Selling Bond Funds?

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Selling Bond Funds?

Postby sdvan » Mon May 13, 2013 1:22 pm

Sorry for another bond funds post. But, I'm starting to rethink my bond fund exposure. I'm in the Van total bond index fund in my IRA and the Cal. intermediate tax exempt bond fund in my taxable account. I hate the thought of significant NAV losses in these funds. These funds are supposed to be the "safe" money while I take risks in the stock side of the portfolio. And, the returns are so pathetic these days, that I'm starting to look at risk/reward. Here are the alternatives:

1. Individual California GO tax exempt bonds. I started buying these about 2 years ago and have a significant amount now in individual bonds that I plan to hold to maturity. When I started buying, I could get a 5% return easily with only a 5-10 year holding period. The returns now are less certain because the bonds are selling above par meaning that if they are called you only get a short term return. Options are to buy short term bonds with returns at less than 1% for up to 3-4 years. Or, bonds with a term of 7-10 years with a guaranteed return even if called of approximately 1.5% with a potential upside in the 2.5-3% range if not called early. Or, bonds with 15-20 year term with guaranteed returns from 1% up to nearly 3% if called early (2-8 years) and with up to 4.3% or so total return if not called early.

2. CD's: Rates are very low with 5 year CD's less than 2%

3. Stable Funds: Again return is very low with no seeming advantage over CD's or individual bonds

I am leaning toward buying more individual bonds. I only buy general obligation California tax exempt bonds. The risk of default is tiny. I have the added advantage of tax exempt interest in my taxable space which pushes the return up significantly. I am struggling a bit with whether to buy shorter term and wait for increases in rates or to go longer term and be happy with low 4% tax exempt returns if the bonds are not called early. All thoughts welcome.
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Re: Selling Bond Funds?

Postby Sbashore » Mon May 13, 2013 4:31 pm

It sounds to me like you are trading one risk for another. I'd figure out what duration I need in my portfolio and buy the bond index funds to meet that duration. A second choice might be to go the CD route if you are really concerned about interest rate risk. Also don't look only at yield, look at total return. Granted total return going forward for bonds is not supposed to be great, but having said that, I don't hold bonds for the return, I hold them to offset equity risk.
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Re: Selling Bond Funds?

Postby sdvan » Mon May 13, 2013 5:47 pm

I hold bond funds to offset equity risk too. The problem I'm having with bond funds is that they are becoming more risky and simultaneously going down in total return. As a result, I'm looking for alternatives that don't have the risk of a significant principle loss while at the same to meeting or beating the total return on the bond funds. To me that isn't a duration question as much as it is a how best to hold fixed income funds to have the lowest risk and highest total return.

With regard to risk, holding individual general obligation bonds issued by the state of California has the same risk as holding a bond fund with California municipal bonds. In fact, I think holding individual general obligation bonds only issued by the state itself could be less risky than the bond fund which also holds local bonds (which may be riskier than GO state bonds). Of course, comparing individual bonds with the total bond index fund is different. There you clearly get some protection from diversification. But, in the current environment, I don't think the diversification is worth the very real likelihood of a signifcant drop in NAV. Of course, I also think the risk of the state of California defaulting on general obligation bonds is so small that it isn't worth worrying about . . .

Let's say I have $1 million to put into a bond fund or individual bonds. The two bond funds that I currently own have a duration of around 5 years. As a result, if interest rates increase by 1%, I quickly suffer a loss of $50K in NAV. If interest rates increase another 1% the following year, I'm now down $100K, etc. Yes, in theory, I could hold for 5 years after each interest rate increase and I'd earn the interest rate prevailing at the time of the interest rate increase. But, at what cost? If instead, I purchase individual bonds and hold them to maturity, I never suffer any NAV loss regardless of what interest rates do. That seems like a much better buffer against equity risk.
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Re: Selling Bond Funds?

Postby Archie Sinclair » Mon May 13, 2013 7:35 pm

sdvan wrote:Yes, in theory, I could hold for 5 years after each interest rate increase and I'd earn the interest rate prevailing at the time of the interest rate increase. But, at what cost? If instead, I purchase individual bonds and hold them to maturity, I never suffer any NAV loss regardless of what interest rates do. That seems like a much better buffer against equity risk.

That's an illusion. The market value of individual bonds will go down temporarily too. It seems like what you're really saying is that you don't want to know the true value of your investments.
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Re: Selling Bond Funds?

Postby LH » Mon May 13, 2013 8:36 pm

I would stay the course.

Financial repression is painful for savers, but bonds even paying negative real, are one of the only things that will possibly protect your money if stocks tank.

Yeah, you can try CDs, just not in cyprus please, and i bonds, and series E, but really beyond those which are limited, there is no substitute for treasuries and TIPS.

I would hate to be a decumulator now getting hit. But for accumulation stay the course.

If you have been in bonds, you have been rewarded, to think you can get the positive, and not get the -=possible=- negative by -=timing=- to me is contrary to all available evidence.

This time is different I suppose........ Time away and good luck. But just be aware, thats it is timing you are doing. You feel bonds are bad, ergo, you get out of bonds.

timing is always done for "all the right reasons"

If a great depression II happens, the risk really shows up and we are in the 20s currently with the 1930s coming up....... you will wish you had the bonds, as california munis and everyone who cant print money outright defaults, and yeah its not roses, as we will all be facing "technical" defaults of one sort or another even federal under some scenerios.

Read diary of a great depression, a mere 80 years ago now... or are we more "modern" now, than the guys in 1920/30s were say to the guys in the panics of the 1800s, and ergo immune??????

Better think about real risk, real hard. These numbers are not monopoly money they are accumulating worldwide now, people actually expect to be -=paid back=- these huge debt sums, with I guess the next generation kicking in the payments(?), now we could well boom again, we could well go really bust such that 2007 is a walk in the park. To write an econ chapter about a great depression two, if it happends, in the next 10 years would be pathetically easy with hindsight in say 2040 given extant facts currently. Doesnt mean it will happen, just that it would be reeeeeal easy to write it using todays financial picture.

I would stick in bonds/tips.

Bonds/tips/financial repression really sucks, but it is safety as much as is available.

I do not think we are all that different from the average western chucklehead in european union cyprus, with 300k "in the bank", nor do I think I am all that different from a MF global "segregated" account holder.

Things could get REALLY interesting, real quick.

Hopefully not. Read diary of the great depression, great easy read, if you want to get a taste of what real risk is.

Think hard friend,

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Re: Selling Bond Funds?

Postby ricb » Mon May 13, 2013 10:43 pm

So, for retiree decumulators you're NOT saying to stay the course with TBM (e.g., BND)?
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Re: Selling Bond Funds?

Postby Sbashore » Tue May 14, 2013 9:03 am

ricb wrote:So, for retiree decumulators you're NOT saying to stay the course with TBM (e.g., BND)?


I'm a retiree in the distribution phase, I stick with what I said above.
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Re: Selling Bond Funds?

Postby sdvan » Tue May 14, 2013 12:21 pm

Thanks for some interesting thoughts. But, I think some are not clear on my question. I am suggesting moving out of two bond funds (total bond and Cal. intermediate tax free) and moving the money into individual California general obligation tax exempt bonds. I hear LH saying that treasuries and TIPs are the only safe FI investments if we have financial armageddon. But, if I were to stay the course with these two bond funds, I would have a small allocation to treasuries and TIPs. So, I think LH is really addressing a different question. My question, put more simply, is whether I should sell at least my Cal. Intermediate tax free bond fund and move the money into individual California general obligation tax exempt bonds?

With regard to LH's issue: While the state of California can't print money, they can raise taxes. No state has ever defaulted on general obligation bonds, right?
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Re: Selling Bond Funds?

Postby ogd » Tue May 14, 2013 12:50 pm

Total Bond Market is a separate issue, but there is no particular difference between individual CA bonds and the bond fund of the same quality and maturity; both have the same risks and returns . As an individual investor, you'll have a much harder time buying the individuals and diversifying enough than you would with a fund, I don't see why it would be worth it.

And yes, CA munis, in one form or another, yield more and are more risky than Total Bond Market.
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Re: Selling Bond Funds?

Postby sdvan » Tue May 14, 2013 1:14 pm

The reason to consider individual bonds is the guarantee that they will not lose NAV if held to maturity. In theory the fund also could function similarly if held for the duration after an interest rate increase. But, the NAV hit from multiple interest rate increases and the tiny returns have me considering individual bonds. An individual bond would function more like a CD. Diversification with state GO bonds is not necessary. All carry the same risk. Plus, state bonds are likely less risky than city, county, school district, etc. bonds held by the bond fund. In other words, I think the individual bonds are no more risky (and potentially less risky) than the bond fund and the return is the same with no risk of NAV loss.
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Re: Selling Bond Funds?

Postby Jebediah » Tue May 14, 2013 1:19 pm

LH wrote:I would stay the course.
Yeah, you can try CDs, just not in cyprus please, and i bonds, and series E, but really beyond those which are limited, there is no substitute for treasuries and TIPS.


Can you explain why an FDIC insured savings account with a higher yield than a treasury fund is no substitute?
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Re: Selling Bond Funds?

Postby ogd » Tue May 14, 2013 1:52 pm

sdvan wrote:The reason to consider individual bonds is the guarantee that they will not lose NAV if held to maturity. In theory the fund also could function similarly if held for the duration after an interest rate increase. But, the NAV hit from multiple interest rate increases and the tiny returns have me considering individual bonds. An individual bond would function more like a CD.


The individual bonds are hit just the same by rate increases. The accounting is different: bond funds lower NAV and raise yield, bonds appear to keep principal and yield constant, at least until you try and sell one. The end result is exactly the same, which is to be expected because it's the rate hike that does the damage and not the bond turnover.

Disregarding default risk for a moment, an individual bond is the same as a CD with no early withdrawals allowed. I love CDs but I would never consider one without early withdrawals (and the possibility of banks refusing to allow them after rates go up still gives me shivers).

sdvan wrote:Diversification with state GO bonds is not necessary. All carry the same risk. Plus, state bonds are likely less risky than city, county, school district, etc. bonds held by the bond fund. In other words, I think the individual bonds are no more risky (and potentially less risky) than the bond fund and the return is the same with no risk of NAV loss.


Agree re: same risk, but diversifying with a slightly more risky asset isn't necessarily a bad idea either. And Vanguard CA funds are very selective when it comes to credit risk.
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Re: Selling Bond Funds?

Postby sdvan » Tue May 14, 2013 1:57 pm

Archie Sinclair wrote:
sdvan wrote:Yes, in theory, I could hold for 5 years after each interest rate increase and I'd earn the interest rate prevailing at the time of the interest rate increase. But, at what cost? If instead, I purchase individual bonds and hold them to maturity, I never suffer any NAV loss regardless of what interest rates do. That seems like a much better buffer against equity risk.

That's an illusion. The market value of individual bonds will go down temporarily too. It seems like what you're really saying is that you don't want to know the true value of your investments.


I think there is a difference. With the bond fund, I don't have any control over the NAV drop. The NAV will go down and the most I can hope to do is to recover that loss with increased payments by holding for the duration of the fund after the interest rate increase. This is compounded if there are multiple interest rate increases. With an individual bond, I don't care whether the value of the bond goes down because I am holding it to maturity. It functions much like a CD. I am guaranteed to receive the full return of principle plus interest as long as I don't sell. There is no such guarantee with a bond fund.
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Re: Selling Bond Funds?

Postby ogd » Tue May 14, 2013 4:35 pm

sdvan wrote:I think there is a difference. With the bond fund, I don't have any control over the NAV drop. The NAV will go down and the most I can hope to do is to recover that loss with increased payments by holding for the duration of the fund after the interest rate increase. This is compounded if there are multiple interest rate increases.


The nature of the NAV drop is such that you can and will recover it for the duration of the fund. Basically, it drops because there are new bonds available with higher yields, and nobody is willing to buy the older bonds without a discount that reflects the yield difference. The fund is required to mark down the value of its assets accordingly. The same exact markdown affects your bonds, except you choose to ignore it because you plan to never sell. Well, if you never sell the fund, you don't care about its NAV either, it's gonna keep yielding $X / month *or higher* whether interest rates stay the same or go up.

I'll repost my example from another thread, viewtopic.php?f=1&t=115577:

ogd wrote: Here's a simplified scenario that I played with when I was making my own version of your decision: suppose today, three of our fellow citizens hold the following assets:

Citizen A, afraid of interest rates but desiring yield, holds muni bonds maturing in 5 years.
Citizen B, being lazy, holds VCADX, with roughly 5 years duration.
Citizen C, being even more afraid of rate increases, holds cash.

Now suppose interest rates rise tomorrow. Just once, decisively and brutally, by like 5%. It hurts like hell, but it's enough to satisfy citizen A's gut instinct that there are no more rate hikes coming. What happens to the three portfolios?

Citizen A has suffered no apparent loss, but will have to wait 5 years to take advantage of the higher rates.
Citizen B has suffered about 25% NAV loss, but his depreciated fund shares are yielding more (on the depreciated basis). The effects of the rate hike will be gone after about 5 years.
Citizen C has suffered no loss and he can buy new bonds and start making the higher yield immediately.

From this it's clear to me that citizen A, although he'd like to think he's in the same boat as citizen C, is actually in the same boat as citizen B. They both suffered a loss, realized or not, whereas citizen C hasn't. To put it another way, citizen A and citizen B's assets are still interchangeable after the rate event, e.g. citizen B can sell his fund at a loss and *buy* the same depreciated bonds that A holds, on the market. By contrast, A and C's portfolios are clearly not interchangeable, there's no way that A can go back to the same amount of cash *now*.

What if the rate event takes place 1 year into the maturity period, you ask? In that case, A indeed loses less than B, but the same as B's cousin, Bprime, who was holding a bond fund with duration four years. And you can push the date further, to the point where if the rate hike happens the day before bond maturity, citizen A's holdings are indeed the same as cash, i.e. no loss.


So what matters is what duration you were holding when the interest rates rose; you take a loss at that exact moment whether it's a bond or a bond fund. As you can see from the other thread, this comes up a lot, and the truth is not intuitive. In my case it took a while to convince myself that I really really didn't need to go through the pain of managing individual bonds. Which was a great relief! :sharebeer
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Re: Selling Bond Funds?

Postby gerrym51 » Tue May 14, 2013 4:41 pm

look at these.

these are muni bond funds with termination dates and they hold all bonds to maturity. it's an option


https://www.fidelity.com/mutual-funds/n ... rity-funds
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Re: Selling Bond Funds?

Postby Scooter57 » Tue May 14, 2013 5:18 pm

The one problem with the limited term muni funds, besides the low yield is that the last year as the bonds mature they move to money market for the proceeds, so you will have a whole year with poorer yield before you get your principal back.
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Re: Selling Bond Funds?

Postby gerrym51 » Tue May 14, 2013 5:30 pm

Scooter57 wrote:The one problem with the limited term muni funds, besides the low yield is that the last year as the bonds mature they move to money market for the proceeds, so you will have a whole year with poorer yield before you get your principal back.


scooter57 is correct they will close the fund to investors 1 year prior to total selling of fund. then they will disburse the proceeds according to number of shares. the 2023 version which i have just invested in will hold all to term.

if it works correctly you should get full NAV plus the interest over the years. it is not guaranteed but it is a way to invest in municipal bonds and lower downside risk-hey if your going to be in bonds-there are not any great choices-i think this is a good bet
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