened to people talk about what a bad investment bonds are now. I realize that as interest rates go up bond prices go down..So what? If you are invested for long term who cares about bond price? I care about default risk, inflation and interest rates..I want rates to go up..Have wanted higher rates for many years. To the extent investors are able to time bond prices I attribute that to luck. Bond traders have so much more knowledge and information available that I do not have. I continue to believe contrary to some that investment grade bond funds are safer and more predictable than equities and perhaps maybe even more important for investors today than in the recent past...Tell me what I'm missing..

Nothing.

Works for me and has for a very long time because I’m a long term investor. I’ve been through numerous interest rate cycles and I rebalance occasionally as needed. I’m very happy with my bond index funds because they have high credit quality and extremely low expense ratios.

Temporary “forced selling” from a mutual fund doesn’t bother me at all because it gives me an opportunity to buy more at lower prices.

 

[lawman]

Nothing.


Temporary “forced selling” from a mutual fund doesn’t bother me at all because it gives me an opportunity to buy more at lower prices.

Interesting..I'll have to think about that..Would that factor in the determination of end of year capital gains or how does that effect total return??

 

[audreyh1]

Bond funds rarely pay out capital gains, they are small, and do so mostly in falling interest rate environments.

 

[lawman]

Bond funds rarely pay out capital gains, they are small, and do so mostly in falling interest rate environments.

VFIDX pays capital gains every Dec..

 

[audreyh1]

My bond funds only occasionally pay capital gains distributions. It’s usually in a falling interest rate environment when they realize some gains. And it’s a tiny amount compared to equity funds. So I don’t worry about cap gains from bond funds.

 

[scrabbler1]

My bond funds only occasionally pay capital gains distributions. It’s usually in a falling interest rate environment when they realize some gains. And it’s a tiny amount compared to equity funds. So I don’t worry about cap gains from bond funds.

In all my years (>30) of being in bond funds, only once did I have an unexpectedly big cap gain distribution. It was back in 2010 when my big bond fund saw a rise in its price going back to late 2008 when I first bought into the fund. It was a 3% short-term cap gain distribution, which is a huge percentage for a bond fund (the $ amount was about $11k). In the past, even a 1% cap gain distribution for a bond fund was a big one. Even worse, because it was a short-term cap gain distribution, it was considered ordinary income reportable as ordinary dividends, so I could not offset it on Schedule D with any cap losses (not that I had any that year).

 

[garyt]

Many investors here use "forever" as their synonym for long-term. This makes MF and their 5-year yardstick rather short when compared to forever.

That's a minimum, they've held many picks for a lot longer.

 

[target2019]

That's a minimum, they've held many picks for a lot longer.

Longer than forever? I'd like to meet those investors!

 

[Gearhead Jim]

Many investors here use "forever" as their synonym for long-term. This makes MF and their 5-year yardstick rather short when compared to forever.

If you plan on holding your investments "forever", then you should also plan on living "forever" to make use of them.

We don't know for sure, but DW and I are probably in our last 10 years. Medium duration bonds (5-10 years) could take a big hit from rising interest rates and not recover in time to act as "ballast" us. For people like us, CD's (or actual bonds if you can diversify), seem like a better idea than a bond fund.

Thoughts?

 

[Montecfo]

If you plan on holding your investments "forever", then you should also plan on living "forever" to make use of them.

We don't know for sure, but DW and I are probably in our last 10 years. Medium duration bonds (5-10 years) could take a big hit from rising interest rates and not recover in time to act as "ballast" us. For people like us, CD's (or actual bonds if you can diversify), seem like a better idea than a bond fund.

Thoughts?

I do agree. But I think most people would be wise to take a similar tack in this rising rate environment.

 

[beachfire]

More info Please

You might look into the Invesco BulletShares. They are a series of bond-fund ETF's, but that contain bonds of a certain maturity date. Thus, you can set up a ladder of maturities, but each rung is spread out over thousands of companies.


Thanks for sharing the links to the Invesco and Blackrock fixed maturity ETFS. Very interesting. Is there a way to better understand the estimated ETF price that would be considered “par value” at maturity. I realize the value at maturity is uncertain. But do they disclose what the ETF price was at initial launch? Would that be a proxy for expected approximate value at maturity? Thanks again.

 

[Out-to-Lunch]

Thanks for sharing the links to the Invesco and Blackrock fixed maturity ETFS. Very interesting. Is there a way to better understand the estimated ETF price that would be considered “par value” at maturity. I realize the value at maturity is uncertain. But do they disclose what the ETF price was at initial launch? Would that be a proxy for expected approximate value at maturity? Thanks again.

That is an excellent question that I do not know the answer to!

I poked around a very little bit, looking at BSCM (which "matures" this year). It was issued in 2013 at a NAV right around $20. It is now trading at $21.30, with an annualized yield to maturity of 1.50%. If I am thinking about this correctly, one should expect to get about $0.32/year going forward, and so the NAV at maturity should be about $21. (Don't forget that the holder has been getting distributions of close to the coupon rate the whole while.) I am confident that someone who understands bonds better than I do may be able to give a better answer.

 

[all4j]

That is an excellent question that I do not know the answer to!

I poked around a very little bit, looking at BSCM (which "matures" this year). It was issued in 2013 at a NAV right around $20. It is now trading at $21.30, with an annualized yield to maturity of 1.50%. If I am thinking about this correctly, one should expect to get about $0.32/year going forward, and so the NAV at maturity should be about $21. (Don't forget that the holder has been getting distributions of close to the coupon rate the whole while.) I am confident that someone who understands bonds better than I do may be able to give a better answer.

Well, I won't claim to understand bonds better, but I've looked into this type of fund in the past & can give a general approach.

I don't think you can predict. At a certain point, the fund manager quits buying new bonds & of course the maturity dates all along have been before end of year. As bonds mature, etc, the $ then goes into cash/equivalents (UST, investment grade paper, etc). When the fund terminates ( & they have some discretion on that), they just liquidate & holder gets their nav. Then you have a gain/loss depending on your basis. So, as end approaches, there will be a cash return drag. In case of an etf, I imagine there might be some odd premium/discounts to nav as calendar clicks by; I've certainly never monitored that.