Are Bogleheads reducing duration of bond holdings?

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garlandwhizzer
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Are Bogleheads reducing duration of bond holdings?

Post by garlandwhizzer » Mon Jun 03, 2013 12:28 pm

In view of the increased sensitivity of intermediate term bond funds to rising interest rates relative to short term bond funds, are any of you shifting a portion of your intermediate term bond funds into short or limited term funds to decrease overall bond portfolio duration, and hence interest rate risk. The extreme position of this strategy would be to put some, not all, of bond allocation into money market funds, no interest but no risk of principle loss, and wait until interest rates have risen to more attractive levels to invest. The less extreme position is to simply lower overall bond portfolio duration.

It seems to me that going forward from here, zero or negative real rates on quality bond instruments, the greatest risk to bond returns may be principle loss due to interest rate risk as opposed to default risk in investment grade corporates and tax exempt bond funds. While there is an argument for "staying the course" with TBM or intermediate Treasuries, that the increased interest payments will in the long run make up for reduced principle values in a rising interest rate environment, given the low interest rate payments presently, that may take many years. In the meantime the net value of bond holdings might diminish relative to a shorter duration bond positon. I'm not certain that I've done the right thing but I have reduced the average duration of my bond holdings to approximately 4 years, 60% intermediate term, 40% short term, and reduced my risk profile according to Vanguard from 2 (high quality bond intermediate bond funds are rated risk level 2 by Vanguard) to about 1.5 (high quality bond funds of short term are rated 1). I expect that we are now at the end of the greatest bull market in bonds in US history and perhaps near the beginning of what may turn out to be the start of a significant bond bear market as ultra low interest rates unwind over many years. It seems to me that lowering interest rate bond risk at this point is worthy of consideration for the goal of capital preservation.

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livesoft
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Re: ARE BOGLEHEADS REDUCING DURATION OF BOND HOLDINGS?

Post by livesoft » Mon Jun 03, 2013 12:33 pm

Here's a poll on the subject: http://www.bogleheads.org/forum/viewtop ... 1&t=112412
The answer is YES according to the poll.

And a similar poll just in April: http://www.bogleheads.org/forum/viewtop ... 0&t=114650
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Blues
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Re: ARE BOGLEHEADS REDUCING DURATION OF BOND HOLDINGS?

Post by Blues » Mon Jun 03, 2013 12:41 pm

We have about 28% of our fixed income investments in TBM (all within our IRA's) which we do not plan on drawing from for >10 years.

The rest of our fixed income investments are shielded from direct interest rate risk within the "G" Fund, CD's, MM and I-Bonds.

I'm pretty comfortable with that allocation going forward and am not planning (at this time) any changes.
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allsop
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Re: ARE BOGLEHEADS REDUCING DURATION OF BOND HOLDINGS?

Post by allsop » Mon Jun 03, 2013 12:54 pm

As a Swedish investor most of my fixed income is in taxable and invested in the Swedish equivalent of FDIC insured CD's with an after-tax real rate of about 1.7% (currently) I have various 1, 2 and 3 years CD's.

A two-year Swedish GB have a yield of 1.0% while a five-year have 1.3%

Below is link to a graph of CPI/CPIF/CPIX for Sweden since 2006: http://www.scb.se/Pages/TableAndChart____284172.aspx

Note that the CPI includes home-owners mortgage interest changes while CPIF keeps the mortgage interest fixed.

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G-Money
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Re: ARE BOGLEHEADS REDUCING DURATION OF BOND HOLDINGS?

Post by G-Money » Mon Jun 03, 2013 9:51 pm

livesoft wrote:Here's a poll on the subject: http://www.bogleheads.org/forum/viewtop ... 1&t=112412
The answer is YES according to the poll.
Perhaps I'm missing something. Didn't 2/3 of the respondents vote that they were NOT making changes?
Don't assume I know what I'm talking about.

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dmcmahon
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Re: Are Bogleheads reducing duration of bond holdings?

Post by dmcmahon » Mon Jun 03, 2013 10:15 pm

I'm a yes to the OP, though re the earlier poll this did not represent a change in strategy since the election so I'm one of the no votes .

Over the years that rates have been dropping I've allowed my bond ladder to unwind without rolling the rungs, in effect allowing the duration to be less than 2 years in a mix of MMs and CDs. The only exception are my TIPS bonds, which haven't matured as they are longer term. There, I've simply stopped buying more with new money.

livesoft
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Re: ARE BOGLEHEADS REDUCING DURATION OF BOND HOLDINGS?

Post by livesoft » Tue Jun 04, 2013 12:47 am

G-Money wrote:
livesoft wrote:Here's a poll on the subject: http://www.bogleheads.org/forum/viewtop ... 1&t=112412
The answer is YES according to the poll.
Perhaps I'm missing something. Didn't 2/3 of the respondents vote that they were NOT making changes?
Yes, you are missing that 1/4 is not zero. :)
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Re: Are Bogleheads reducing duration of bond holdings?

Post by z3r0c00l » Tue Jun 04, 2013 4:24 am

Not changing a thing over here. 5 years duration is not a big deal.

IlliniDave
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Re: Are Bogleheads reducing duration of bond holdings?

Post by IlliniDave » Tue Jun 04, 2013 5:26 am

I haven't done much different. In my 401 I've got a pretty good dollop of Pimco Total Return which is intermediate-term, the backup to my emergency fund at VG is short-term index and ltd-term tax exempt, and I have a bit of intermediate-term tax-exempt in my taxable retirement account. I've never held long-term bonds and, market-timing or not, I wouldn't move in that direction now.
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Re: Are Bogleheads reducing duration of bond holdings?

Post by YDNAL » Tue Jun 04, 2013 9:05 am

garlandwhizzer wrote:In view of the increased sensitivity of intermediate term bond funds to rising interest rates relative to short term bond funds, are any of you shifting a portion of your intermediate term bond funds into short or limited term funds to decrease overall bond portfolio duration, and hence interest rate risk.
I saw the polls linked by livesoft, and in the first poll it appears the 1/4 of the people have shifted duration - so that answers your main question GW. Which brings me to the observation below followed by simple questions (#3).

ALL retired (and consuming) people should be shifting duration to meet liabilities.
  • 1. Just for illustration: Vanguard TBM (5.3-year); ST Bond Index (2.7-year) average duration.
    2. Minimally, I see retirees' every year transferring need for year 3 to CD(?) and for year 5 from Total Bond to ST Bond:
    • Year 1: bank account
      Year 2: CD(?)
      Year 3, 4, 5: ST Bond Index
      Year 6 and longer: Total Bond
    3. No ? Why not ?
People seem scared into thinking that it is sacrilege (or something) to use strategies that may be seen by hard core Bogleheads as "market timing".
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G-Money
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Re: Are Bogleheads reducing duration of bond holdings?

Post by G-Money » Tue Jun 04, 2013 9:10 am

livesoft wrote:
G-Money wrote:
livesoft wrote:Here's a poll on the subject: http://www.bogleheads.org/forum/viewtop ... 1&t=112412
The answer is YES according to the poll.
Perhaps I'm missing something. Didn't 2/3 of the respondents vote that they were NOT making changes?
Yes, you are missing that 1/4 is not zero. :)
Ah, I see. I suppose one could accurately say Bogleheads are shortening the duration of the bond holdings, lengthening the duration of their bond holdings, keeping the duration of their bond holdings constant, forgoing bonds altogether, and avoiding discussion about their bonds. :)
Don't assume I know what I'm talking about.

rkhusky
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Re: Are Bogleheads reducing duration of bond holdings?

Post by rkhusky » Tue Jun 04, 2013 9:19 am

G-Money wrote:
livesoft wrote:
G-Money wrote:
livesoft wrote:Here's a poll on the subject: http://www.bogleheads.org/forum/viewtop ... 1&t=112412
The answer is YES according to the poll.
Perhaps I'm missing something. Didn't 2/3 of the respondents vote that they were NOT making changes?
Yes, you are missing that 1/4 is not zero. :)
Ah, I see. I suppose one could accurately say Bogleheads are shortening the duration of the bond holdings, lengthening the duration of their bond holdings, keeping the duration of their bond holdings constant, forgoing bonds altogether, and avoiding discussion about their bonds. :)
One could also reply that 1/4 is greater than 1/25.

connya
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Re: Are Bogleheads reducing duration of bond holdings?

Post by connya » Tue Jun 04, 2013 9:59 am

Fractional semantics aside, I can't understand the rationale behind shortening duration unless 1) you need the funds in less than 6 years as Landy pointed out or 2) you are moving into CD's.

Going into a short term bond fund or a money market does not sound like a winning strategy unless you do successfully time the market (both shortening duration now and lengthening duration later). Everybody "knows" that rates are going to rise. The market "knows" that rates are going to rise and that is priced into current yields as Larry Swedroe explains in a couple of his more recent bond articles (How Bernanke's testimony affects investors and Fed tightening: A disciplined response). The market thinks TBM is going to yield about 1.6% over five years, and it thinks ST bonds are going to yield about 0.5% over two and a half years. By moving from TBM to ST bond funds you seem to be saying "I believe rates are going to rise FASTER than the market expects them to." Given the efficiency of the bond market I can't see how this is a good idea.

The argument of "bonds are for safety" is also confusing to me. As Robert T. shows in his thread Diversifying Power of Longer Term US Treasuries, longer term treasury and corporate bonds generally (though not always) have stronger negative correlation with stocks than shorter term bonds. So you are not just sacrificing intermediate/long term performance for better short term performance, you are sacrificing intermediate/long term performance AND the negative correlation in case of a stock crash for better short term performance.

If I am mistaken please tell me, but I can't see any reason for moving to short term bonds or money markets besides timing the market or addressing short-term financial needs.

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G-Money
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Re: Are Bogleheads reducing duration of bond holdings?

Post by G-Money » Tue Jun 04, 2013 10:09 am

connya wrote:If I am mistaken please tell me, but I can't see any reason for moving to short term bonds or money markets besides timing the market or addressing short-term financial needs.
Some people follow Larry's rule-of-thumb of demanding an extra 0.20% in yield for each additional year in duration. Since the yield curve shifts over time, you might be lengthening or shortening your bond holdings' duration to implement this strategy. Larry had a similar rule-of-thumb for adjusting the maturities of TIPS and the % of TIPS in fixed income based upon the real yield.

I suppose that might be considered market timing. I'm pretty sure the people who implement this strategy don't particularly care what it's called.
Don't assume I know what I'm talking about.

connya
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Re: Are Bogleheads reducing duration of bond holdings?

Post by connya » Tue Jun 04, 2013 10:38 am

G-Money wrote:
connya wrote:If I am mistaken please tell me, but I can't see any reason for moving to short term bonds or money markets besides timing the market or addressing short-term financial needs.
Some people follow Larry's rule-of-thumb of demanding an extra 0.20% in yield for each additional year in duration. Since the yield curve shifts over time, you might be lengthening or shortening your bond holdings' duration to implement this strategy. Larry had a similar rule-of-thumb for adjusting the maturities of TIPS and the % of TIPS in fixed income based upon the real yield.

I suppose that might be considered market timing. I'm pretty sure the people who implement this strategy don't particularly care what it's called.
That 20 bps rule seems to be based on the idea that you can get a better risk/return ratio by passively picking certain points on the yield curve (is that right?). Although I wouldn't call that market timing it does assume that there is some inefficiency in the bond market. I find the idea that an individual investor can exploit inefficiencies in this highly efficient market through a simple algorithm very counterintuitive.

As an aside, somebody following that rule would currently be buying 10 year treasuries.

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Kevin M
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Re: Are Bogleheads reducing duration of bond holdings?

Post by Kevin M » Tue Jun 04, 2013 3:52 pm

Over about the last two years I have gradually shifted about 2/3 of my fixed income into CDs, leaving the remaining 1/3 primarily in intermediate-term investment-grade and muni bond funds. I have already posted a lot on this forum and on my blog about why. This has effectively lowered my duration significantly, if you're considering duration a measure of interest-rate risk.

You can earn between 1.5% and 2% on a 5-year CD with an early withdrawal penalty (EWP) of between 60 days and 365 days of interest, thus capping your downside to somewhere between 0.25% and 2%; I view this as a better way to look at interest-rate risk for CDs (as opposed to duration). A 5-year Treasury is only yielding about 1%, and has significant interest-rate risk, so a good CD is a much better deal.

One way to look at it is that I've replaced the treasuries, agencies, and MBS in Total Bond Market with CDs, and am using intermediate-term investment-grade and munis for the rest. This gives me a higher overall yield and less interest-rate risk than TBM, with comparable credit risk.

Kevin
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