[EU] Yields of Bond Funds questions

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RME
Posts: 27
Joined: Thu Jan 25, 2018 10:01 am

[EU] Yields of Bond Funds questions

Post by RME » Fri Apr 27, 2018 1:54 am

What do you think about the current state of low interest rates?
Is it dangerous to get involved in bond funds with durations of 7-8 years?

I find it curious how it is very difficult to find key data of a bond fund such as the weighted average coupon, yield at maturity, duration and effective duration.

For example, try to obtain this data from the following fund: https://www.amundi.es/retail/product/view/LU1437018598


Looking for data of similar funds I see that the situation is the following:


European Corporate Bonds
------------------------------------
Weighted average coupon: 2.12%
Performance at expiration: 1.43%
Duration: 5-6 years
Effective duration: 5,23 years


Global government bonds Hedged EUR
------------------------------------
Weighted average coupon: 2.25%
Performance at expiration: 1.25%
Duration: 8,05 years
Effective duration: 7.87 years


European Government bonds
------------------------------------
Weighted average coupon: 2.80%
Performance at expiration: 0.70%
Duration: 8,5-9 years
Effective duration: 7.8 years


I understand that buying the European Government Bonds fund today would get only 0.70% annualized and that if interest rates rose by 1% it would lower its price by 7% (?) Although obviously if we keep it until expiration we should get that 0, 7%

Is not it too high a risk to earn that 0.7%? What is your opinion?

Valuethinker
Posts: 35958
Joined: Fri May 11, 2007 11:07 am

Re: [EU] Yields of Bond Funds questions

Post by Valuethinker » Fri Apr 27, 2018 5:46 am

RME wrote:
Fri Apr 27, 2018 1:54 am
What do you think about the current state of low interest rates?
Is it dangerous to get involved in bond funds with durations of 7-8 years?

I find it curious how it is very difficult to find key data of a bond fund such as the weighted average coupon, yield at maturity, duration and effective duration.

For example, try to obtain this data from the following fund: https://www.amundi.es/retail/product/view/LU1437018598


Looking for data of similar funds I see that the situation is the following:


European Corporate Bonds
------------------------------------
Weighted average coupon: 2.12%
Performance at expiration: 1.43%
Duration: 5-6 years
Effective duration: 5,23 years


Global government bonds Hedged EUR
------------------------------------
Weighted average coupon: 2.25%
Performance at expiration: 1.25%
Duration: 8,05 years
Effective duration: 7.87 years


European Government bonds
------------------------------------
Weighted average coupon: 2.80%
Performance at expiration: 0.70%
Duration: 8,5-9 years
Effective duration: 7.8 years


I understand that buying the European Government Bonds fund today would get only 0.70% annualized and that if interest rates rose by 1% it would lower its price by 7% (?) Although obviously if we keep it until expiration we should get that 0, 7%

Is not it too high a risk to earn that 0.7%? What is your opinion?
"Performance to expiration" is, I think, "Yield to Maturity"? or Gross Redemption Yield is the term in the UK.

The 0.7% is only relevant compared to other alternatives.

It is a positive yield. There's bonds in the Eurozone paying a negative yield (German government/ Bunds). So in fact it's not a bad yield.

All things being equal you are right about interest rate moves. However all things are not equal-- for one thing, interest rate moves seldom, if ever, move uniformly across the whole yield curve. When the Central Bank tightens, short yields go up (prices fall) but longer yields tend to move a lot less. Also Central Banks tend to "trail" their interest rate moves, so that the market is aware of the direction and rough timing and is not surprised when they actually occur.

(there's a thing called Bond Convexity which measures how sensitive a bond price is to changes in interest rates - technically the 2nd derivative of price wrt yield or rather the change in price wrt the change in yield).

My concern with Eurozone yields is not so much that they are low. That's just the pain we take, and within Eurozone deposit insurance limits (100K EUR backed by the national government) it's sometimes possible to beat bonds, with less interest rate risk (an advantage retail investors have over institutional) however the Greek bank account freezing (and Cyprus) was pretty scary.

My concern is credit risk within Eurozone. Italy is the largest govt bond market, Spain is either number 2 or 3. The market is telling us (yield spread over Bunds) that they are not risk free. OK it's a nightmare scenario that Italy exits the Euro and restructures its debt, inflicting losses on bond holders. But the market is telling us the probability is not zero. Spain I would have less worries about (they've been through the eye of the storm, their politics seemed less fractured) BUT there is Catalonia, and that will now fester. And of course there are the little countries like Portugal. In and of themselves not significant but they could start a contagion. A Eurozone crisis, which could become a banking crisis, which could become a crash.

So I suggest holding global government bonds to dilute that risk. Yes you are putting 20% of your portfolio in Japan, and a legislative-executive standoff could lead to a technical US default, but fundamentally those countries have their own currencies and can thus order the Central Bank to buy government bonds (Quantitative Easing &, if direct from the Treasury, printing money*). Their currencies would fall but that's why we currency hedge.

Italy would still be a disaster (c. 7% of the fund?) but its weighting in the Eurozone govt bond index is over 20%?

You pays your money and you takes your choice. I hold Short Term gilt (UK) govt bond funds. BUT:

1. the yield is essentially zero

2. if this government falls, and it well could, and the left wing party (or parties in coalition) are elected, then GBP probably falls at least 10% and maybe 20%. There is significant event risk around a change of government &/ or a "hard Brexit" (no deal) scenario.

So I have reduced interest rate risk, but am taking other risks.

* I am not sure of the legal position of the Federal Reserve in doing that, but I assume, as with the Crash of 2008-09, that if it has to be done, a way will be found to do it.

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BeBH65
Posts: 1236
Joined: Sat Jul 04, 2015 7:28 am

Re: [EU] Yields of Bond Funds questions

Post by BeBH65 » Fri Apr 27, 2018 9:02 am

I like Morningstar to compare funds: if you know the isin you can find the funds quicly; for instance.

What is the role of bonds in your portfolio?
In this forum bonds are aften chosen as they provide stability to the portfolio, for growth and return we look at equity.
There have been multiple EURO bond threads this year - do a search in the search box - top right corner
RME wrote:
Fri Apr 27, 2018 1:54 am
Although obviously if we keep it until expiration we should get that 0, 7%
If i am not mistaken tehse bond funds will renew their holdings. The oldest bonds of shortest duration will then be replaced by new ones with longer duration (at the new intrest rate). Have a look at this wiki page for more background: Individual_bonds_vs_a_bond_fund
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

Valuethinker
Posts: 35958
Joined: Fri May 11, 2007 11:07 am

Re: [EU] Yields of Bond Funds questions

Post by Valuethinker » Fri Apr 27, 2018 11:25 am

BeBH65 wrote:
Fri Apr 27, 2018 9:02 am

If i am not mistaken tehse bond funds will renew their holdings. The oldest bonds of shortest duration will then be replaced by new ones with longer duration (at the new intrest rate). Have a look at this wiki page for more background: Individual_bonds_vs_a_bond_fund
Yes that is true.

The fund (index) will try to achieve a duration close as possible to the benchmark, and that will mean selling bonds before maturity and buying new bonds.

Thus, over time, a rise in yields will be reflected in an increase in yields of the fund.

Rule of thumb: as long as one's own need for cash is larger than the duration of the fund, then a rise in interest rates broadly increases your total return from the fund for you as holder. That, I should stress, is a rule of thumb-- I've not formally demonstrated it.

Bond ladders are used where one has a finite time horizon for need for cash. Thus the shortening duration of the portfolio is not an issue. In fact perfectly immunized portfolio (immunized => cash inflows matched in scale & timing to outflows) is one made up of the appropriate zero coupon bonds. That would be hard to implement in real life for a retail investor, and could give messy tax issues (taxation on accrued interest for which one has not received actual cash income).

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