know the data before buying HY bonds

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know the data before buying HY bonds

Postby larryswedroe » Thu May 02, 2013 1:18 pm

the longer rates stay down the more I am asked about higher yielding investments.

Investors should be aware that they trade one risk for another when buying high yield

http://www.cbsnews.com/8301-505123_162-57582535/know-the-data-before-buying-high-yield-bonds/
Hope this is helpful

Best wishes
Larry
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Re: know the data before buying HY bonds

Postby Rick Ferri » Thu May 02, 2013 1:54 pm

When the safety of bonds was needed most, VWEHX didn't perform well.


If your article assumes that "safety" means no temporary loss in nominal principal value when stocks decline, then why recommend 5-year Treasuries bonds? During the first half of 1974 , Treasury bonds got smacked hard right along with equity. It happened again in the first quarter 1977, first quarter 1980, and in the third quarter 1981, second quarter of 1984, second and third quarters of 1994, and in other periods.

I'll add that 5-year T-notes are not safe if you're concerned about inflation. 5-year notes are yielding 0.65% today while the Federal Reserve targets 2.0% inflation over the same period.

If an investor were to believe that "safety" means earning a real return from their fixed income portfolio after inflation, or at least not losing real value, then a little high yield makes perfect sense in a well diversified portfolio.

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Re: know the data before buying HY bonds

Postby nisiprius » Thu May 02, 2013 2:37 pm

I don't think we should continually keep redefining words like "risk" and "safety."
If an investor were to believe that 'safety' means earning a real return from their fixed income portfolio after inflation..."
This is trendy definition of "safety" that I cannot recall hearing until recently.

From 1970 through 1980, FDIC-insured bank account lagged inflation, if I recall correctly by as much as 5%, but were customarily described as "safe." Even if the word "safe" was usually followed by "but."

If you are in San Francisco at 8 a.m. and you need to be in Los Angeles by noon, and the choice is to drive 60 mph and be late, or to drive 100 mph and have a chance of making it, a chance of getting pulled over, and a chance of getting killed, most people would simply say "driving 60 mph is safer, but of course you will be late," not "driving 100 mph is safer."

Yield is yield. Safety is safety. A risky investment does not become safe merely because safe investments have low yield.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Thu May 02, 2013 4:37 pm

A risky investment means you don't have money when you need it. If someone needed all the money from their investment portfolio next year, they I wouldn't recommend the Vanguard High-Yield Corporate Bond fund either.

What If you don't need all the money? Then it's a different risk. The risk is a very long-term decline in prices. That never happened with VWEHX. I don't know anyone who has the Vanguard High-Yield Corporate as part of their long-term allocation and hasn't made a good return on this fund.

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Re: know the data before buying HY bonds

Postby larryswedroe » Thu May 02, 2013 10:24 pm

safe bonds by always refers to the credit quality, one can then take term risk or not, or inflation risk or not (TIPS)
forewarned is forearmed

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Re: know the data before buying HY bonds

Postby larryswedroe » Thu May 02, 2013 11:04 pm

I would add this
If say 5 year Treasuries do poorly because rates are rising, then HY will also do poorly
They might do somewhat better than Treasuries because their higher coupons makes their duration bit shorter, but they also might do much worse if rising rates are caused by inflation and you get Fed tightening which leads to credit risk showing up

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Re: know the data before buying HY bonds

Postby Baseballmom94 » Thu May 02, 2013 11:25 pm

Unfortunately, VWEHX - the Vanguard High Yield Corporate Bond fund - is now closed to new investors.
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Re: know the data before buying HY bonds

Postby larryswedroe » Fri May 03, 2013 7:57 am

baseballmom
I would say fortunately it's closed (:-)) might prevent some investors from chasing yields

Best wishes
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Re: know the data before buying HY bonds

Postby Rick Ferri » Fri May 03, 2013 9:14 am

larryswedroe wrote:baseballmom
I would say fortunately it's closed (:-)) might prevent some investors from chasing yields

Best wishes
Larry


That's something about HY that Larry and I can agree on. :happy

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Re: know the data before buying HY bonds

Postby Baseballmom94 » Fri May 03, 2013 10:08 am

Okay, I get your point, Larry and Rick. :) However, I'm confused about something -- Rick, I thought that I read on one of the threads that you advocated 20% High Yield Corporate Bonds as part of an investor's bond allocation -- what fund are you referring to and are you still recommending this to be part of one's fixed income allocation? Thanks from a new Boglehead who is on a steep learning curve!
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Re: know the data before buying HY bonds

Postby louis c » Fri May 03, 2013 10:09 am

larryswedroe wrote:the longer rates stay down the more I am asked about higher yielding investments.

Investors should be aware that they trade one risk for another when buying high yield

http://www.cbsnews.com/8301-505123_162-57582535/know-the-data-before-buying-high-yield-bonds/
Hope this is helpful

Best wishes
Larry


Agree HY should not be used to chase yield due to the current financial repression. The latter part of this Vanguard paper does a decent job explaining the long term implications of asset class diversification - including HY, versus the implications over shorter time horizons.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Fri May 03, 2013 10:29 am

Baseballmom94 wrote:Okay, I get your point, Larry and Rick. :) However, I'm confused about something -- Rick, I thought that I read on one of the threads that you advocated 20% High Yield Corporate Bonds as part of an investor's bond allocation -- what fund are you referring to and are you still recommending this to be part of one's fixed income allocation? Thanks from a new Boglehead who is on a steep learning curve!


You can still buy VWEHX if you already own it. TIAA-CREF High-Yield (TIHRX) is a fair alternative.We get lower cost institutional class. IShare High Yield Bond ETF (HYG) is also available.

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Re: know the data before buying HY bonds

Postby mdpsychcrnp » Fri May 03, 2013 9:45 pm

Rick,
What about JNK?
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Re: know the data before buying HY bonds

Postby Scooter57 » Sat May 04, 2013 10:54 am

Rick Ferri wrote:he risk is a very long-term decline in prices. That never happened with VWEHX.



VWEHX was started very close to the start of the long bull market in bonds, at a time when junk bonds were paying rates in the high teens an more.

Their performance going forward will have to be very different from anything you can observe in their past performance.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 11:00 am

Scooter57 wrote:VWEHX was started very close to the start of the long bull market in bonds, at a time when junk bonds were paying rates in the high teens an more.Their performance going forward will have to be very different from anything you can observe in their past performance.


I agree, and I believe the performance will be better under a stable to rising rate environment relative to Treasury bonds. Higher interest rates caused a lot of defaults and downgrades that hurt performance. In addition, falling interest rates over the past 30 years allowed stronger companies to refinanced debt and called-in securities early, which lower HY returns.

Rick Ferri
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Re: know the data before buying HY bonds

Postby Noobvestor » Sat May 04, 2013 11:02 am

Rick Ferri wrote:A risky investment means you don't have money when you need it. If someone needed all the money from their investment portfolio next year, they I wouldn't recommend the Vanguard High-Yield Corporate Bond fund either.

What If you don't need all the money? Then it's a different risk.i


With all due respect, I think you're missing the point of the (Nis') analogy. If you have a slight shortfall in money, you can change your lifestyle a little or use credit temporarily. If you're slightly late to the meeting, you can excuse your absence and hope for the best. On the flip side, if high-yield tanks alongside stocks, or your ticket costs you more than the meeting was worth to you, you may be worse off than you would have been for taking on those risks. Neither is ideal, but neither is black-and-white either.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 11:09 am

There are two schools of thought. Larry's school says take risk with equity and invest the rest in "safe" fixed income and leave "riskier" bonds out such as high yield and mortgages. My school is to have a total-total bond market portfolio that includes all asset classes, and then set the portfolio risk based on this portfolio. I believe my strategy is more practical because it doesn't try to pick winners and losers.

That being said, either strategy is fine. We're talking about out portfolio strategies being different, not investment philosophy. We're all Bogleheads', so we all believe in the same basic investment concepts of low-cost, diversification, etc. Yet if there was a polled on strategy, we'd get a thousand different answers.

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Re: know the data before buying HY bonds

Postby nedsaid » Sat May 04, 2013 11:16 am

My take on this argument on High Yield Bonds is that your entry point into these bonds makes a lot of difference.

The wrong time to buy high yield bonds is when everyone is interested in them and chasing yield. It is a recipe for heartburn if not outright heart break. One could nibble at these now but I sure would not pile in. Buying in as part of an investment or diversification plan would be okay.

Recessions are good time to buy in when people hate these things.

What I am trying to say is that you have to pay attention to valuations.
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Re: know the data before buying HY bonds

Postby OverTheHill » Sat May 04, 2013 11:26 am

Rick Ferri wrote:
larryswedroe wrote:baseballmom
I would say fortunately it's closed (:-)) might prevent some investors from chasing yields

Best wishes
Larry


That's something about HY that Larry and I can agree on. :happy

Rick Ferri

Not really. Vanguard High Yield is open to Flagship clients. I might also add that Larry seems to have a blind spot when it comes to high yield and tilting at windmills (aka, SV).
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Re: know the data before buying HY bonds

Postby plannerman » Sat May 04, 2013 11:36 am

Let's say one has decided to reduce the duration of their bond portfolio and has a choice of exchanging Vanguard's High Yield Fund, GNMA Fund and/or Intermediate Term Investment Grade Fund into Vanguard's Short-Term Investment Grade Fund. Which would you exchange and why?

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Re: know the data before buying HY bonds

Postby The Wizard » Sat May 04, 2013 11:44 am

Rick Ferri wrote:
Baseballmom94 wrote:Okay, I get your point, Larry and Rick. :) However, I'm confused about something -- Rick, I thought that I read on one of the threads that you advocated 20% High Yield Corporate Bonds as part of an investor's bond allocation -- what fund are you referring to and are you still recommending this to be part of one's fixed income allocation? Thanks from a new Boglehead who is on a steep learning curve!


You can still buy VWEHX if you already own it. TIAA-CREF High-Yield (TIHRX) is a fair alternative.We get lower cost institutional class. IShare High Yield Bond ETF (HYG) is also available.

Rick Ferri

The TIAA-CREF HY bond fund (TIHYX), which I have access to, isn't just a fair alternative; it outpaces VWEHX in all timespans on my M* plots. I don't know if this is due to higher credit-risk bonds or not, but that's what it is.
I keep a fraction of my non-equities $$ in TIHYX...
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 1:55 pm

The Wizard wrote:The TIAA-CREF HY bond fund (TIHYX), which I have access to, isn't just a fair alternative; it outpaces VWEHX in all timespans on my M* plots. I don't know if this is due to higher credit-risk bonds or not, but that's what it is.


TIHYX has higher credit risk than VWEHX. There's no free lunch.

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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 2:30 pm

Rick Ferri wrote:If an investor were to believe that "safety" means earning a real return from their fixed income portfolio after inflation, or at least not losing real value, then a little high yield makes perfect sense in a well diversified portfolio.

Rick Ferri


Might as well replace "high yield" in the sentence above with "dividend stocks". You're just yield chasing.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 2:52 pm

Jebediah wrote:
Rick Ferri wrote:If an investor were to believe that "safety" means earning a real return from their fixed income portfolio after inflation, or at least not losing real value, then a little high yield makes perfect sense in a well diversified portfolio.

Rick Ferri


Might as well replace "high yield" in the sentence above with "dividend stocks". You're just yield chasing.


Your wrong. Owning some HY because it's part of the US bond market is not chasing yield. I've owned 20% HY in my fixed income portfolio for 15 years. When HY rose, I sold some, and when it fell, I bought some. That is not "chasing" yield.

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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 3:15 pm

Rick Ferri wrote:
Jebediah wrote:
Rick Ferri wrote:If an investor were to believe that "safety" means earning a real return from their fixed income portfolio after inflation, or at least not losing real value, then a little high yield makes perfect sense in a well diversified portfolio.

Rick Ferri


Might as well replace "high yield" in the sentence above with "dividend stocks". You're just yield chasing.


Your wrong. Owning some HY because it's part of the US bond market is not chasing yield. I've owned 20% HY in my fixed income portfolio for 15 years. When HY rose, I sold some, and when it fell, I bought some. That is not "chasing" yield.

Rick Ferri


You just got done telling us the reason to own it is to get a yield that beats inflation. This is exactly what yield chasing is, no matter how long you do it. Now you want to back up and say your reason is that it's technically part of the bond market, which you want to own in its entirety (for its own sake I guess). Ok then, how are your EM bonds, MBS, and junk doing? Are you invested in Lending Club? You can beat the hell out of inflation there if you do it right.

The point is that it's a hybrid investment with a strong correlation to equities. Call it what it is and quit hiding behind the fact that it's technically in the bond family. You do a disservice to investors by calling it just another bond when investors ought to know that HY and junk aren't just bonds, they are hybrids.
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Re: know the data before buying HY bonds

Postby Beagler » Sat May 04, 2013 3:30 pm

Jebediah wrote:
Rick Ferri wrote:If an investor were to believe that "safety" means earning a real return from their fixed income portfolio after inflation, or at least not losing real value, then a little high yield makes perfect sense in a well diversified portfolio.

Rick Ferri


Might as well replace "high yield" in the sentence above with "dividend stocks". You're just yield chasing.



Some recent comments by Mr. Bogle on dividend stocks:

"Bogle: I think it is a pretty good strategy for those willing to take the market bumps. When you think about it, what’s important when you buy for dividends is the dividend. And your annual income is what you're trying to protect. And it basically does not matter—except to your brain and your behavior—that the value of the principal is going up and down, up or down, year after year. It shouldn’t matter to you. But for an awful lot of investors, it does. The long-term fixture of dividends on the S&P 500, for example, is almost without a blemish. It’s up and up and up and up and up, an exception in the ’30s, and an exception obviously in 2008, generated almost entirely by bank stocks.

So I feel pretty comfortable that dividend streams aren't going to plummet. I think they should gradually ease up. So if people are going to be able to endure the temptation to get out when something goes way down, I think it’s worth doing this at the edges. Twenty percent—I don’t know how to give you a number, really, but I’ve never plunged into anything. The S&P is now yielding about 2 percent, so maybe you move the equity position partly into income-producing stock to get, say, as much as 3 percent, is one way to do it. So it’s all balancing out a portfolio that you can hold onto forever."
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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 3:32 pm

I agree with you that dividend stocks are a great way to chase yield.
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Re: know the data before buying HY bonds

Postby Beagler » Sat May 04, 2013 3:38 pm

Vaguard's HY fund is not as "junky" as others.



High-Yield Corp Fund Adm
Aaa 1.0%
Aa1 0.0%
Aa2 0.0%
Aa3 0.0%
A1 0.0%
A2 0.0%
A3 0.0%
Baa1 0.0%
Baa2 1.1%
Baa3 5.6%
Ba1 11.5%
Ba2 14.5%
Ba3 26.0%
B1 17.0%
B2 7.8%
B3 7.3%
Caa1 4.1%
Caa2 0.3%
Caa3 0.0%
Ca 0.0%
C 0.0%
DEFAULT 0.0%
NOT RATED 3.8%
Total 100.0%
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Re: know the data before buying HY bonds

Postby Beagler » Sat May 04, 2013 3:39 pm

Jebediah wrote:I agree with you that dividend stocks are a great way to chase yield.


Those are, obviously, Mr. Bogle's words. Not mine.

In case you missed it, here are his thoughts on TBM. http://www.morningstar.com/cover/videoc ... ?id=592689
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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 3:52 pm

Not as junky should be a bad thing right? If we want credit risk, then why not more of it? Point is it's not well rewarded regardless of whether it's watered down or not, and much more correlated to equities than term risk.
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Re: know the data before buying HY bonds

Postby Dale_G » Sat May 04, 2013 4:17 pm

Jebediah wrote:
You just got done telling us the reason to own it is to get a yield that beats inflation. This is exactly what yield chasing is, no matter how long you do it.

snip .......The point is that it's a hybrid investment with a strong correlation to equities . ......when investors ought to know that HY and junk aren't just bonds, they are hybrids.


I've owned Vanguard High Yield continuously for 18 years, typically 15% of the bond portfolio, with the recognition that it sometimes exhibits equity characteristics. And yes, I definitely prefer to own investments that are likely to beat inflation.

Hybrid? So what. Someone looking at the performance of my Roth (which contains Total Stock and Total Bond) would think it contained a hybrid fund. I'm sure many Bogleheads won't want to give up their Wellington or Wellesley funds because they are hybrids.

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Re: know the data before buying HY bonds

Postby nisiprius » Sat May 04, 2013 4:33 pm

Rick Ferri wrote:
The Wizard wrote:The TIAA-CREF HY bond fund (TIHYX), which I have access to, isn't just a fair alternative; it outpaces VWEHX in all timespans on my M* plots. I don't know if this is due to higher credit-risk bonds or not, but that's what it is.
TIHYX has higher credit risk than VWEHX. There's no free lunch.--Rick Ferri
Risk, return, and lunch. What sort of lunch does High-Yield itself provide? A $10,000 investment on 12/31/2007 in VWEHX would have dropped to a low point of $7,257.

One in Total Stock, VTSMX, to $5,173. One in Total Bond, to $9,810. Clearly, by any measure, the high-yield bond fund was considerably riskier than investment-grade bonds. Not just a little, a lot.

Image

If we do the math and ask "what mixture of stocks and bonds would have had the same drop as VWEHX," on the day VTSMX was $5,173, Total Bond was $10,388, and accordingly... you could have had a mixture of 60% Total Stock + 40% Total Bond, and... if unrebalanced...

...it would have dropped to 60% * 5,173 + 40% * 10,388 = $7,259, or about the same amount as VWEHX did.

If we add a couple of real-world funds with about that mix--Balanced Index and Wellington--we find that they dropped further than that--to $6,898 and $6,873--due to the effect of rebalancing. But still, 60/40 is roughly similar in risk to high-yield bonds. If we add a couple of funds with lower stock allocations--Wellesley Income and LifeStrategy income--we find that those two funds dropped much less than High-Yield did.

Image

So: 60/40, Balanced Index and Wellington, a little more risky than High Yield but not a lot more risky. Wellesley, about 40/60, and LifeStrategy, about 30/70, much less risky. Go back to the earliest point of the youngest fund, LifeStrategy Income:

Image

Overall, it looks to me as if the two funds with about the same risk as High-Yield did much better. Wellesley, which clearly had much lower risk, did much better. And LifeStrategy Income had far lower risk--look how smooth the purple line is compared with High-Yield, blue--did a little worse.

Overall, I see no evidence at all for the risk-reward of High Yield as being better than for a simple mix of stocks and investment-grade bonds. That is, no evidence that adding high-yield is going to be any better than just upping stock allocation.

Now it may be true that High-Yield doesn't behave exactly the same way as a mixture of stock and investment-grade bonds and thus contributes a smidgeon of diversification effect to a portfolio. But broadly, exactly the same factors that cause stock declines cause high-yield declines, so they aren't hugely different.

In order to go back as far as we can, I'm just going to show High-Yield, Wellington, and Wellesley. Yes, it's a pity there isn't a suitable index fund. Wellington and Wellesley do not hold any junk bonds, at least not currently; Morningstar is showing them as strictly investment-grade, lowest held by either fund is BBB.

It is obvious that mixing High-Yield with either Wellington or Wellesley would have been, overall, a drag on return. The question is: when would it have helped? Where is either of those funds going down that High-Yield is doing up? Where would it had a smoothing benefit from diversification? It may be there in some numerical analysis, but to the naked eye it is awfully hard to see.

Image
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Re: know the data before buying HY bonds

Postby Beagler » Sat May 04, 2013 4:36 pm

Dale_G wrote:
Jebediah wrote:
You just got done telling us the reason to own it is to get a yield that beats inflation. This is exactly what yield chasing is, no matter how long you do it.

snip .......The point is that it's a hybrid investment with a strong correlation to equities . ......when investors ought to know that HY and junk aren't just bonds, they are hybrids.


I've owned Vanguard High Yield continuously for 18 years, typically 15% of the bond portfolio, with the recognition that it sometimes exhibits equity characteristics. And yes, I definitely prefer to own investments that are likely to beat inflation.

Hybrid? So what. Someone looking at the performance of my Roth (which contains Total Stock and Total Bond) would think it contained a hybrid fund. I'm sure many Bogleheads won't want to give up their Wellington or Wellesley funds because they are hybrids.

Dale


Utility stocks have hybrid (bond-like) attributes. Should they be expunged from TSM? :)
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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 5:06 pm

Hybrid-risk products are not necessarily a problem. The problem is that investors want to kid themselves that they can get extra yield in their bonds and still consider it part of the 'safe side' of their portfolio. As nisiprius demonstrates, there is no point to taking this risk in credit when you could do so in beta. It's neither efficient in the portfolio or well-rewarded. So what's the reason to do it anyway? "I want my bonds to beat inflation!" I get the lure, but thinking that way is taking your eye off the ball-- the ball being investing for exposure to well-rewarded, well-known, and efficient risk factors, and not just a jones for yield.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 5:22 pm

Jebediah wrote:The point is that it's a hybrid investment with a strong correlation to equities. Call it what it is and quit hiding behind the fact that it's technically in the bond family. You do a disservice to investors by calling it just another bond when investors ought to know that HY and junk aren't just bonds, they are hybrids.


You're definition of hybrid is incorrect. Convertible bonds are a hybrid security. They are composed of a bond with equity option. This is very different than HY bonds. High yield bonds are not a hybrid investments. There are not created by putting debt and equity together. Just because the return of HY falls between stocks and Treasury bonds over the long-term doesn't make a hybrid of stocks Treasury bonds.There have been long periods when HY outperforms both stocks and bonds, which could never happen with a hybrid security.

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Re: know the data before buying HY bonds

Postby pkcrafter » Sat May 04, 2013 5:35 pm

From what I've read, high-yield bonds tend to hold up well in rising rate environments. There are many references supporting this on the web--here's one from PIMCO.

In a rising rate environment, as would be expected in the recovery phase of the economic cycle, high yield bonds would be expected to outperform many other fixed income classes.


http://www.pimco.com/EN/Education/Pages/TheRoleofHighYieldBonds.aspx

Also consider the duration of Vanguard's high-yield bond fund is a moderate 4.35. Bottom line: High-yield reacts differently than high quality bonds and are therefore a diversifier and a reasonable choice for a portfolio, but they also tend to have equity-like qualities in market drops, and that needs to be taken into account as well.

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Re: know the data before buying HY bonds

Postby nisiprius » Sat May 04, 2013 5:38 pm

Rick Ferri wrote:There have been long periods when HY outperforms both stocks and bonds, which could never happen with a hybrid security.
I do see an impressive three-year period, 1991 through 1993, inclusive.

What are some others we should know about?

I don't see other places where Vanguard High Yield (blue) is obviously rising faster than Wellesley (orange, 40% stocks) or Wellington (green, 60% stocks). Mostly, it's rising slower. A hefty 15% (total, not annualized) better than Wellesley or Wellington over those three years, but for the most part not before that and not after that.

Image
Image

If we start the race in 1991, allow high yield to start out with that period of outperformance, it gets well ahead--but the others are caught up by 2000 and then pass it.

Image
Last edited by nisiprius on Sat May 04, 2013 5:50 pm, edited 2 times in total.
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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 5:48 pm

Rick Ferri wrote:
Jebediah wrote:The point is that it's a hybrid investment with a strong correlation to equities. Call it what it is and quit hiding behind the fact that it's technically in the bond family. You do a disservice to investors by calling it just another bond when investors ought to know that HY and junk aren't just bonds, they are hybrids.


You're definition of hybrid is incorrect. Convertible bonds are a hybrid security. They are composed of a bond with equity option. This is very different than HY bonds. High yield bonds are not a hybrid investments. There are not created by putting debt and equity together. Just because the return of HY falls between stocks and Treasury bonds over the long-term doesn't make a hybrid of stocks Treasury bonds.There have been long periods when HY outperforms both stocks and bonds, which could never happen with a hybrid security.

Rick Ferri


Yes I was using the term loosely to refer to the hybrid credit and term risks. Since credit on that scale correlates well with beta, HY bonds are sometimes considered to have an equity-like component and hybrid in that sense. I concede the technical point.
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Re: know the data before buying HY bonds

Postby Jebediah » Sat May 04, 2013 6:14 pm

pkcrafter wrote:From what I've read, high-yield bonds tend to hold up well in rising rate environments. There are many references supporting this on the web--here's one from PIMCO.

In a rising rate environment, as would be expected in the recovery phase of the economic cycle, high yield bonds would be expected to outperform many other fixed income classes.


http://www.pimco.com/EN/Education/Pages/TheRoleofHighYieldBonds.aspx
Paul


I think you misunderstand that quote. They are touting the typically short durations that HY bonds have, thus less term risk than say 10 year T-notes. Anything with less term risk holds up better in a rising rate environment.

Here is the entire paragraph, for context:

Relatively low duration. Low duration, or sensitivity to changes in interest rates, tends to lower volatility. One reason high yield bonds often have relatively low duration is that they tend to have shorter maturities; they are typically issued with terms of 10 years or less and are often callable after four or five years. Generally, high yield bond prices are much more sensitive to the economic outlook and corporate earnings than to day-to-day fluctuations in interest rates. In a rising rate environment, as would be expected in the recovery phase of the economic cycle, high yield bonds would be expected to outperform many other fixed income classes. That said, the high yield sector does not demand great economic times; most issuers may function very well and continue to reliably service their debt in a low growth environment.

The "piece" (cough, marketing material) also says this:

Equity-like long-term return potential. High yield bonds and equities tend to respond in a similar way to the overall market environment, which can lead to similar return profiles over a full market cycle.

Notice how they use the words "return" and "risk" selectively. When we're talking about HY's equity-like characteristics (what I mean by "hybrid"), they talk about return. When discussing the lowish durations of HY, they talk about risk.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sat May 04, 2013 7:06 pm

Jebediah wrote:Since credit on that scale correlates well with beta, HY bonds are sometimes considered to have an equity-like component and hybrid in that sense. I concede the technical point.


Over the long-term, the correlation of credit risk and equity is is positive , but it's not always positive. You can look at the variability of the correlation using a rolling 3-year averarge and see that there are periods where little correlation existed, which I did for my All About Asset Allocation book. Let's look at another example. Real estate prices correlate with the stock market over the long-term also, but that doesn't make real estate and common stocks that same thing. A rolling correlation shows the REITs and common stocks have had negative correlation at times.

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Re: know the data before buying HY bonds

Postby Beagler » Sat May 04, 2013 7:16 pm

The fund holds $18 billion in assets. Not too shabby for a class of bonds held in such disdain by some.
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Re: know the data before buying HY bonds

Postby Dale_G » Sat May 04, 2013 7:27 pm

Beagler wrote:The fund holds $18 billion in assets. Not too shabby for a class of bonds held in such disdain by some.
https://personal.vanguard.com/us/funds/ ... =INT#tab=0


And 70% is held in the form of Admiral shares. Not too likely held by widows and orphans down to their last thousand dollars.

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Re: know the data before buying HY bonds

Postby larryswedroe » Sun May 05, 2013 8:52 am

Over the long-term, the correlation of credit risk and equity is is positive , but it's not always positive.


Of course this is true and it's why you should ignore HY, because the correlation has a nasty tendency to rise towards one just at exactly the wrong time, increasing the tail risks Certainly hurting those in withdrawal phase.


Pretty smart guy named David Swensen provided this advice in his book Unconventional Success
Well-informed investors avoid the no-win consequences of high-yield fixed income investing

Best wishes
Larry
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Re: know the data before buying HY bonds

Postby BlueEars » Sun May 05, 2013 11:01 am

Rick Ferri wrote:There are two schools of thought. Larry's school says take risk with equity and invest the rest in "safe" fixed income and leave "riskier" bonds out such as high yield and mortgages. My school is to have a total-total bond market portfolio that includes all asset classes, and then set the portfolio risk based on this portfolio. I believe my strategy is more practical because it doesn't try to pick winners and losers.

That being said, either strategy is fine. We're talking about out portfolio strategies being different, not investment philosophy. We're all Bogleheads', so we all believe in the same basic investment concepts of low-cost, diversification, etc. Yet if there was a polled on strategy, we'd get a thousand different answers.

Rick Ferri

This sounds like a reasonable approach. Rick, when you recommend a portfolio with HY as one component do you stress test it with a 1930's type scenario? How does it hold up to a more traditional 60/40 portfolio of diversified equities and bonds rated mostly at or above Baa?

I'm most concerned about a 2008-2009 decline that didn't stop in March 2009 but just continued like in the 1930's ... tail risk. I'm open minded in including HY in a portfolio.
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Re: know the data before buying HY bonds

Postby louis c » Sun May 05, 2013 12:58 pm

nisiprius wrote:
Rick Ferri wrote:There have been long periods when HY outperforms both stocks and bonds, which could never happen with a hybrid security.
I do see an impressive three-year period, 1991 through 1993, inclusive.

What are some others we should know about?

I don't see other places where Vanguard High Yield (blue) is obviously rising faster than Wellesley (orange, 40% stocks) or Wellington (green, 60% stocks). Mostly, it's rising slower. A hefty 15% (total, not annualized) better than Wellesley or Wellington over those three years, but for the most part not before that and not after that.

Image
Image

If we start the race in 1991, allow high yield to start out with that period of outperformance, it gets well ahead--but the others are caught up by 2000 and then pass it.

Image



Nisi, I hope I know you well enough to say you are not predicting the same relative "underperformance" into the future.

That said, I do see a number of other, albeit shorter, periods during which HY outperformed. In any case you already made my point: HY performs differently than other classes. I will add it also generates a real return. Therefore, if I am contemplating portfolio composition for a long term horizon, HY is worthy of my consideration. I don't fault anyone for deciding not to include it, and I will accept the caution concerning risk specific to the withdrawal phase, but I fail to see why HY is not considered by critics to be a distinctly performing asset. Your own chart shows it is. How does that not help add asset diversification to a portfolio?

Regarding other posts, I have not heard Larry say it does not generate a real return, and if I understand him correctly, his primary concern is that the risk/reward is not attractive relative to other (but fewer in total) asset alternatives. I don't think the risk/reward is attractive for T-Bills versus CDs, but I would not tell someone not to include them in a portfolio. Why? Because they provide asset diversification. In fact, I would be more inclined to exclude T-Bills than HY based on the argument they are more likely to fail at generating a real return after inflation and taxes. No one I know would consider HY to be just like investment grade bonds, nor would they not make a risk adjustment to account for it.
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Re: know the data before buying HY bonds

Postby Beagler » Sun May 05, 2013 1:23 pm

larryswedroe wrote:Pretty smart guy named David Swensen provided this advice in his book Unconventional Success
Well-informed investors avoid the no-win consequences of high-yield fixed income investing

Best wishes
Larry


Swensen also advises against investing in municipal bonds (with the exception of money market muni funds). In his books I saw no exception for the types of high-quality munis BAM favors. It would seen inconsistent to take Swensen's advice cafteria-style.
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Re: know the data before buying HY bonds

Postby Rick Ferri » Sun May 05, 2013 2:26 pm

There is another discussion on high yield bonds going on under this conversation: What is the consensus on High Yield Bond Funds?

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