Yet another bond fund question

[tominboise]

I am trying to educate myself further in bond funds. Why? Because I own some in my IRA, purchased on the advice of a financial planner 4 years ago, as part of my asset allocation.

When I look at the fund information on two funds I own, I see this information:

VCIT / VCSH:
Yield to Maturity - 6.0% / 6.0%
Average Maturity - 7.5 years / 2.9 years
Average Duration - 6.0 years / 2.6 years
Average Coupon - 3.9% / 3.7%

Am I correct in assuming that as time marches on, the YTM will continue to rise as these funds buy higher rate corporate bonds that have been in the market recently?

If so, does that manifest itself as higher dividend payouts going forward? Ultimately higher fund prices?
Some other way?

 

[MichaelB]

I am trying to educate myself further in bond funds. Why? Because I own some in my IRA, purchased on the advice of a financial planner 4 years ago, as part of my asset allocation.

When I look at the fund information on two funds I own, I see this information:

VCIT / VCSH:
Yield to Maturity - 6.0% / 6.0%
Average Maturity - 7.5 years / 2.9 years
Average Duration - 6.0 years / 2.6 years

Am I correct in assuming that as time marches on, the YTM will continue to rise as these funds buy higher rate corporate bonds that have been in the market recently?

If so, does that manifest itself as higher dividend payouts going forward? Ultimately higher fund prices?
Some other way?

The YTM is likely to stay where it’s at unless market rates increase. The coupon rate or the amount the fund pays in interest is currently below that and should rise as fund holdings mature and are replaced, until the coupon rate approaches the YTM.

 

[Al18]

I think the bond fund market has greatly changed in the past 4 years because of Fed rate hikes.

 

[tominboise]

The YTM is likely to stay where it’s at unless market rates increase. The coupon rate or the amount the fund pays in interest is currently below that and should rise as fund holdings mature and are replaced, until the coupon rate approaches the YTM.

I have added the coupon rates to my original post. Thanks for that insight. So if nothing else changed (impossible, I know), the coupon rate and YTM will eventually merge.

 

[all4j]

I have added the coupon rates to my original post. Thanks for that insight. So if nothing else changed (impossible, I know), the coupon rate and YTM will eventually merge.

Not sure of relevance. Note the turnover of each fund. I know this is counter to much of what is said on this board, but funds don't usually hold to maturity -- they buy/sell to match benchmark as bonds age.

Assuming you are reinvesting in your retirement account, if rates go up & prices fall, the distribution buys more. This will probably have a bigger impact than they ytm of the bond holdings.

 

[MichaelB]

I have added the coupon rates to my original post. Thanks for that insight. So if nothing else changed (impossible, I know), the coupon rate and YTM will eventually merge.

They probably won’t merge but the difference between them will reduce substantially. If you hold the fund for a period equaling the duration and reinvest, you would receive about the same as if you were to buy a new bond that matures at the same time.

 

[all4j]

They probably won’t merge but the difference between them will reduce substantially. If you hold the fund for a period equaling the duration and reinvest, you would receive about the same as if you were to buy a new bond that matures at the same time.

Could you expand on the difference reducing? May not match the 2 funds OP has, but data was easier for me to get for treasuries. Looked at a 10 year from 5 years ago. So, it was at 3.12% -- coupon rate to stay the same for life of bond. Today, 5 years later, the 5 year is at 4.8% (thinking of ytm). Don't know how yield curve will look in 3 years, but if it didn't change from today, the 2 year is 5.03....See my question on the difference narrowing?

 

[MichaelB]

Could you expand on the difference reducing? May not match the 2 funds OP has, but data was easier for me to get for treasuries. Looked at a 10 year from 5 years ago. So, it was at 3.12% -- coupon rate to stay the same for life of bond. Today, 5 years later, the 5 year is at 4.8% (thinking of ytm). Don't know how yield curve will look in 3 years, but if it didn't change from today, the 2 year is 5.03....See my question on the difference narrowing?

Not sure I understand the question. Using VCIT (intermediate bond ETF) YTM is 6% and coupon rate is 3.9%. The fund holdings are 5-10 year maturities and took a pretty big hit in NAV in ‘21-‘22, which shows as the difference between the coupon rate and YTM. As those bonds mature or are sold, new ones come in at the current market rates. In theory, if all the bonds were replaced the YTM and coupon rate would be much closer.

 

[all4j]

Not sure I understand the question. Using VCIT (intermediate bond ETF) YTM is 6% and coupon rate is 3.9%. The fund holdings are 5-10 year maturities and took a pretty big hit in NAV in ‘21-‘22, which shows as the difference between the coupon rate and YTM. As those bonds mature or are sold, new ones come in at the current market rates. In theory, if all the bonds were replaced the YTM and coupon rate would be much closer.

tl;dr version -- I was mildly curious enough to ask for more, but not so much that I'll continue. As in my 1st post, I'm not following relevance of the topic. Appreciated your reply & didn't want to leave hanging.

So, here's full version.... Not sure I can ask any clearer. Restating after seeing quoted post..."why?". Explain the theory. My earlier post didn't have precise ytm, but showed more divergence than convergence.

So, seems to me that coupon & ytm will converge as bond price approaches par, which maybe happens as bond matures? Is that what you are saying? If so, doesn't really have anything to do with replacing bonds. In fact, replacing a bond nearing maturity with a bond further from maturity may make it worse. I think ytm will vary based on when in life of the bond it is bought, if at a discount or premium, & where it resides on yield curve.

As I had said, I don't think most funds are going to hold to maturity. But with inverted yield curve, unfamiliarity I have with these funds, I'm not sure I would expect a convergence or what action I would take depending upon this.

Just my thoughts...treat as rhetorical if you wish