How does accumulating bond ETF make money?

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wiserabbit
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Joined: Sat Nov 10, 2018 7:25 am

How does accumulating bond ETF make money?

Post by wiserabbit » Thu Dec 06, 2018 6:53 am

Hi Bogleheads!

Sorry for somewhat dummy question :) I understand that accumulating bond ETFs reinvest the interest into more bonds. But how does such ETF holder actually make profit? My expectation was that they should steadily appreciate in price. But that does not seem to be the case with, for example, AGGU (iShares Core Global Aggregate Bond UCITS ETF) - chart: http://take.ms/4szFa

What am I missing here?

J G Bankerton
Posts: 336
Joined: Thu Sep 14, 2017 3:30 pm

Re: How does accumulating bond ETF make money?

Post by J G Bankerton » Thu Dec 06, 2018 6:56 am

Bonds are for income. Buy a 10 year bond at 3% and it will pay 3% a year and after 10 years you get your principal back. The worth of your principal goes up or down depending on interest rate and time to maturity. If you reinvest dividends you get more bonds the price doesn't go up.
Last edited by J G Bankerton on Thu Dec 06, 2018 7:01 am, edited 1 time in total.

AlohaJoe
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Location: Saigon, Vietnam

Re: How does accumulating bond ETF make money?

Post by AlohaJoe » Thu Dec 06, 2018 7:00 am

J G Bankerton wrote:
Thu Dec 06, 2018 6:56 am
Bonds are for income. Buy a 10 year bond at 3% and it will pay 3% a year and after 10 years you get your principal back. The worth of your principal goes up or down depending on interest rate and time to maturity.
This is true but irrelevant to the OP's question. The OP is asking about accumulating funds, which do not pay out 3% (or any percent) a year.
wiserabbit wrote:
Thu Dec 06, 2018 6:53 am
But that does not seem to be the case with, for example, AGGU (iShares Core Global Aggregate Bond UCITS ETF) - chart: http://take.ms/4szFa
The fund has accumulated interest. But it has also lost principal. So it has (sorta, more or less) broken even. If you go look at a price chart for a non-accumulating fund (like Vanguard's BNDX) you'll see that it dropped (a bit). That's the loss in principal. The loss in principal is obscured by the accumulating nature of the fund.

J G Bankerton
Posts: 336
Joined: Thu Sep 14, 2017 3:30 pm

Re: How does accumulating bond ETF make money?

Post by J G Bankerton » Thu Dec 06, 2018 7:05 am

AlohaJoe wrote:
Thu Dec 06, 2018 7:00 am

The fund has accumulated interest. But it has also lost principal. So it has (sorta, more or less) broken even. If you go look at a price chart for a non-accumulating fund (like Vanguard's BNDX) you'll see that it dropped (a bit). That's the loss in principal. The loss in principal is obscured by the accumulating nature of the fund.
If these work like regular bonds the principal will return to book value at maturity. Bonds are for income not growth. Hold to maturity and one gets 100% of the principal back.

AlohaJoe
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Location: Saigon, Vietnam

Re: How does accumulating bond ETF make money?

Post by AlohaJoe » Thu Dec 06, 2018 7:35 am

J G Bankerton wrote:
Thu Dec 06, 2018 7:05 am
If these work like regular bonds the principal will return to book value at maturity. Bonds are for income not growth. Hold to maturity and one gets 100% of the principal back.
They don't. In particular they are a fund, not a bond. There is also no income at all.

J G Bankerton
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Joined: Thu Sep 14, 2017 3:30 pm

Re: How does accumulating bond ETF make money?

Post by J G Bankerton » Thu Dec 06, 2018 7:58 am

AlohaJoe wrote:
Thu Dec 06, 2018 7:35 am
J G Bankerton wrote:
Thu Dec 06, 2018 7:05 am
If these work like regular bonds the principal will return to book value at maturity. Bonds are for income not growth. Hold to maturity and one gets 100% of the principal back.
They don't. In particular they are a fund, not a bond.
True a fund that holds bonds. It works the same way if rates rise the value of the principal falls. If rates fall the value of the principal rises.

A fund may have to sell bonds when they no longer fit the benchmark but if one holds the fund forever the principal returns to par. The OP may have to wait a long time for his principal to return to par but bonds are not for growth. The income is used to buy more bonds.

Valuethinker
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Re: How does accumulating bond ETF make money?

Post by Valuethinker » Thu Dec 06, 2018 8:20 am

wiserabbit wrote:
Thu Dec 06, 2018 6:53 am
Hi Bogleheads!

Sorry for somewhat dummy question :) I understand that accumulating bond ETFs reinvest the interest into more bonds. But how does such ETF holder actually make profit? My expectation was that they should steadily appreciate in price. But that does not seem to be the case with, for example, AGGU (iShares Core Global Aggregate Bond UCITS ETF) - chart: http://take.ms/4szFa

What am I missing here?
The accumulated interest from the bonds is balanced against losses of principal due to higher interest rates or sale of bonds at a capital loss*.


* Investment Grade bond funds seldom actually hold defaulted bonds. Rather, when the bond is close to falling below Investment Grade, or below IG, they sell it (at a marked down price, probably a considerable capital loss) to the natural investors in potentially distressed debt.

J G Bankerton
Posts: 336
Joined: Thu Sep 14, 2017 3:30 pm

Re: How does accumulating bond ETF make money?

Post by J G Bankerton » Thu Dec 06, 2018 8:41 am

Valuethinker wrote:
Thu Dec 06, 2018 8:20 am
The accumulated interest from the bonds is balanced against losses of principal due to higher interest rates or sale of bonds at a capital loss*.
Reinvestment of dividends is mandatory in this fund; the dividend yield is zero. Most bond funds pay the dividend monthly and it is taxed as regular income even if one reinvest the dividend.

Not to side track this for the OP but are there taxable events when the fund reinvests the dividend? These are US bonds held in an Irish ETF so the question is academic for US.

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