Evaluating bond funds

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skylarkguy
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Joined: Sat Feb 19, 2022 4:23 pm

Evaluating bond funds

Post by skylarkguy »

I'm confused about how to evaluate bond funds. I currently use FXNAX (ER = .025) in my IRA, which is what people seem to like for a three fund portfolio. However, I see that FSHNX (ER = .02) seems to have performed better over the last ten years.

I see that the 3 year Sharpe ratio is higher for FSHNX (.13) vs FXNAX (-.17) and both have similar R2 and standard deviations. What am I missing? If the only objection to FSHNX is that it's "riskier," I don't understand why that is sufficient reason. Perhaps there are better bond strategies than a bond index fund, but that seems like another topic.
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vineviz
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Re: Evaluating bond funds

Post by vineviz »

skylarkguy wrote: Wed Aug 03, 2022 3:25 pm I'm confused about how to evaluate bond funds. I currently use FXNAX (ER = .025) in my IRA, which is what people seem to like for a three fund portfolio. However, I see that FSHNX (ER = .02) seems to have performed better over the last ten years.

I see that the 3 year Sharpe ratio is higher for FSHNX (.13) vs FXNAX (-.17) and both have similar R2 and standard deviations. What am I missing? If the only objection to FSHNX is that it's "riskier," I don't understand why that is sufficient reason. Perhaps there are better bond strategies than a bond index fund, but that seems like another topic.
Step 1: Don't look at "what has performed better over the last ten years".

Step 2: Forget that Sharpe ratios exist. They are useless and, worse, usually misused.

Step 3: Outline WHY you think you should own a bond fund: what financial goals do you have that you think a bond fund will help you achieve?

Unless you can specify an objective, it's really hard to perform an evaluation.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Doctor Rhythm
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Re: Evaluating bond funds

Post by Doctor Rhythm »

skylarkguy wrote: Wed Aug 03, 2022 3:25 pm If the only objection to FSHNX is that it's "riskier," I don't understand why that is sufficient reason. Perhaps there are better bond strategies than a bond index fund, but that seems like another topic.
Risk is a primary factor for selecting or rejecting an investment. It is far more useful to consider risk than to look at past returns. Otherwise, one would just pick the best past-performing funds or individual stocks and easily beat the total market. It’s why most people beyond a certain vintage aren’t 100% stock. It’s why this forum exists.

For your specific scenario: FSHNX is a junk bond (aka high yield) fund. Many investors want their bonds to remain relatively stable during recessions or the times their stocks fall. Bonds that have a lot of default risk don’t do that very well (see 2008).
Topic Author
skylarkguy
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Joined: Sat Feb 19, 2022 4:23 pm

Re: Evaluating bond funds

Post by skylarkguy »

vineviz wrote: Wed Aug 03, 2022 3:40 pm
skylarkguy wrote: Wed Aug 03, 2022 3:25 pm I'm confused about how to evaluate bond funds. I currently use FXNAX (ER = .025) in my IRA, which is what people seem to like for a three fund portfolio. However, I see that FSHNX (ER = .02) seems to have performed better over the last ten years.

I see that the 3 year Sharpe ratio is higher for FSHNX (.13) vs FXNAX (-.17) and both have similar R2 and standard deviations. What am I missing? If the only objection to FSHNX is that it's "riskier," I don't understand why that is sufficient reason. Perhaps there are better bond strategies than a bond index fund, but that seems like another topic.
Step 1: Don't look at "what has performed better over the last ten years".

Step 2: Forget that Sharpe ratios exist. They are useless and, worse, usually misused.

Step 3: Outline WHY you think you should own a bond fund: what financial goals do you have that you think a bond fund will help you achieve?

Unless you can specify an objective, it's really hard to perform an evaluation.
Re Step 3: I want my asset allocation to be 90 - 95% equities and 5 - 10 % fixed income. Bond index funds seem the simplest way to accomplish that.
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vineviz
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Re: Evaluating bond funds

Post by vineviz »

skylarkguy wrote: Wed Aug 03, 2022 10:09 pm Re Step 3: I want my asset allocation to be 90 - 95% equities and 5 - 10 % fixed income.
But WHY do you want that allocation?

Why not 100% stocks or 50% stocks? What’s the goal here?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
dbr
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Re: Evaluating bond funds

Post by dbr »

I would stop with the "evaluating" and start with some characterizing.

1. Presumably you already know you want diversified (within their type), low cost, usually index funds.

2. The primary factors that describe a bond fund are credit risk and term risk. High yield, corporates and so on have higher credit risk. Treasuries have the least credit risk. Term risk is measured by duration. In general higher risk relates to higher returns and lower risk to lower returns. You just decide what you are trying to do.

3. Other characteristics that might be important to you are bonds that are tax exempt, meaning municipal bonds, and bonds that are inflation indexed, meaning I bonds and TIPS. Treasuries of any kind are state tax exempt. You decide how important these characteristics might be to you.

I hold intermediate term TIPS funds because funds are serviceable and convenient, I want inflation indexed bonds, intermediate term is a reasonable middle of the road match in a stock and bond portfolio for long term holdings without going to extremes of risk, and Treasuries do not have default risk. I don't sit around and make comparisons to what some other bonds did or might do. If I want to take more or less risk or try for more or less return in investing I would consider a different allocation between stocks and bonds.

In general I would assert that there are more differences among bonds of all types than there are good reasons to choose among them. Many choices in bonds serve the same end and there is no opening for being clever about it.
Topic Author
skylarkguy
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Joined: Sat Feb 19, 2022 4:23 pm

Re: Evaluating bond funds

Post by skylarkguy »

dbr wrote: Thu Aug 04, 2022 8:25 am I would stop with the "evaluating" and start with some characterizing.

1. Presumably you already know you want diversified (within their type), low cost, usually index funds.

2. The primary factors that describe a bond fund are credit risk and term risk. High yield, corporates and so on have higher credit risk. Treasuries have the least credit risk. Term risk is measured by duration. In general higher risk relates to higher returns and lower risk to lower returns. You just decide what you are trying to do.

3. Other characteristics that might be important to you are bonds that are tax exempt, meaning municipal bonds, and bonds that are inflation indexed, meaning I bonds and TIPS. Treasuries of any kind are state tax exempt. You decide how important these characteristics might be to you.

I hold intermediate term TIPS funds because funds are serviceable and convenient, I want inflation indexed bonds, intermediate term is a reasonable middle of the road match in a stock and bond portfolio for long term holdings without going to extremes of risk, and Treasuries do not have default risk. I don't sit around and make comparisons to what some other bonds did or might do. If I want to take more or less risk or try for more or less return in investing I would consider a different allocation between stocks and bonds.

In general I would assert that there are more differences among bonds of all types than there are good reasons to choose among them. Many choices in bonds serve the same end and there is no opening for being clever about it.
Thanks for this explanation. Your point (2) above makes sense to me as a way to think about risk. The points made in (3) are also useful. I agree that there are multiple things to consider when thinking about strategy for fixed income investments (e.g. risk, taxes, inflation) so it's helpful to have the information the way you explained it.
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