Would Demand For Bonds Temper the Drop in NAV

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max12377
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Would Demand For Bonds Temper the Drop in NAV

Post by max12377 » Sun Jul 26, 2015 7:02 am

If rates rise and, subsequently, the bond funds 'nav' drops in proportion to average duration of the bond fund, is it possible that the magnitude of the drop will be tempered by the public demand for better yielding bond funds? In other words, if there is a rush to buy the bond funds once the yield improves, would that keep the NAV from dropping somewhat?

Seems like a lot of folks are holding less bonds because yields are so lousy. But once they improve, would the rush to buy, assuming there is one, cause the NAV to drop less?

Just curious.

Max

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SimpleGift
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by SimpleGift » Sun Jul 26, 2015 10:27 am

I'm no bond expert, but I'll take a stab at answering your question.

My sense is the short end of the yield curve (say, 1-3 year average maturity) is much more strongly influenced by the Fed's raising interest rates. But intermediate and longer-term bonds are more influenced by the supply and demand for bonds, growth and inflation. In other words, it's entirely possible that a rise in short-term rates caused by Fed tightening will result a flattening of the yield curve, with short-term rates rising more than long-term rates.

One reason this seems likely is the relative attractiveness of U.S. Treasury rates compared to yields of other developed countries (chart below). As the U.S. contemplates tighter monetary policy, other countries are still easing. The substantial yield advantage of U.S. Treasuries is likely to continue attracting assets to the U.S., suppressing intermediate and longer-term rates.

So I think your supply/demand thesis makes sense, but mainly for intermediate and longer term bonds.

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by Sidney » Sun Jul 26, 2015 10:32 am

max12377 wrote:If rates rise and, subsequently, the bond funds 'nav' drops in proportion to average duration of the bond fund, is it possible that the magnitude of the drop will be tempered by the public demand for better yielding bond funds? In other words, if there is a rush to buy the bond funds once the yield improves, would that keep the NAV from dropping somewhat?

Seems like a lot of folks are holding less bonds because yields are so lousy. But once they improve, would the rush to buy, assuming there is one, cause the NAV to drop less?

Just curious.

Max
If the NAV doesn't drop, the rate hasn't risen. It is math. Now, if you are asking if high demand for bonds will offset other factors which are trying to push rates up -- sure, that's possible.
I always wanted to be a procrastinator.

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max12377
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by max12377 » Sun Jul 26, 2015 10:55 am

Thank you Todd. I find that reassuring for those of us that are sticking with a total bond fund whose average duration is medium term. I expect many folks are/have shortened their bond duration somewhat (OK, I admit I dropped some 8 yr duration TIPS) but it's not a given that it's the right move. I'm starting to like Total Bond more and more.

Sidney, yes, I was just focused on the demand side. I understand the rate rises in tandem with the NAV dropping as that is generally how the bond math works. I just haven't seen anyone address the effect of a significant move of Joe Q. Public back into bonds once rates become "attractive" again.

I personally would probably hold more bonds once rates rise again. But then again, it smacks of thinking I can time the bond market! Drat! Very Unbogleheadish. :oops:

My rationale for asking the question was just to question if it's a given that bond funds will perform badly when rates rise. In other words, I am putting my money on a "certain" loser. Maybe.. but maybe not!

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by ogd » Sun Jul 26, 2015 11:10 am

Yes, I think they would become much more attractive. When you hear someone fantasizing about a 10% drop in intermediate bonds, ask them if you think bonds yielding 4% will find no buyers. I mean, 4% is already a different "rate environment". I think many retirees / conservative investors who have uncomfortably moved to other instruments would be breathing a sigh of relief and buy. I also think this is quite far in the future.

By the way, everything you've said applies to "bonds" equally, not just "funds". For example, if you went to the WSJ treasury quote page and scrolled down to the 5 year maturities, those bonds (whether recent issues, depreciated, or very old issues, premium) will all read 3.5%+ in the last column, the yield.
max12377 wrote:I personally would probably hold more bonds once rates rise again. But then again, it smacks of thinking I can time the bond market! Drat! Very Unbogleheadish.
Sometimes this timing is legitimate. If the instrument you're using an alternative is not accessible to the market at large, like bank CDs or Stable Value funds, then it isn't as much "market timing" as "good deal hunting". Nothing forbids pricing discrepancies that the market is not allowed to close.

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by longinvest » Sun Jul 26, 2015 11:14 am

Max,

The way I look at it is this. As I have a balanced portfolio (it contains both stocks and bonds), my AA forces me to hold less bond* when they are expensive (low yields). If bonds became cheaper (higher yields), my AA would force me to buy more bonds.

* I actually mean fewer bonds, in the sense that if I want $100 in bonds, and each bond costs $5, I'll have 20 bonds. If prices dropped to $4, I would buy 5 additional bonds. As I hold a bond fund, this is indirect.

So, I don't need to do anything other than stick to my AA. I don't have to worry about timing the bond market.
Last edited by longinvest on Sun Jul 26, 2015 11:25 am, edited 2 times in total.
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by lack_ey » Sun Jul 26, 2015 11:15 am

Rates... which rates?

This happened last time:
Image

Longer rates didn't go up that much.

If shorter-term rates go up but the market doesn't really think they'll eventually go up sustainably above what longer-term rates are (among other things), then demand for the longer-term securities will still be fine at the present rates, probably. That may or may not happen next time shorter-term rates go up, whenever that is.

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by longinvest » Sun Jul 26, 2015 11:17 am

ogd wrote:
max12377 wrote:I personally would probably hold more bonds once rates rise again. But then again, it smacks of thinking I can time the bond market! Drat! Very Unbogleheadish.
Sometimes this timing is legitimate. If the instrument you're using an alternative is not accessible to the market at large, like bank CDs or Stable Value funds, then it isn't as much "market timing" as "good deal hunting". Nothing forbids pricing discrepancies that the market is not allowed to close.
ogd,

Have you found the magic formula to predict the exact future return of TBM over the next 5 years and provide a guarantee that it will be lower than that of a 5-year CD bought today?

:wink:

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by ogd » Sun Jul 26, 2015 11:29 am

longinvest wrote:
ogd wrote:Sometimes this timing is legitimate. If the instrument you're using an alternative is not accessible to the market at large, like bank CDs or Stable Value funds, then it isn't as much "market timing" as "good deal hunting". Nothing forbids pricing discrepancies that the market is not allowed to close.
ogd,

Have you found the magic formula to predict the exact future return of TBM over the next 5 years and provide a guarantee that it will be lower than that of a 5-year CD bought today?
No, but I know what I'm buying with each share and it still ain't as good as what I can buy at a bank. The dynamics of the fund may work out better than a pure CD over time, but I'm fairly confident right now that I can get better dynamics using declining duration CDs and an increasing amount of longer bonds to compensate. But this is probably a discussion for another thread.

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by longinvest » Sun Jul 26, 2015 11:49 am

ogd wrote:
longinvest wrote:
ogd wrote:Sometimes this timing is legitimate. If the instrument you're using an alternative is not accessible to the market at large, like bank CDs or Stable Value funds, then it isn't as much "market timing" as "good deal hunting". Nothing forbids pricing discrepancies that the market is not allowed to close.
ogd,

Have you found the magic formula to predict the exact future return of TBM over the next 5 years and provide a guarantee that it will be lower than that of a 5-year CD bought today?
No, but I know what I'm buying with each share and it still ain't as good as what I can buy at a bank. The dynamics of the fund may work out better than a pure CD over time, but I'm fairly confident right now that I can get better dynamics using declining duration CDs and an increasing amount of longer bonds to compensate. But this is probably a discussion for another thread.
It's really too bad. I would have loved to learn of a method to get guaranteed higher returns for lower risk!
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by JoMoney » Sun Jul 26, 2015 4:24 pm

The big fear has been that rising interest rates will cause a mass exodus and severe liquidity problems in the bond market - particularly for large mutual funds - too many sellers. I think this is the first time I've heard a hypothesis that rising rates would cause more buyers in bonds... but hey, it could happen that way too :beer
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by ogd » Sun Jul 26, 2015 4:45 pm

JoMoney wrote:The big fear has been that rising interest rates will cause a mass exodus and severe liquidity problems in the bond market - particularly for large mutual funds - too many sellers. I think this is the first time I've heard a hypothesis that rising rates would cause more buyers in bonds... but hey, it could happen that way too :beer
It would only be the sane thing to do. If you like bonds at 2%, why would you not like bonds yielding 4%? Unlike stock declines, this is actually guaranteed, in the safe sectors.

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Re: Would Demand For Bonds Temper the Drop in NAV

Post by grabiner » Sun Jul 26, 2015 6:07 pm

max12377 wrote:If rates rise and, subsequently, the bond funds 'nav' drops in proportion to average duration of the bond fund, is it possible that the magnitude of the drop will be tempered by the public demand for better yielding bond funds? In other words, if there is a rush to buy the bond funds once the yield improves, would that keep the NAV from dropping somewhat?
The cause and effect goes the other way. Bonds, like other products sold in a market, have their prices set by supply and demand. If the demand for bonds falls, the price will fall until demand matches supply, and the yield of a bond rises when its price falls. At a lower price (higher yield), there will be a balance.
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Re: Would Demand For Bonds Temper the Drop in NAV

Post by DireWolf » Sun Jul 26, 2015 7:02 pm

Like many investors, I don't fully understand bonds. When interest rates finally start to rise, I'm going to start a CD ladder.

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