with Treasury bonds and FDIC insured CDs, there's no need to diversify because there isn't any credit risk
A bond fund with an average duration of five years has exactly the same risk profile of a bond ladder with an average duration of five years. The reality is that an interest rate move will cause the portfolio's value to rise (or fall) by the same amount whether your holdings are a fund or a ladder. And if the bond manager harvests a gain, he must then reinvest the money at a now lower rate, leaving the fund in the same position, with the exception of having incurred trading costs.
First, we get the same prices they get. As do basically all patient institutional type investors. Having said that an individual can buy small pieces that a fund would never buy, and pick up significant yield differences.
Second,why would you want to own bonds from states that deliver you lower AT returns, and in Vanguard's case have both call risk and possibly ATM bonds? And in Vanguard's case owning both lower credits and also bonds in sectors we would not buy. Their advantage is at least you are diversifying those risks. I would not buy those type riskier bonds unless in a fund, for same reason I would not buy individual stocks.
Third, there are times when shorter term CDs make more sense in AT returns than munis and a muni fund won't buy them. A ladder can buy what is most appropriate at the time. This happened a lot in past few years.
Fourth. your point on TLH is just wrong. First the curves can shift leaving some bonds with losses and others not. Second,over time you're buying at different rates so it's easy to show you can have some bonds with gains and some with losses (and because we buy the same type bonds for all clients it's easy to arrange swaps so both parties don't pay spreads.
First you are comparing a patient buyer like DFA with active traders. That is not apples to apples. A patient institutional buyer like us will get the same prices
Second, while larger lots can get better prices to a point, that is not always the case and in fact as I pointed out you can get much better yields with very small lots if patient. Also when we buy we can buy large lots and split them up among various clients since they all hold the same type bonds.
Third, the clients don't do any of the work, the manager does and never once had a client say it was too complex.
fourth, it's not just the TLH, its the wrong states and wrong instruments (CDs vs munis).
That may have been true at one time as the rating agencies had different scales for munis and corporates but no longer true.
And if I would buy single As basically would buy a fund, not individual bonds, to me the idiosyncratic risk begins to be too high. One way to address this is to buy A if three years or less and have lower % limitation on max for an issuer. Say 10% for AAA, 5% AA and 2% single A.
That is about right. With munis though if you eliminate the sectors with low persistence of ratings (health care, multifamily) then there are virtually no losses in AAA/AA munis
Sidney wrote:My understanding was that VG eliminated PABs from all their TE funds except the MM and the high-yield.
For those who choose not to hold individual bonds, is there a better option than VG?
Avoiding the impact of hot fund flows
The fund, therefore, must buy more bonds in a low-rate environment, lowering the average rate for all investors.
Having said that you are adding longer duration bonds to portfolio, increasing the term risk of the portfolio.
The other side of the coin is the greater danger, rates rise and investors sell, that causes fund to sell bonds that are not as liquid and likely incurring significant market impact costs. This is especially true of munis.
Likely had effect when Whitney's forecast came out and scared investors who pulled huge amounts from muni funds.
For example someone living in Texas should almost certainly not own NY or Cal bonds, but if you buy a national fund you will.
stlutz wrote:Actually, this discussion does raise a question for me. Given the liquidity risk and very slightly higher default risk of muni bonds, how much more yield do people here ask for over, say, Treasury bonds of equivalent duration (on a tax-equivalent basis)?
larryswedroe wrote:Anyone with a bloomberg terminal can check the interbank prices with that cusip, as all trades are required to be reported to the MSRB - Municipal Securities Rulemaking Board.
stlutz wrote:More broadly, it should be noted that munis tend to have higher stock market correlation than other types of bonds (even corporate bonds). State/local government finances are dependent upon sales taxes, property taxes etc., and hence their receipts rise and fall with the economy. During downturns, they become greater credit risks. So, their price movements will not always be in line with the Treasury market.
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