Sell-Off Risk in Bond Funds

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Fryxell
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Re: Sell-Off Risk in Bond Funds

Post by Fryxell » Thu Jul 04, 2013 1:29 pm

ogd wrote: On the contrary -- if you're holding on, the ETF protects you from sellers, which are charged the full cost of liquidity and then some. The mispricing that you wrote about only applies to the mutual fund.
I believe Rick Ferri holds the mutual funds because he wants to be the seller in illiquid markets, for rebalancing purposes. But you are correct, with an ETF you do not have to bear the costs that other shareholders impose on the fund.

richard
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Re: Sell-Off Risk in Bond Funds

Post by richard » Thu Jul 04, 2013 1:38 pm

Fryxell wrote:
richard wrote: BTW, consider where the fund got the extra $25,000 needed to pay the sellers. Also, consider what happens if redemption orders come in late in the day.
I'm not sure what you mean by the "extra $25,000."
You had posted
5. The fund NAV is now back to $450,000. 500 bonds x $500 = $250,000; and $200,000 cash.
6. Sellers are redeemed for half of $450,000, or $225,000.
The fund had $200,000 in cash and you appear to be paying the sellers $225,000. Aren't you?

Vanguard (and other funds) also use futures to mange purchases and redemptions. That appears to help with liquidity issues.
Fryxell wrote:I don't think the exact timing of the redemptions changes the basic mechanics that much. The key idea is that there is an arbitrage in price between when the fund may be forced to sell in illiquid or volatile conditions (at a lower price), and when the NAV is calculated (at a higher price).
A lot depends on when and how the fund manager decides to sell to meet redemptions. In your example, they sold at the worst possible time. As I understand it, they put a lot of effort into avoiding such situations. They have succeeded (at least so far) - other than one or two cases in which Vanguard bet wrong on interest rates, I can't remember a Vanguard stock or bond fund diverging significantly from its benchmark, including in 2008.

Beagler
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Re: Sell-Off Risk in Bond Funds

Post by Beagler » Thu Jul 04, 2013 2:36 pm

richard wrote: ...other than one or two cases in which Vanguard bet wrong on interest rates, I can't remember a Vanguard stock or bond fund diverging significantly from its benchmark, including in 2008.

The 2002 TBM debacle comes to mind. http://www.sec.gov/Archives/edgar/data/ ... inprog.txt
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Epsilon Delta
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Re: Sell-Off Risk in Bond Funds

Post by Epsilon Delta » Thu Jul 04, 2013 2:43 pm

Another tool Vanguard has to protect long term share holders is fair-value pricing. If a fund is unable to sell certain holdings, in quantities proportional to redemptions, at the current bid (because the market is temporarily illiquid) the value of those holdings is arguably lower than the market bid. Vanguard could assign the illiquid holdings a lower value, which would reduce the NAV and hence the amount payed to panic sellers. This retains more of the value for long term share holders.

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ogd
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Re: Sell-Off Risk in Bond Funds

Post by ogd » Thu Jul 04, 2013 2:45 pm

Beagler wrote:
richard wrote: ...other than one or two cases in which Vanguard bet wrong on interest rates, I can't remember a Vanguard stock or bond fund diverging significantly from its benchmark, including in 2008.

The 2002 TBM debacle comes to mind. http://www.sec.gov/Archives/edgar/data/ ... inprog.txt
Very interesting, thanks. I hadn't noticed that on the long-term chart vs the difference from expenses.

They attribute the tracking error to bad sampling of corporate bonds, which overweighed telecoms and energy (read: Enron, WorldCom). Net cash flows across the share classes were still positive.

linuxizer
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Re: Sell-Off Risk in Bond Funds

Post by linuxizer » Thu Jul 04, 2013 2:49 pm

Beagler wrote:The 2002 TBM debacle comes to mind. http://www.sec.gov/Archives/edgar/data/ ... inprog.txt
They made a mistake in diverging from the composition of the index. That's not sell-off risk as we're trying to focus down on in this thread. Interesting though....

dumbmoney
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Re: Sell-Off Risk in Bond Funds

Post by dumbmoney » Thu Jul 04, 2013 5:56 pm

Call_Me_Op wrote:
dumbmoney wrote:I don't know what is meant by sell off risk, but certainly fund flows can damage share holders, especially if the NAV is wildly unrealistic. A too-high NAV will cause a "run" on the fund by sophisticated investors. After the fund's liquid assets are exhausted and the fund starts selling the illiquid assets, the NAV collapses, revealing the fact that the NAV was too high.
I believe you meant to say "unsophisticated" investors.
No, I meant sophisticated. Unsophisticated investors don't run and get ripped off.

I believe this actually happened with some bond funds in 2008. The tip off is a steady NAV followed by sudden collapse - very different from normal zig-zag market volatility.
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