Running my own bond fund, comparing to VAB - Page 3
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Thread: Running my own bond fund, comparing to VAB

  1. #21
    Senior Member Argonaut's Avatar
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    Yeah, I agree with mordko. The generals are always fighting the last war.

    When it comes down to it, investing is really about predicting the future. Because no one can do that with total accuracy, you just have to play your probabilities.

    What I would be curious about, and maybe something j4b could do the calcs on, is what is the current ceiling on bonds? How much would your bonds have to rise to reach a YTM of zero? I know bonds in Europe and Japan reached below zero yields, but lets ignore that for now.


  2. #22
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    If there is deflation, nominal bonds, especially nominal government bonds, will do well. With fiat currencies, deflation is less of an issue. If there is significant inflation, inflation indexed bonds will do well. However, the taxation of inflation indexed bonds is worse than that of nominal bonds. And the supply of inflation indexed bonds in Canada isn't high. Over short periods of high inflation, inflation indexed bonds will likely to better than stocks, at least in pretax returns. Over periods of 5 years or more, stocks usually manage to keep up with inflation. They did in the Weimar Republic.

    A problem for me is bonds in a taxable account. I knew about the tax advantages of discount bonds and GICs to premium bonds. But I hadn't heard the idea of selling a bond, when the capital gain on the bond equals the remaining interest on it (YTM of zero). If transaction costs are minimal, you've cut your tax bill in half on the remaining interest. Thanks for pointing this out.

  3. #23
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    So Argo, do you maintain a bond allocation as well?

    If interest rates hover around current levels (that is, don't make a dramatic move in either direction) then VAB will return slightly better than 2% annual going forward. Maybe much better, if the yield curve is steep. Similar return with GICs.

    I can't do the other calculation right now, and I'm not sure it's easy to calculate. It's a very different question of how much a single bond price has to rise, vs the portfolio value of a bond fund.

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  5. #24
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    Quote Originally Posted by 0okm9ijn View Post
    A problem for me is bonds in a taxable account. I knew about the tax advantages of discount bonds and GICs to premium bonds. But I hadn't heard the idea of selling a bond, when the capital gain on the bond equals the remaining interest on it (YTM of zero). If transaction costs are minimal, you've cut your tax bill in half on the remaining interest. Thanks for pointing this out.
    Are you referring to the bond rolling activity? Yes, just check the YTM of a bond about 1-2 years from maturity. It doesn't have to be exactly zero, just low.

  6. #25
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    Quote Originally Posted by james4beach View Post
    mordko, do you foresee (or think there's a reasonably good chance) of a prolonged period of low inflation ahead?

    I agree that stocks definitely handle inflation well. Personally I think low inflation or even deflation are possibilities on the horizon -- which is a reason I keep an allocation to cash & bonds.
    Personally, I struggle to see how we can keep inflation at current levels. Right now it's low primarily thanks to cheap Chinese and Mexican/Indian imports. Costs in these countries will eventually start going up as their rates are increasing and productivity platos. There are other short-term factors which may push up inflation, e.g. protectionism. On top of it all, governments are starting to pressure central banks (we are seeing this not just in Turkey but also in Britain, Europe, Japan and now US).

    Having said this, Canadian consensus is infinitely low inflation forever, so who am I to argue? Anything is possible.

  7. #26
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    If interest rates hover around current levels (that is, don't make a dramatic move in either direction) then VAB will return slightly better than 2% annual going forward.
    Exactly, which is real return of around about zero. Investors are assuming that the risk is exactly nil. Who buys based on the required rate of return of nothing? How do people buying bonds make this math work?

    I mean, I would like to buy bonds but don't understand the math; there is something I am missing.

  8. #27
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    So mordko if I understand you correctly, you're saying you don't see the appeal of bond funds because of the zero real rate of return - is that right?

    It sounds like you're leaning towards higher inflation expectation?

  9. #28
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    Quote Originally Posted by james4beach View Post
    So mordko if I understand you correctly, you're saying you don't see the appeal of bond funds because of the zero real rate of return - is that right?

    It sounds like you're leaning towards higher inflation expectation?
    I am guessing higher inflation in 12 months time and beyond but I would like to have a hedge in case I am wrong. Normally it would be bonds.

    The part I don't get with bonds is how they are priced. If their real rate of return is zero + you carry risk then what is the logic of buying them??? Basically you are taking on some risk for free and then you pay tax for the pleasure. Why?
    Last edited by mordko; 2017-02-07 at 05:53 PM.

  10. #29
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    I feel like the core aspect of bonds is that you are guaranteed the return at the moment you buy it. That's totally unlike stocks, real estate, commodities.

    There were times when bonds paid a premium over inflation. Unfortunately this is not one of those times. What's still worth something is the fact they offer return of capital, and you can't lose money unless they default.

    I understand the real return aspect but there's a huge difference still between something like a bond that guarantees a 2% notional return, vs a stock that could return anywhere from -50% to +100% over the next couple of years.

  11. #30
    Senior Member Argonaut's Avatar
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    j4b: I don't maintain a bond allocation now, although I could in theory in the future. Right now I see them as something approaching high risk and low reward. Makes no logical sense. Depends what interest rates do in the future but I plan on having an allocation when I get older and have more wealth to protect. Right now cash is OK for me for safety.

    I know that calculation wouldn't be easy, but I would love to see it. Probably could do a sample of a few individual bonds and average them out. Just curious to know how much upside is really left besides the coupon.


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