Are actively managed bond funds a better choice ?

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Are actively managed bond funds a better choice ?

Postby Bustoff » Fri Feb 08, 2013 7:50 am

We all know stock index funds consistently outperform actively managed stock funds. But does the same hold true for bond funds ? Are passively managed bond funds a better choice than actively managed bond funds for a retired investor ?

I'm not trying to argue one way or another regarding active or passively managed bond funds. (I don't have a clue)

Up until now, I simply assumed that all the advantages of passively managed index funds, including long term performance, applied to both stock and bonds.

It was a NY Times article that prompted my curiosity. The article claims that, more recently, many actively managed bond funds are outperforming the indexes. And in a sneaky way, the author tries to suggest it's all due to the way the indexes are constructed.

http://www.nytimes.com/2012/10/07/your-money/bond-funds-excel-by-avoiding-indexes.html?_r=0
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Re: Are actively managed bond funds a better choice ?

Postby johnep » Fri Feb 08, 2013 8:42 am

The article clearly states that majority of index, Barclays Aggregate is used as example, are heavily weighted towards treasuries and other govt securities, representing roughly 80% of index. Corporate bonds represent only 20%. The Fed is holding down rates for treasuries and this has allowed active bond funds that invest more in corporates or other types of bonds to outperform. This is likely to continue until the bond market reverts back to normal, whenever and whatever that is. Some of these active bond funds cited in article have varying degrees of bond credit quality which also introduces greater credit risk.
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Re: Are actively managed bond funds a better choice ?

Postby Bustoff » Fri Feb 08, 2013 9:27 am

johnep wrote: The Fed is holding down rates for treasuries and this has allowed active bond funds that invest more in corporates or other types of bonds to outperform.


So the only difference between a passive vs. active bond fund is the inclusion or exclusion of Treasuries ?
Wouldn't that limit the definition of a passive bond fund to one that holds Treasuries ?
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Re: Are actively managed bond funds a better choice ?

Postby kenschmidt » Fri Feb 08, 2013 9:40 am

The reason stock index funds outperform their active counterparts is because of lower costs - in terms of both expense ratios and transaction costs associated with turnover. The same is true of bond funds. So when selecting a bond fund, low cost is going to be the most important factor. If you are selecting from Vanguard's bond funds, they are all low cost, so there aren't any bad choices in my opinion. I would focus more on the types of bonds held. Do you want a broad based fund such as Total Bond Index or are you looking for specific types like Treasuries or duration such as Short or Intermediate term?
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Re: Are actively managed bond funds a better choice ?

Postby Bustoff » Fri Feb 08, 2013 10:01 am

kenschmidt wrote:The reason stock index funds outperform their active counterparts is because of lower costs - in terms of both expense ratios and transaction costs associated with turnover. The same is true of bond funds. So when selecting a bond fund, low cost is going to be the most important factor. If you are selecting from Vanguard's bond funds, they are all low cost, so there aren't any bad choices in my opinion. I would focus more on the types of bonds held. Do you want a broad based fund such as Total Bond Index or are you looking for specific types like Treasuries or duration such as Short or Intermediate term?


Investors in the accumulation phase use bonds more for their risk reduction value rather than income. However, once you are retired and presumably have a higher allocation of bonds, the income aspect of bonds is more important. So you want the highest return with the least risk as possible.

The question then, is whether the Vanguard Total Bond Fund is the best overall choice for providing retirees with the best risk/reward.
Last edited by Bustoff on Fri Feb 08, 2013 1:59 pm, edited 1 time in total.
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Re: Are actively managed bond funds a better choice ?

Postby Call_Me_Op » Fri Feb 08, 2013 10:32 am

Most actively managed bond funds have very high turnovers - exceeding 200%. It would be interesting to see a discussion of the relevance of this factor. Is this due to bond maturity mostly, or is there a lot of buying and selling?
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Re: Are actively managed bond funds a better choice ?

Postby hlfo718 » Fri Feb 08, 2013 10:36 am

I think using active managers are ok but same as equity, keep costs low and understand the credit and duration risks. I have mostly with Vang Inter and ST Inv Grade as well as Wellington and Wellesley.
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Re: Are actively managed bond funds a better choice ?

Postby House Blend » Fri Feb 08, 2013 10:57 am

It's not even the right question.

The right question is: "Are lower ER bond funds a better choice?"

Take a managed bond fund that benchmarks against the usual BarCap Agg index. They'll need to stretch for yield to cover their a$$ (er, I mean expenses), so their portfolio won't resemble the benchmark all that well. Now take a look at how well they did in 2008. Not.

Given a managed bond fund with an ER of 0.10% versus an index fund with the same benchmark and an ER of 0.60%, I'll take the managed fund.
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Re: Are actively managed bond funds a better choice ?

Postby larryswedroe » Fri Feb 08, 2013 11:00 am

Bustoff
The evidence is that as bad as active stock managers do, bond managers much worse odds of beating index, though with as you would logically think, a lower dispersion of returns. The reason is simple, bonds of the same credit rating are much closer substitutes for each other than their stocks are. They are much more likely to have similar returns.
Think Treasuries, the only value added opportunity is guessing on rates, not selection. With investment grade bonds they are going to perform very similarly since most of the risk is rate, not credit. Now in junk bonds there is more idiosyncratic risk so more opportunity, but now trading costs can kill you
When you look say at S&P Active vs Passive scorecard you'll see bond winner persistence always way below stock winner persistence

If interested in more I wrote about this in my book Only Guide to Winning Bond Strategy

Best wishes
Larry
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Re: Are actively managed bond funds a better choice ?

Postby Call_Me_Op » Fri Feb 08, 2013 11:00 am

House Blend wrote:It's not even the right question.

The right question is: "Are lower ER bond funds a better choice?"


Doesn't this perspective ignore trading costs?
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Re: Are actively managed bond funds a better choice ?

Postby Bustoff » Fri Feb 08, 2013 11:11 am

larryswedroe wrote:Bustoff
The evidence is that as bad as active stock managers do, bond managers much worse odds of beating index, though with as you would logically think, a lower dispersion of returns. The reason is simple, bonds of the same credit rating are much closer substitutes for each other than their stocks are. They are much more likely to have similar returns.
Think Treasuries, the only value added opportunity is guessing on rates, not selection. With investment grade bonds they are going to perform very similarly since most of the risk is rate, not credit. Now in junk bonds there is more idiosyncratic risk so more opportunity, but now trading costs can kill you
When you look say at S&P Active vs Passive scorecard you'll see bond winner persistence always way below stock winner persistence

If interested in more I wrote about this in my book Only Guide to Winning Bond Strategy

Best wishes
Larry


Thanks Larry - the book is sitting on my lap right now. Just got it back from the St.Louis County Library. . . I think it's their only copy.
I want something better than 70% TBF though.
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Re: Are actively managed bond funds a better choice ?

Postby rixer » Fri Feb 08, 2013 12:12 pm

Some popular multisector managed bond funds are paying close to 6%. If you're retired and can live on 4%, Does it matter if the bond fund drops in value? You shouldn't have to sell it and your income should rise as the rates go up. Anyway, that's what I'm starting to think. Is the risk of default so great on an entire fund like that?
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Re: Are actively managed bond funds a better choice ?

Postby larryswedroe » Fri Feb 08, 2013 12:39 pm

rixer
NEVER make the mistake of confusing YIELD and return. High yield bonds have had yields hundreds of basis points higher than investment grade and Treasury bonds and almost all of that yield differential is not realized. Calls and default risks are the reasons. And the risks show up at the wrong time, much higher volatility in these bonds, so a problem for those in withdrawal phase
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Re: Are actively managed bond funds a better choice ?

Postby baw703916 » Fri Feb 08, 2013 12:41 pm

What is an active bond fund?

Remember that most Vanguard bond funds are "actively managed," at least in the technical sense of not tracking an index.

Should one not buy VIPSX because it's actively managed?
VWITX? (Intermadiate Tax-exempt)
etc?
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Re: Are actively managed bond funds a better choice ?

Postby ftobin » Fri Feb 08, 2013 1:44 pm

baw703916 wrote:Should one not buy VIPSX because it's actively managed?

The question is, would you buy it over Fidelity Spartan Inflation-Protected Bond Index (FSIQX)?
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Re: Are actively managed bond funds a better choice ?

Postby Bustoff » Fri Feb 08, 2013 1:44 pm

baw703916 wrote:What is an active bond fund?

Remember that most Vanguard bond funds are "actively managed," at least in the technical sense of not tracking an index.

Should one not buy VIPSX because it's actively managed?
VWITX? (Intermadiate Tax-exempt)
etc?


"Active" in the sense that the fund is not constructed to track the performance of a another market-weighted bond index.
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Re: Are actively managed bond funds a better choice ?

Postby ftobin » Fri Feb 08, 2013 1:52 pm

Bustoff wrote:"Active" in the sense that the fund is not constructed to track the performance of a another market-weighted bond index.

Quick points of note of turnover:
Code: Select all
T-Rowe Price    PRIPX  7%
DFA             DIPSX  9%
Vanguard        VIPSX  28%             
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Re: Are actively managed bond funds a better choice ?

Postby pkcrafter » Fri Feb 08, 2013 7:43 pm

You will hear a lot of PIMCO bond fund holders claim that PIMCO bond fund X easily beats the index. Doubleline Total Return Bond is in there too. It sounds like Total Bond index, but that's the only similarity. It is short term but has a yield of 5.87%. That should tell investors it must have higher risk.

M* lumps all kinds of bond funds into the category benchmarked by Barclays Agg Bond index, and the PIMCO bond funds and Doubleline, being nothing close to the benchmark, do outperform because many PIMCO funds are leveraged or they are rated far less than AA like the Doubleline fund. In fact, the category average is not even close to the benchmark. Furthermore, the holders of these active funds then compare performance to the fund that does track the benchmark, Vanguard Total Bond Index and claim that their Bond Fund X easily beats the index fund. Rule: If a bond fund has higher costs and higher returns, it must be taking higher risk because, as noted above, the bond market is pretty efficient and costs have a major effect of performance. Many investors don't seem to want to agree with that.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
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Re: Are actively managed bond funds a better choice ?

Postby fundtalker123 » Fri Feb 08, 2013 8:45 pm

Suppose you only had two bond funds to choose from in your retirement plan, a long bond index with mean duration ~20 years and an active bond fund wherein the manager could adjust the duration at whim. Suppose interest rates were at a historically low point and happened to sharply rise over the next few years. Suppose the active manager correctly guessed this was going to happen and adjusted the duration to ~1 year and then raised it slowly over the next few years as interest rates rose. Suppose the ER for the active fund was 0.5 vs. 0.2 for the index fund. Although I cannot predict the future, it is quite feasible in this case that the active fund could significantly outperform the index fund....this does not seem that unrealistic....so maybe you would think twice if these were the only two funds available
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Re: Are actively managed bond funds a better choice ?

Postby gkaplan » Fri Feb 08, 2013 8:56 pm

fundtalker123 wrote:Suppose you only had two bond funds to choose from in your retirement plan, a long bond index with mean duration ~20 years and an active bond fund wherein the manager could adjust the duration at whim. Suppose interest rates were at a historically low point and happened to sharply rise over the next few years. Suppose the active manager correctly guessed this was going to happen and adjusted the duration to ~1 year and then raised it slowly over the next few years as interest rates rose. Suppose the ER for the active fund was 0.5 vs. 0.2 for the index fund. Although I cannot predict the future, it is quite feasible in this case that the active fund could significantly outperform the index fund....this does not seem that unrealistic....so maybe you would think twice if these were the only two funds available



A lot of supposes and ifs in your scenario.
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Re: Are actively managed bond funds a better choice ?

Postby baw703916 » Fri Feb 08, 2013 9:52 pm

fundtalker123 wrote:Suppose the ER for the active fund was 0.5 vs. 0.2 for the index fund.


If you buy the active fund, you might have to make a new avatar. :wink:
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