Grok's tip #14: Avoid long-term corporate bonds

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Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 4:56 pm

Grok's Tip #14: Avoid long-term corporate bonds

It's a tough fixed income investing environment out there, no question. Bond yields are brutally low with the 10 year treasury yield under 2% and t-bills yielding 0%. There has been a lot of talk about corporate bonds, and in particular some may think that long-term corporate bonds, with yields of around 4.5%, might be worth a look. Apple for example recently sold 30 year corporate bonds at a yield of 3.88% which was a spread over treasuries of 100 bps. Investors were so excited about the offering that it was 3 times oversubscribed.  

http://www.fool.com/retirement/general/ ... stors.aspx

Vanguard introduced a long term corporate bond ETF in late 2009 and the returns have been very good, averaging 12% annual return since inception. So should you dive in?

My advice: stay away!

To understand why, let's look at the long term returns. Over the past 40 years, the average annual return since inception of the Barclays long term corporate bond index was 8.88%.  Not too shabby. But wait- what was the return over the same period of the long-term treasury index? You guessed it, almost exactly the same, it clocked in at 8.78%. And of course you can buy and hold treasuries directly at no cost. Whereas even the ultra-low cost Vanguard ETF charges 12 bps annually- so after costs the corporate bonds lagged by 2bps.

So basically, over this long 40 year period investors received no compensation for bearing all the extra risks of corporate bonds, credit risk, liquidity risk, etc.

So why is investing in long-term corporate bonds a mug's game? Who knows? My own view is that it may have something to do with the limited life-span of corporations. See this link for example

http://www.innosight.com/innovation-res ... al2012.pdf

The chart shows that the average lifespan of a company in the S&P 500 index has declined from around 30 years in the mid '70s to less than 15 years today. It's a volatile uncertain world out there and getting more so. 

But wait, you say, doesn't the same argument apply to equity index investing? The difference I think is a fundamental one between stock and bond investing. With stocks you have unlimited upside. So if a few companies fail, that can be more than compensated for by the companies whose value skyrockets like Google, and well, I guess Apple! But on the bond side, your upside is capped. When you are only getting a measly 1% per year over treasuries it only takes one Enron to ruin the return for your whole bond portfolio.

So skip long-term corporate bonds! Take your risk on the equity side!
Last edited by grok87 on Thu May 16, 2013 11:55 pm, edited 2 times in total.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby LadyGeek » Thu May 16, 2013 7:23 pm

Tip #14 is in the wiki. See: Grok's tips for the complete list.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby learning_head » Thu May 16, 2013 8:47 pm

Thank you grok! Very timely and useful IMO! Hope this will be an interesting thread and I recently was wondering under what cases would folks here recommend investing in these.

Regarding reasons - Swensen, in his book, describes why to avoid any corporate bonds, and one basic reason is that it is not an even playing field. According to him, sellers are much more sophisticated / knowledgeable than buyers for whatever reasons in that market. I don't recall exactly why (after all, buyers include large institutions, insurance companies, etc but he provides the reasons in the book and discusses that this is how the system is setup). One interesting point I recall he mentions is that good bond buyers have to be good at both equity analysis (to analyze company risks), AND bond analysis. However, it's much more lucrative to be in equity trading than fixed income trading, so anyone who is good in equity side analysis just goes there and bond side folks are not as good. I thought buying bonds would be simpler, but apparently I was wrong...

Another reason - company management has opposite interests to their bond buyers but at least to some degree in-line interests with their equity buyers. (For treasuries, on the other hand, he argues government's interests are more in line with the buyers.)

Another reason he had mentioned for things to watch out is "callability" conditions; i.e. bond condition allowing company to pay out early. This is clearly a one-sided advantage to the seller and not the buyer. So, if rates rise, issuers hold on to cheap debt; else they effectively refinance. There are practically no bonds out there sold with opposite conditions ("puttability"). For similar reasons he had warned about investing mortgage based securities or their any derivatives / gnma's / etc...
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby Munir » Thu May 16, 2013 9:05 pm

Question to Grok: why do you think does Jack Bogle recommend intermediate to long corporate bonds?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 9:59 pm

Munir wrote:Question to Grok: why do you think does Jack Bogle recommend intermediate to long corporate bonds?

Hi Munir,
I was not aware that he recommended long corporate bonds. Do you have a source/reference?
cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 10:01 pm

learning_head wrote:Thank you grok! Very timely and useful IMO! Hope this will be an interesting thread and I recently was wondering under what cases would folks here recommend investing in these.

Regarding reasons - Swensen, in his book, describes why to avoid any corporate bonds, and one basic reason is that it is not an even playing field. According to him, sellers are much more sophisticated / knowledgeable than buyers for whatever reasons in that market. I don't recall exactly why (after all, buyers include large institutions, insurance companies, etc but he provides the reasons in the book and discusses that this is how the system is setup). One interesting point I recall he mentions is that good bond buyers have to be good at both equity analysis (to analyze company risks), AND bond analysis. However, it's much more lucrative to be in equity trading than fixed income trading, so anyone who is good in equity side analysis just goes there and bond side folks are not as good. I thought buying bonds would be simpler, but apparently I was wrong...

Another reason - company management has opposite interests to their bond buyers but at least to some degree in-line interests with their equity buyers. (For treasuries, on the other hand, he argues government's interests are more in line with the buyers.)

Another reason he had mentioned for things to watch out is "callability" conditions; i.e. bond condition allowing company to pay out early. This is clearly a one-sided advantage to the seller and not the buyer. So, if rates rise, issuers hold on to cheap debt; else they effectively refinance. There are practically no bonds out there sold with opposite conditions ("puttability"). For similar reasons he had warned about investing mortgage based securities or their any derivatives / gnma's / etc...

THanks learning_head-I'm a big fan of Swensen's as well and I think all the above points make sense.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby Artsdoctor » Thu May 16, 2013 10:05 pm

Hi, Munir,

I don't think Jack Bogle went so far as to recommend long corporates. He's been advocating a true corporate index fund and he's advocated an institutional share class of intermediate corporates specifically. I think Grok is talking about true long bonds; for example, the estimated duration in Vanguard's intermediate corporate ETF is 6.5 years while the long-term corporate ETF has an estimated duration of 14.0 years. That's quite a difference and in this environment, the long bond fund exposes holders to significant interest rate risk.

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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby jginseattle » Thu May 16, 2013 10:07 pm

Only short-term credits have sufficiently rewarded investors. But, as Ilmanen says, they're risky with the worst losses occurring during bad times.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby LadyGeek » Thu May 16, 2013 10:09 pm

grok87 wrote:
Munir wrote:Question to Grok: why do you think does Jack Bogle recommend intermediate to long corporate bonds?

Hi Munir,
I was not aware that he recommended long corporate bonds. Do you have a source/reference?
cheers,

Hi grok,

I did a quick forum search. Here's a recent thread: Bogle again calls for a total corporate bond fund, the direct article link: Bogle: ‘Total’ Corporate Bond Fund Needed
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 10:22 pm

Artsdoctor wrote:Hi, Munir,

I don't think Jack Bogle went so far as to recommend long corporates. He's been advocating a true corporate index fund and he's advocated an institutional share class of intermediate corporates specifically. I think Grok is talking about true long bonds; for example, the estimated duration in Vanguard's intermediate corporate ETF is 6.5 years while the long-term corporate ETF has an estimated duration of 14.0 years. That's quite a difference and in this environment, the long bond fund exposes holders to significant interest rate risk.

Artsdoctor

Thanks Artsdoctor- all that seems right.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 10:32 pm

LadyGeek wrote:
grok87 wrote:
Munir wrote:Question to Grok: why do you think does Jack Bogle recommend intermediate to long corporate bonds?

Hi Munir,
I was not aware that he recommended long corporate bonds. Do you have a source/reference?
cheers,

Hi grok,

I did a quick forum search. Here's a recent thread: Bogle again calls for a total corporate bond fund, the direct article link: Bogle: ‘Total’ Corporate Bond Fund Needed

Thanks LadyGeek,
This source may be helpful.
https://indices.barcap.com/index.dxml
if one looks at the various credit indices available, the durations are

U.S. Credit 7.07

1-3 Yr Credit 2.04

U.S. Intermediate Credit 4.49

U.S. Long Credit A 14.13

So I think Mr. Bogle may be advocating a Total Corporate Bond fund which would correspond (roughly) to the U.S. Credit Index which has a duration of 7.07 years. That's quite different that the US Long Credit Index which has a duration of 14.13 years.

Also in case anyone is wondering about the difference between Credit and Corporate it has to do with entities like provinces and states that issue taxable bonds and are not considered sovereigns- i.e. they have credit risk, even though they are not corporations.

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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 16, 2013 10:41 pm

jginseattle wrote:Only short-term credits have sufficiently rewarded investors. But, as Ilmanen says, they're risky with the worst losses occurring during bad times.

Agree.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby Munir » Fri May 17, 2013 12:55 am

grok87 wrote:
LadyGeek wrote:
grok87 wrote:
Munir wrote:Question to Grok: why do you think does Jack Bogle recommend intermediate to long corporate bonds?

Hi Munir,
I was not aware that he recommended long corporate bonds. Do you have a source/reference?
cheers,

Hi grok,

I did a quick forum search. Here's a recent thread: Bogle again calls for a total corporate bond fund, the direct article link: Bogle: ‘Total’ Corporate Bond Fund Needed

Thanks LadyGeek,
This source may be helpful.
https://indices.barcap.com/index.dxml
if one looks at the various credit indices available, the durations are

U.S. Credit 7.07

1-3 Yr Credit 2.04

U.S. Intermediate Credit 4.49

U.S. Long Credit A 14.13

So I think Mr. Bogle may be advocating a Total Corporate Bond fund which would correspond (roughly) to the U.S. Credit Index which has a duration of 7.07 years. That's quite different that the US Long Credit Index which has a duration of 14.13 years.

Also in case anyone is wondering about the difference between Credit and Corporate it has to do with entities like provinces and states that issue taxable bonds and are not considered sovereigns- i.e. they have credit risk, even though they are not corporations.

cheers,


Agree with all above comments. My statement was too general and vague. My memory of what Bogle said (sorry-I don't have a reference) is that he recommended corporate bonds longer than intermediate and shorter than long term i.e. somehwere in between. Artsdoctor and LadyGeek came to my rescue and I interperet grok's comments as agreeing too.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby louis c » Fri May 17, 2013 10:29 am

I will take a stab at paraphrasing Mr. Bogle's comments ...He discussed corporate bonds on at least two different occasions.. in one he pointed out that the aggregate bond index has become over-weighted in treasuries due to QE, and no longer accurately reflected the composition of the total bond market. In the other, he suggested that investors who were looking for a bit more yield and willing to take a bit more risk could increase their holdings of corporate bonds because the spread between corporates and treasuries was attractive due to QE. I did not find any reference to long term bonds but I think intermediates.

Sources:

http://www.morningstar.com/cover/videoc ... ?id=592689

viewtopic.php?f=10&t=101344
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Sat May 18, 2013 11:30 am

louis c wrote:I will take a stab at paraphrasing Mr. Bogle's comments ...He discussed corporate bonds on at least two different occasions.. in one he pointed out that the aggregate bond index has become over-weighted in treasuries due to QE, and no longer accurately reflected the composition of the total bond market. In the other, he suggested that investors who were looking for a bit more yield and willing to take a bit more risk could increase their holdings of corporate bonds because the spread between corporates and treasuries was attractive due to QE. I did not find any reference to long term bonds but I think intermediates.

Sources:

http://www.morningstar.com/cover/videoc ... ?id=592689

viewtopic.php?f=10&t=101344

Thanks louis!
I mean no disrespect to Mr. Bogle whom I greatly admire, but I am not really in agreement with investing in a "total corporate bond" fund. I basically agree with jginseattle that the only corporate bonds that have historically provided conmpensation for credit risk/liquidity risk are short term ones. And that even then it may not be worth it because of portfolio effect- ie the losses tend to show up at the same time as stock losses.

I'll try to post some more data on these points later.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby jmk » Sat May 18, 2013 7:37 pm

grok87 wrote:Over the past 40 years, the average annual return since inception of the Barclays long term corporate bond index was 8.88%.  Not too shabby. But wait- what was the return over the same period of the long-term treasury index? You guessed it, almost exactly the same, it clocked in at 8.78%. And of course you can buy and hold treasuries directly at no cost. Whereas even the ultra-low cost Vanguard ETF charges 12 bps annually- so after costs the corporate bonds lagged by 2bps.
So basically, over this long 40 year period investors received no compensation for bearing all the extra risks of corporate bonds, credit risk, liquidity risk, etc.


In theory this makes sense, but in practice there has been about the same returns with noticeably less volatility in corporate long term bonds than in long term treasuries. Looking at the Ibbotson annual returns 1926-2008 supplemented by the Vanguard long-term corporate and treasury funds 2009-2012 we find:

Code: Select all
1926-2012:
.................................. Mean.....Geo... SD... Max Down ... ....Max Up
Long term corporate bonds (20y):..6.5.......6.2....8.3.....-8.1 (1969)....  42.6 (1982)
Long term government bond (20y): .6.2......5.7 ...9.7.....-11.9 (2009).... 40.4 (1982)


So, taking a longer history, the advantage cuts to corporates in terms of maximum drawdown, sd, and returns. I'm not sure why this is, frankly.

None of which is to say one should invest in long-term bonds of either kind versus more equities, of course. Based on the Ibbotson data, a 50% SP500 /%50-Intermediate (5y) Treasury mix would be almost identical to a 42%SP500, 58% LTCorp mix in this period in terms of returns and volatility. But what would be the advantage of the latter?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Sat May 18, 2013 9:06 pm

jkandell wrote:
grok87 wrote:Over the past 40 years, the average annual return since inception of the Barclays long term corporate bond index was 8.88%.  Not too shabby. But wait- what was the return over the same period of the long-term treasury index? You guessed it, almost exactly the same, it clocked in at 8.78%. And of course you can buy and hold treasuries directly at no cost. Whereas even the ultra-low cost Vanguard ETF charges 12 bps annually- so after costs the corporate bonds lagged by 2bps.
So basically, over this long 40 year period investors received no compensation for bearing all the extra risks of corporate bonds, credit risk, liquidity risk, etc.


In theory this makes sense, but in practice there has been higher returns with less volatility in corporate long term bonds than in long term treasuries. Looking at the Ibbotson annual returns 1926-2008 supplemented by the Vanguard long-term corporate and treasury funds 2009-2012 we find:

Code: Select all
1926-2012:
.................................. Mean.....Geo... SD... Max Down ... ....Max Up
Long term corporate bonds (20y):..6.5.......6.2....8.3.....-8.1 (1969)....  42.6 (1982)
Long term government bond (20y): .6.2......5.7 ...9.7.....-11.9 (2009).... 40.4 (1982)


So, taking a longer history, the advantage cuts to corporates in terms of maximum drawdown, sd, and returns. (This, of course, says nothing how either mixes into a larger portfolio.)

None of which is to say one should invest in long-term bonds of either kind versus more equities, of course. Based on the Ibbotson data, a 50% SP500 /%50-Intermediate (5y) Treasury mix would be almost identical to a 42%SP500, 58% LTCorp mix in this period in terms of returns and volatility. But what would be the advantage of the latter? And with current yields it's even harder to make a case for using corporate bonds for risk over more equities.


Hmm...that's very interesting. Thanks for posting. So for 1926-2012 (an 87 year period) Long corporates outperformed treasuries by 50 bps while for 1973-mid 2013 (say a 40 year period) they outperformed treasuries by just 10 bps. So long corporates may perhaps have decently outperformed treasuries for the first 47 years of the period- I think by about 84 bps or so. In other words I think the math is roughly:

50 bps excess return (1926-2012) =
(84 bp excess return * 47 years + 10 bp excess return * 40 years)/87 years.

Not exact math of course but probably close enough.

So that ties back to the Innosight study I linked to. Perhaps 50-75 years ago long term corporates were a better bet, i.e. more likely to deliver a decent excess return. But they certainly don't seem to have done so recently (last 40 years), even without going into portfolio mathematics. Maybe that has something to do with the lifespan of corporations being shorter now than in the past. Or maybe in the old days it was tougher for corporations to issue long term bonds, so only the really best ones could.
All I can say is it makes me nervous how people snapped up those 30 year Apple bonds at 100 bps over treasuries.
Nike issued even tighter at just 75 bps
http://www.highyieldbond.com/2013/04/
do we really think these companies will be around in 30 years? how many companies from 30 years ago are still around today?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby jmk » Sat May 18, 2013 9:40 pm

grok87 wrote:Hmm...that's very interesting. Thanks for posting. So for 1926-2012 (an 87 year period) Long corporates outperformed treasuries by 50 bps while for 1973-mid 2013 (say a 40 year period) they outperformed treasuries by just 10 bps. So long corporates may perhaps have decently outperformed treasuries for the first 47 years of the period- I think by about 84 bps or so. In other words I think the math is roughly:
50 bps excess return (1926-2012) =
(84 bp excess return * 47 years + 10 bp excess return * 40 years)/87 years. ...
So that ties back to the Innosight study I linked to. Perhaps 50-75 years ago long term corporates were a better bet, i.e. more likely to deliver a decent excess return. But they certainly don't seem to have done so recently (last 40 years), even without going into portfolio mathematics. Maybe that has something to do with the lifespan of corporations being shorter now than in the past. Or maybe in the old days it was tougher for corporations to issue long term bonds, so only the really best ones could.


Again, the Ibbotson data doesn't match that. For what it's worth, the last forty years, 1973-2008, Ibbottson returns (which don't take into account expense ratios), supplemented by Vanguard funds 2009-2012 are:
Code: Select all
1973-2012
Long term 20y corporate bonds: mean 9.5; sd 10.2, max down, -7.4; max up 42.6
Long term 20y govt bonds: mean 9.6; sd 12.2; max down -11.9; max up 40.4.


So the long term corporate and treasuries are pretty identical over the last forty years too. (The SD difference narrows a bit.) The "bad" years tend to match in the two indexes, but, e.g. 2009 Vanguard LT treasury lost 11.93% whereas the Vanguard long-term corporate index gained 8.89%.

Don't take this to mean I disagree with your larger point.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Sat May 18, 2013 9:46 pm

jkandell wrote:
grok87 wrote:Hmm...that's very interesting. Thanks for posting. So for 1926-2012 (an 87 year period) Long corporates outperformed treasuries by 50 bps while for 1973-mid 2013 (say a 40 year period) they outperformed treasuries by just 10 bps. So long corporates may perhaps have decently outperformed treasuries for the first 47 years of the period- I think by about 84 bps or so. In other words I think the math is roughly:
50 bps excess return (1926-2012) =
(84 bp excess return * 47 years + 10 bp excess return * 40 years)/87 years. ...
So that ties back to the Innosight study I linked to. Perhaps 50-75 years ago long term corporates were a better bet, i.e. more likely to deliver a decent excess return. But they certainly don't seem to have done so recently (last 40 years), even without going into portfolio mathematics. Maybe that has something to do with the lifespan of corporations being shorter now than in the past. Or maybe in the old days it was tougher for corporations to issue long term bonds, so only the really best ones could.


Again, the Ibbotson data doesn't match that. For what it's worth, the last forty years, 1973-2008, Ibbottson returns (which don't take into account expense ratios), supplemented by Vanguard funds 2009-2012 are:
Code: Select all
1973-2012
Long term 20y corporate bonds: mean 9.5; sd 10.2, max down, -7.4; max up 42.6
Long term 20y govt bonds: mean 9.6; sd 12.2; max down -11.9; max up 40.4.


So the long term corporate and treasuries are pretty identical over the last forty years too. (The SD difference narrows a bit.) The "bad" years tend to match in the two indexes, but, e.g. 2009 Vanguard LT treasury lost 11.93% whereas the Vanguard long-term corporate index gained 8.89%.

Don't take this to mean I disagree with your larger point.

thanks. No I think your ibbotson data is confirming my barclays index data. I agree that long term corporate bonds and long term government bonds had the same return for the past 40 years (that was the point of my original post). What i was trying to say in response to your post is that I think long term corporate bonds outperformed long term treasuries by 84 bps on average per year for the period 1926-1973.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby RyeWhiskey » Sun May 19, 2013 12:12 am

All data below from M*:
Image

Blue = Vanguard Long Term Treasury Index VUSTX
Orange = Vanguard Long Term Investment Grade Index VWESX

Over the past 15 years it seems as though VUSTX was more volatile (SD: 10.29) than VWESX (SD: 9.11) as well. And "overall," Morningstar gives them both Average return and risk ratings. So, given that VUSTX is yielding 2.79% and VWESX is yielding 4.45%... the choice seems obvious for the investor with a bond horizon beyond 20 years.

Furthermore, looking at Vanguard's website now, VWESX has a shorter duration (13.9 yrs vs. 15.5 yrs). Vanguard also ranks them equally in terms of risk.

I'm not saying that they are equally risky assets, the Treasuries are obviously a safer choice. But the yield spread is pretty significant at the moment, perhaps enough to compensate for that extra risk?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby Munir » Sun May 19, 2013 1:51 am

RyeWhiskey wrote:All data below from M*:
Image

Blue = Vanguard Long Term Treasury Index VUSTX
Orange = Vanguard Long Term Investment Grade Index VWESX

Over the past 15 years it seems as though VUSTX was more volatile (SD: 10.29) than VWESX (SD: 9.11) as well. And "overall," Morningstar gives them both Average return and risk ratings. So, given that VUSTX is yielding 2.79% and VWESX is yielding 4.45%... the choice seems obvious for the investor with a bond horizon beyond 20 years.

Furthermore, looking at Vanguard's website now, VWESX has a shorter duration (13.9 yrs vs. 15.5 yrs). Vanguard also ranks them equally in terms of risk.

I'm not saying that they are equally risky assets, the Treasuries are obviously a safer choice. But the yield spread is pretty significant at the moment, perhaps enough to compensate for that extra risk?


I wonder if the graphs for Vanguard Intermediate Investment Grade (VFIDX) and Vanguard Intermediate Treasury (VFIUX) will look the same in relation to each other as the long term graphs did?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Tue May 21, 2013 10:04 pm

RyeWhiskey wrote:All data below from M*:
Image

Blue = Vanguard Long Term Treasury Index VUSTX
Orange = Vanguard Long Term Investment Grade Index VWESX

Over the past 15 years it seems as though VUSTX was more volatile (SD: 10.29) than VWESX (SD: 9.11) as well. And "overall," Morningstar gives them both Average return and risk ratings. So, given that VUSTX is yielding 2.79% and VWESX is yielding 4.45%... the choice seems obvious for the investor with a bond horizon beyond 20 years.

Furthermore, looking at Vanguard's website now, VWESX has a shorter duration (13.9 yrs vs. 15.5 yrs). Vanguard also ranks them equally in terms of risk.

I'm not saying that they are equally risky assets, the Treasuries are obviously a safer choice. But the yield spread is pretty significant at the moment, perhaps enough to compensate for that extra risk?

Hi RyeWhiskey,
You raise an interesting point about the yield spread and whether it is enough to compensate for the risk. I think William Bernstein says in one of his books (4 pillars of investing i think) that time to buy corporate bonds is when the spreads are wide.
Spreads for long corporates don't look particularly wide now. I think the spread is about 165 bps. The average starting from 1989 (first year barclays publishes it) is about 148 bps.

12/1989 1.048546
12/1990 1.400997
0.867619
0.722294
0.743204
0.860853
0.769315
0.672044
0.768412
1.264497
1.259541
2.386146
1.813979
1.907896
1.154834
1.091325
1.278883
1.307976
1.983788
4.52326
1.697572
1.686904
2.434184
12/2012 1.849255

THe other problem with waiting till spreads get wide to buy corporate bonds is that that is when stocks will likely be cheap as well. For example the max of 452 bps was at 12/2008 when the s&p was like at 900. So at that point it may be better to buy stocks.
cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 23, 2013 8:15 am

jkandell wrote:
grok87 wrote:Hmm...that's very interesting. Thanks for posting. So for 1926-2012 (an 87 year period) Long corporates outperformed treasuries by 50 bps while for 1973-mid 2013 (say a 40 year period) they outperformed treasuries by just 10 bps. So long corporates may perhaps have decently outperformed treasuries for the first 47 years of the period- I think by about 84 bps or so. In other words I think the math is roughly:
50 bps excess return (1926-2012) =
(84 bp excess return * 47 years + 10 bp excess return * 40 years)/87 years. ...
So that ties back to the Innosight study I linked to. Perhaps 50-75 years ago long term corporates were a better bet, i.e. more likely to deliver a decent excess return. But they certainly don't seem to have done so recently (last 40 years), even without going into portfolio mathematics. Maybe that has something to do with the lifespan of corporations being shorter now than in the past. Or maybe in the old days it was tougher for corporations to issue long term bonds, so only the really best ones could.


Again, the Ibbotson data doesn't match that. For what it's worth, the last forty years, 1973-2008, Ibbottson returns (which don't take into account expense ratios), supplemented by Vanguard funds 2009-2012 are:
Code: Select all
1973-2012
Long term 20y corporate bonds: mean 9.5; sd 10.2, max down, -7.4; max up 42.6
Long term 20y govt bonds: mean 9.6; sd 12.2; max down -11.9; max up 40.4.


So the long term corporate and treasuries are pretty identical over the last forty years too. (The SD difference narrows a bit.) The "bad" years tend to match in the two indexes, but, e.g. 2009 Vanguard LT treasury lost 11.93% whereas the Vanguard long-term corporate index gained 8.89%.

Don't take this to mean I disagree with your larger point.

Also I think the ibbotson index has an 8% return for long corporates in 2008 (the key recent bad year) whereas the barclays long corporate index lost 5% and the vanguard fund was also down. I think this may be because the ibbotson index is of high to very high quality corporate bonds. Maybe A or better? See this link for example
http://papers.ssrn.com/sol3/papers.cfm? ... id=1898178
that is very interesting...
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby RyeWhiskey » Fri May 24, 2013 8:44 pm

grok87 wrote:
RyeWhiskey wrote:All data below from M*:
Image

Blue = Vanguard Long Term Treasury Index VUSTX
Orange = Vanguard Long Term Investment Grade Index VWESX

Over the past 15 years it seems as though VUSTX was more volatile (SD: 10.29) than VWESX (SD: 9.11) as well. And "overall," Morningstar gives them both Average return and risk ratings. So, given that VUSTX is yielding 2.79% and VWESX is yielding 4.45%... the choice seems obvious for the investor with a bond horizon beyond 20 years.

Furthermore, looking at Vanguard's website now, VWESX has a shorter duration (13.9 yrs vs. 15.5 yrs). Vanguard also ranks them equally in terms of risk.

I'm not saying that they are equally risky assets, the Treasuries are obviously a safer choice. But the yield spread is pretty significant at the moment, perhaps enough to compensate for that extra risk?

Hi RyeWhiskey,
You raise an interesting point about the yield spread and whether it is enough to compensate for the risk. I think William Bernstein says in one of his books (4 pillars of investing i think) that time to buy corporate bonds is when the spreads are wide.
Spreads for long corporates don't look particularly wide now. I think the spread is about 165 bps. The average starting from 1989 (first year barclays publishes it) is about 148 bps.

12/1989 1.048546
12/1990 1.400997
0.867619
0.722294
0.743204
0.860853
0.769315
0.672044
0.768412
1.264497
1.259541
2.386146
1.813979
1.907896
1.154834
1.091325
1.278883
1.307976
1.983788
4.52326
1.697572
1.686904
2.434184
12/2012 1.849255

THe other problem with waiting till spreads get wide to buy corporate bonds is that that is when stocks will likely be cheap as well. For example the max of 452 bps was at 12/2008 when the s&p was like at 900. So at that point it may be better to buy stocks.
cheers,


That's a good point. Perhaps the best solution for an investor with a long-term time horizon, 30+ years, say, would be Vanguard's Long Term Bond Index VBLTX which effectively offers a basic 50/50 split between corporates and treasuries with a slight lean to corporates at the moment. In fact, it looks like over the long run the more diversified fund out-performs the others by about 0.25% over 15 years (M*). A long term investor would also get peace of mind knowing that s/he owned both primary long term bond markets in one low cost fund rather than attempting to divvy it up one way or another.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Sat May 25, 2013 8:25 am

RyeWhiskey wrote:
That's a good point. Perhaps the best solution for an investor with a long-term time horizon, 30+ years, say, would be Vanguard's Long Term Bond Index VBLTX which effectively offers a basic 50/50 split between corporates and treasuries with a slight lean to corporates at the moment. In fact, it looks like over the long run the more diversified fund out-performs the others by about 0.25% over 15 years (M*). A long term investor would also get peace of mind knowing that s/he owned both primary long term bond markets in one low cost fund rather than attempting to divvy it up one way or another.

Hi RyeWhiskey,
I agree with your point theoretically. The vanguard long term bond index tracks the Barclays long government/credit index.

I looked at the 40 year data on Barclays. Here are the average annual returns( 1973 - 5/24/13)


Us long treasuries: 8.76%
Us long corporates: 8.87%
Us long government/credit: 8.93%

So it looks like their may be a slight rebalancing bonus of owning a fund divided between long term corporates and treasuries. But over 40 years it was pretty slight- between 5-20 bps.
And again the nice thing about treasuries is that you can buy them yourself at low/no cost.
That's what I'm doing, but I'm buying 30 year tips, there is another auction coming up next month.
Cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby RyeWhiskey » Tue May 28, 2013 3:37 pm

grok87 wrote:
RyeWhiskey wrote:
That's a good point. Perhaps the best solution for an investor with a long-term time horizon, 30+ years, say, would be Vanguard's Long Term Bond Index VBLTX which effectively offers a basic 50/50 split between corporates and treasuries with a slight lean to corporates at the moment. In fact, it looks like over the long run the more diversified fund out-performs the others by about 0.25% over 15 years (M*). A long term investor would also get peace of mind knowing that s/he owned both primary long term bond markets in one low cost fund rather than attempting to divvy it up one way or another.

Hi RyeWhiskey,
I agree with your point theoretically. The vanguard long term bond index tracks the Barclays long government/credit index.

I looked at the 40 year data on Barclays. Here are the average annual returns( 1973 - 5/24/13)


Us long treasuries: 8.76%
Us long corporates: 8.87%
Us long government/credit: 8.93%

So it looks like their may be a slight rebalancing bonus of owning a fund divided between long term corporates and treasuries. But over 40 years it was pretty slight- between 5-20 bps.
And again the nice thing about treasuries is that you can buy them yourself at low/no cost.
That's what I'm doing, but I'm buying 30 year tips, there is another auction coming up next month.
Cheers,


Excellent point re: buying treasuries individually at no cost. In fact, the HBPP recommends just this for the long-term treasury portion of their portfolio. I don't think this is the right choice for me, however, as I have a limited amount of starting principle to work with. I'm 27 and my current allocation to bonds is 30% of my ~30k portfolio. I have my bond portion in my Roth so it's easy for rebalancing etc... to keep it in a fund.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby ps56k » Tue May 28, 2013 4:48 pm

I have to quit reading all these articles.... they are giving me a headache :)

Currently holding these bond funds - equal parts -
classic VBMFX, VIPSX, and the LT Corp VWESX and Wellesley VWINX.

So now, after reading all the postings.... how to divide or consolidate this bond pie ?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Tue May 28, 2013 7:03 pm

RyeWhiskey wrote:
grok87 wrote:
RyeWhiskey wrote:
That's a good point. Perhaps the best solution for an investor with a long-term time horizon, 30+ years, say, would be Vanguard's Long Term Bond Index VBLTX which effectively offers a basic 50/50 split between corporates and treasuries with a slight lean to corporates at the moment. In fact, it looks like over the long run the more diversified fund out-performs the others by about 0.25% over 15 years (M*). A long term investor would also get peace of mind knowing that s/he owned both primary long term bond markets in one low cost fund rather than attempting to divvy it up one way or another.

Hi RyeWhiskey,
I agree with your point theoretically. The vanguard long term bond index tracks the Barclays long government/credit index.

I looked at the 40 year data on Barclays. Here are the average annual returns( 1973 - 5/24/13)


Us long treasuries: 8.76%
Us long corporates: 8.87%
Us long government/credit: 8.93%

So it looks like their may be a slight rebalancing bonus of owning a fund divided between long term corporates and treasuries. But over 40 years it was pretty slight- between 5-20 bps.
And again the nice thing about treasuries is that you can buy them yourself at low/no cost.
That's what I'm doing, but I'm buying 30 year tips, there is another auction coming up next month.
Cheers,


Excellent point re: buying treasuries individually at no cost. In fact, the HBPP recommends just this for the long-term treasury portion of their portfolio. I don't think this is the right choice for me, however, as I have a limited amount of starting principle to work with. I'm 27 and my current allocation to bonds is 30% of my ~30k portfolio. I have my bond portion in my Roth so it's easy for rebalancing etc... to keep it in a fund.

makes sense
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Tue May 28, 2013 7:05 pm

ps56k wrote:I have to quit reading all these articles.... they are giving me a headache :)

Currently holding these bond funds - equal parts -
classic VBMFX, VIPSX, and the LT Corp VWESX and Wellesley VWINX.

So now, after reading all the postings.... how to divide or consolidate this bond pie ?

Well if you have read this thread it may not surprise you that i would advise, as a first step, getting rid of LT Corp VWESX!
:)
cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby abuss368 » Tue May 28, 2013 7:16 pm

Another forum member "EDN" used to post that if an investor spends 2 minutes a year thinking about bond funds, it is 90 seconds to many.

I always liked that quote.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby ps56k » Tue May 28, 2013 7:31 pm

From M* chart -
looking at a 5yr view - the LT Corp, and LT Bond type funds are at the top,
while the Total Bond fund is at the very bottom...

Image
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby jim47 » Tue May 28, 2013 7:59 pm

I have put, since I became a Boglehead investor, a substantial amount into the total bond market index fund. As you know, although it's overall terms intermediate it does contain a number of long bonds. What is your recommendation as to what I should do with this particular fund? Thank you in advance.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby bottomfisher » Tue May 28, 2013 9:25 pm

jim47 wrote:I have put, since I became a Boglehead investor, a substantial amount into the total bond market index fund. As you know, although it's overall terms intermediate it does contain a number of long bonds. What is your recommendation as to what I should do with this particular fund? Thank you in advance.


Don't throw out the baby with the bathwater. I would not make any significant changes based on this fund holding a number of long-term bonds. Long-term bonds have their risks but they also have their rewards. Total bond market index is solid, well diversified fund that holds enough other bond types to provide stability to the fund when different types of bond holdings are underperforming. Thats its purpose as a total index fund.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Tue May 28, 2013 10:41 pm

abuss368 wrote:Another forum member "EDN" used to post that if an investor spends 2 minutes a year thinking about bond funds, it is 90 seconds to many.

I always liked that quote.

i tried looking for that quote and was told that board member edn does not exist!
memberlist.php?mode=viewprofile&u=41763

:shock:
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Tue May 28, 2013 11:10 pm

jim47 wrote:I have put, since I became a Boglehead investor, a substantial amount into the total bond market index fund. As you know, although it's overall terms intermediate it does contain a number of long bonds. What is your recommendation as to what I should do with this particular fund? Thank you in advance.

Hi jim,
i am not really a fan of the total bond market index fund. I follow David Swensen in thinking it is best to use treasuries and tips for your bond holdings. These days i favor credit union cds with guaranteed easy early withdrawal penalties as a substitute for treasuries and ibonds as a substitute for tips.

But if you like the total bond market index, i wouldn't let the specific issue of its holding long term bonds necessarily put you off. From Vanguard's website it holds about 14% in long term bonds (10 years and greater maturity)
https://personal.vanguard.com/us/FundsS ... =INT#tab=2
that doesn't seem like a huge amount.

The point of my thread was more about folks who might be thinking that, hey the total market bond index is only yielding 1.7% and thinking they might want/need to shift some funds into the long term corporate bond fund which is yielding around 4.5%. Again I would advise against THAT.

cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby bayview » Tue May 28, 2013 11:16 pm

grok87 wrote:
abuss368 wrote:Another forum member "EDN" used to post that if an investor spends 2 minutes a year thinking about bond funds, it is 90 seconds to many.

I always liked that quote.

i tried looking for that quote and was told that board member edn does not exist!
memberlist.php?mode=viewprofile&u=41763

:shock:

lol, Eric won't be happy to hear that...

I like that quote, although I just re-read another of his posts and have been brooding over it for the last half hour, so I suppose I've used up my next 60 years worth of bond meditations. http://www.bogleheads.org/forum/viewtopic.php?f=10&t=115106#p1675540
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby nedsaid » Wed May 29, 2013 9:23 am

This is a real good post. Very informative. I didn't know the return of long term corporates and long term treasuries were about the same. So you get no benefit from taking the additional risk.

I have pretty much stayed away from long term bonds period. The only exception would be what is in my TIPS funds. This is a decision made by whoever manages those funds. I have been mostly in the intermediate term maturities.

Thanks for the great information.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby Buysider » Wed May 29, 2013 11:45 am

Grok,

How much information about the next 10-20 years worth of returns in LT Gov't vs. Corps do you think is contained in the history you looked at over the prior 40 years? Do you have any sense on if or why the market has mispriced corporate bonds in the past and why or if you think that mispricing will continue or get more extreme in the future?
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby hollowcave2 » Wed May 29, 2013 12:04 pm

Vanguard introduced a long term corporate bond ETF in late 2009 and the returns have been very good, averaging 12% annual return since inception


Does this ETF follow the Long Term Investment Grade Fund? I've been in the fund for about a decade now and I don't plan to change. Perhaps Intermediate Term Investment Grade would be a less risky choice, but I purchased this fund with the intention of keeping it for awhile. It's been good. How many years have I listened to the warnings of rising rates on bond funds? I welcome higher rates, at least slowly rising rates, because overall, I'd do better with more income. I'm still over a decade away from retirement and I'd reinvest all distributions. So I'm staying, thank you.

However, if someone was looking for a new fund or ETF today, I'd recommend the Intermediate fund as a starting point for most investors. For me, I can tolerate higher risk and have a long term horizon, so I'm sticking with the Long term. The drop in NAV due to rising rates would be a short term effect.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby bottomfisher » Wed May 29, 2013 2:08 pm

nedsaid wrote:This is a real good post. Very informative. I didn't know the return of long term corporates and long term treasuries were about the same. So you get no benefit from taking the additional risk.


I was surprised too when I saw the graph of Vg LT Treasury vs Investment Grade performance. I agree with the conclusion that in the past risk adjusted return of LT Treasury was better than LT Investment Grade. However, I already own LT Investment Grade. And so my thoughts are similiar to:

hollowcave2 wrote:Does this ETF follow the Long Term Investment Grade Fund? I've been in the fund for about a decade now and I don't plan to change. Perhaps Intermediate Term Investment Grade would be a less risky choice, but I purchased this fund with the intention of keeping it for awhile. It's been good. How many years have I listened to the warnings of rising rates on bond funds? I welcome higher rates, at least slowly rising rates, because overall, I'd do better with more income. I'm still over a decade away from retirement and I'd reinvest all distributions. So I'm staying, thank you.

However, if someone was looking for a new fund or ETF today, I'd recommend the Intermediate fund as a starting point for most investors. For me, I can tolerate higher risk and have a long term horizon, so I'm sticking with the Long term. The drop in NAV due to rising rates would be a short term effect.


So I'll stay the course as well with LT Investment Grade fund. The current yield has allowed it to outperform LT Treasury this past year by a good margin. I'm at least 25 years from retirement so rising interest rates should help me long-term more than hurt me short term.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby abuss368 » Wed May 29, 2013 2:33 pm

grok87 wrote:
abuss368 wrote:Another forum member "EDN" used to post that if an investor spends 2 minutes a year thinking about bond funds, it is 90 seconds to many.

I always liked that quote.

i tried looking for that quote and was told that board member edn does not exist!
memberlist.php?mode=viewprofile&u=41763

:shock:


Eric (aka EDN) is no longer a forum member as of a few weeks ago. We had many good posts and discussions on that quote.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Wed May 29, 2013 4:52 pm

nedsaid wrote:This is a real good post. Very informative. I didn't know the return of long term corporates and long term treasuries were about the same. So you get no benefit from taking the additional risk.

I have pretty much stayed away from long term bonds period. The only exception would be what is in my TIPS funds. This is a decision made by whoever manages those funds. I have been mostly in the intermediate term maturities.

Thanks for the great information.

Thanks for the kind words nedsaid!
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Wed May 29, 2013 8:24 pm

Buysider wrote:Grok,

How much information about the next 10-20 years worth of returns in LT Gov't vs. Corps do you think is contained in the history you looked at over the prior 40 years? Do you have any sense on if or why the market has mispriced corporate bonds in the past and why or if you think that mispricing will continue or get more extreme in the future?

Good questions. I guess I don't know. The next 40 years or 10 or 20 could turn out differently I guess.
But 40 years is a long time for a risk premium not to show up. If the equity risk premium was zero for 40 years I think we would all be wailing and gnashing our teeth
But somehow with bonds nobody seems to care-everybody is gobbling up those 30 year bonds from Apple and Nike at 100 bps or less.
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Thu May 30, 2013 8:30 pm

hollowcave2 wrote:
Vanguard introduced a long term corporate bond ETF in late 2009 and the returns have been very good, averaging 12% annual return since inception


Does this ETF follow the Long Term Investment Grade Fund? I've been in the fund for about a decade now and I don't plan to change. Perhaps Intermediate Term Investment Grade would be a less risky choice, but I purchased this fund with the intention of keeping it for awhile. It's been good. How many years have I listened to the warnings of rising rates on bond funds? I welcome higher rates, at least slowly rising rates, because overall, I'd do better with more income. I'm still over a decade away from retirement and I'd reinvest all distributions. So I'm staying, thank you.

However, if someone was looking for a new fund or ETF today, I'd recommend the Intermediate fund as a starting point for most investors. For me, I can tolerate higher risk and have a long term horizon, so I'm sticking with the Long term. The drop in NAV due to rising rates would be a short term effect.

Hi Hollowcave,
I think the Long term investment grade bond fund is around 80% corporates but also owns some treasuries and taxable municipals.

The point of my post was not to say avoid all long term bonds. It was to say that if you do want to invest in long term bonds I think treasuries are better than corporates. Personally I'm buying long term tips.
Cheers,
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Re: Grok's tip #14: Avoid long-term corporate bonds

Postby grok87 » Fri Oct 18, 2013 1:01 pm

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