Running my own bond fund, comparing to VAB - Page 12
Page 12 of 12 FirstFirst ... 2101112
Results 111 to 116 of 116

Thread: Running my own bond fund, comparing to VAB

  1. #111
    Senior Member
    Join Date
    Nov 2012
    Location
    Pacific
    Posts
    7,428
    Quote Originally Posted by goldman View Post
    Great thread, and your work at running your own private bond fund is inspiring James! Unfortunate that rates are so low and we face the risk of rising rates.
    Bond yields can either go higher or lower. Nobody knows. Even if the Fed raises rates, the bond market may have already priced this in, so it's a total unknown what will happen to the bond yields.

    With a fund like your fund, ZAG, VAB, or XBB ... a growing concern is duration risk that the fund value will drop as rates rise. ZAG has a duration of 7 similar to yours.
    Clarifying, 7 is my avg maturity, not the duration. My avg maturity is lower than ZAG, VAB, XBB. My duration is probably a bit lower than theirs as well.

    The US Fed is expected to raise rates about 3 or 4 times during 2017 for approximately an increase of .75 - 1%. Even though its US rates, it obviously effects rates in Canada when you study the charts.
    Right, the Canadian bond market moves very similarly to the US bond market.

    should these 7 year duration funds not be expected to drop about 7% in fund value by the end of the year?
    You're echoing some common misconceptions

    (1) The central bank is raising the overnight rate, but this is not the same as the bond yield, especially not at 10 year maturity on the yield curve. Here's a web site that shows the US yield curve.

    The Federal Reserve, or Bank of Canada, etc only directly changes the short end of the curve: the cash rate. They do not change the other rates on the yield curve; that's determined by the bond market. Let's say the Federal Reserve does raise rates a total of 1.0%. What will happen to the 10 year point on the yield curve? Who knows -- it could go down, up, or stay the same.

    This is one of the key misinterpretations about the Fed "raising rates" and its impact on bond funds. Even if we think it's 100% certain that the Fed will raise rates by one percent, we don't know what will happen to the yield at 10 years on the yield curve. For example: the bond market might have already priced this in. That means that by the time the Fed raises rates, it's old news to the bond market and perhaps the 10 year yield does not react at all.

    Between Jan 2004 and Jan 2007, the Federal Reserve increased the fed funds rate a whopping +4.25% and the 10 year yield increased just +0.3%. This was a far more aggressive rate tightening regime than today, and yet bond funds (like AGG exposed to the 10 year yield) did very well. AGG returned +3.42% per year. I should add that early in this time line it did decline, temporarily, 5%.

    (2) That calculation where duration translates to % move is applicable to an individual bond. If you have a specific govt bond with duration=7 and if the yield of that bond increases by 1% then yes, the price is expected to drop 7%.

    For the rest of this discussion I will assume we're talking about a 1% increase in the yield of the 10 year, which as I described in (1) is not necessarily what happens when the Fed raises rates by 1%

    With the bond fund, yes if the rates suddenly increase by 1%, then the fund with duration=7 will decline by 7%. However once you start spacing it out over time, you're also getting interest earned on bonds, and new bonds that bring in higher levels of interest due to the increase in rates.

    So yes it's true that a sharp increase in rates can cause that 7% price decline as you mention. However, gradual increases in rates won't cause that effect.

    Last edited by james4beach; 2017-03-18 at 05:56 PM.

  2. #112
    Senior Member
    Join Date
    Nov 2012
    Location
    Pacific
    Posts
    7,428
    Quote Originally Posted by james4beach View Post
    Between Jan 2004 and Jan 2007, the Federal Reserve increased the fed funds rate a whopping +4.25% and the 10 year yield increased just +0.3%. This was a far more aggressive rate tightening regime than today, and yet bond funds (like AGG exposed to the 10 year yield) did very well. AGG returned +3.42% per year.
    I realize I've made another long winded bond post, but I want to highlight this important point.

    Why did AGG (exposed to the 10 year yield) have such a great return even though the Federal Reserve increased interest rates by 4.25% ?

    (1) Central banks don't set the yield of the 10 year bond, which is the key factor for VAB, XBB, ZAG or AGG in the US. The central bank can raise cash rates but the 10 year yield may or may not increase. It does tend to follow, but not in lock step. e.g. 2004-2007, the Fed increased the fed funds rate +4.25% and the 10 year yield increased just +0.3%.

    (2) Even if the 10 year yield does increase, a relatively slow increase in yields does not hurt a bond fund.

  3. #113
    Senior Member
    Join Date
    Nov 2012
    Location
    Pacific
    Posts
    7,428
    Another example. Between Jan 1994 and May 1995, the Fed increased rates +3.0%. The 10 year treasury bond yield increased +1.3% ... http://stockcharts.com/h-sc/ui?s=%24...d=p35931391770

    Bond funds similar to VAB saw a temporary 6% decline but ended positive 3%, as shown here ... http://stockcharts.com/h-sc/ui?s=VBM...d=p94689011619

    Notice that the temporary losses in bond funds were nowhere near as severe as someone may have predicted by saying 3.0 rate hike x duration of 6.0 = 18% decline. And after this 15 month series of Fed rate hikes, the bond fund was ultimately higher by 3%

  4. Remove Advertisements
    CanadianMoneyForum.com
    Advertisements
     

  5. #114
    Senior Member GreatLaker's Avatar
    Join Date
    Mar 2014
    Location
    Toronto, Ontario
    Posts
    544
    Quote Originally Posted by james4beach View Post
    (2) That calculation where duration translates to % move is applicable to an individual bond. If you have a specific govt bond with duration=7 and if the yield of that bond increases by 1% then yes, the price is expected to drop 7%.

    For the rest of this discussion I will assume we're talking about a 1% increase in the yield of the 10 year, which as I described in (1) is not necessarily what happens when the Fed raises rates by 1%

    With the bond fund, yes if the rates suddenly increase by 1%, then the fund with duration=7 will decline by 7%. However once you start spacing it out over time, you're also getting interest earned on bonds, and new bonds that bring in higher levels of interest due to the increase in rates.

    So yes it's true that a sharp increase in rates can cause that 7% price decline as you mention. However, gradual increases in rates won't cause that effect.
    Well said James. No one knows what is in store for long-term interest rates, even in response to Fed rate changes. Investors forget that bond total returns are the combination of price changes and interest payments. And as older bonds mature or are sold off, newer bonds with higher rates are purchased, driving fund returns back up.

    I hold VAB and have no plans to sell any of it for at least 5 years and hopefully 10 years.

    One minor point, and it's probably just semantics of how you wrote it, but you said "a specific govt bond with duration=7 and if the yield of that bond increases by 1% then yes, the price is expected to drop 7%". The cause and effect are actually the opposite. The price of a bond will drop until its yield increases to that of newly issued bonds (with similar risk and duration characteristics). Sorry but I could not resist pointing that out.
    Invest your time actively and your money passively.

  6. #115
    Member
    Join Date
    Jun 2012
    Posts
    36
    http://www.sensibleinvesting.tv/docu...20sensible.pdf

    The above link is from the website sensibleinvesting.tv. For a novice investor, it's a good website.

    The following isn't directly relevant to this thread, but it is to novice bond investors.

    UK BBB bonds, from Nov 2007 to Feb 2009, declined 15% in value. I knew that junk bonds did poorly at that time. And I knew that high quality bonds increased in value during that time. But I didn't know what happened to bonds in between the two categories. BBB bonds are considered investment grade. It would be interesting to see what happened to A bonds during this time period. If BBB bonds were down 15%, my guess is that A bond might very well have had a modest loss during this time. If you're using bonds to diversify equity risk, then perhaps the minimum credit quality should be AA.

    Edited to include the following. During the same time period, UK high yield went down 24% and UK stocks went down 41%. Were BBB bonds greatly different than junk bonds?
    Last edited by 0okm9ijn; 2017-03-20 at 05:47 PM.

  7. #116
    Member
    Join Date
    Jun 2012
    Posts
    36
    http://www.servowealth.com/blog/be-c...ith-your-bonds

    This is a followup on my last post. It seems that it's been too long to edit my last post, so I have to start a new post.

    This is about what bonds went up in 2008 and what went down.

    The link above shows US intermediate bond returns in 2008. High yield was down around -26%. Baa around -8%. A around -5%. Aa around +2%. Aaa around +8%. US Government (I assume Treasuries) around +10%.

    There's a clear message here. In a flight to quality, the bonds that will diversify stocks are likely to be bonds with credit ratings of at least Aa. And you can make a case that Aa bonds didn't diversify stocks in 2008, although they did dilute them, just as cash would have done.


Page 12 of 12 FirstFirst ... 2101112

Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •