Short-Term Investment Grade Corporate Bond Funds

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magneto
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Short-Term Investment Grade Corporate Bond Funds

Post by magneto » Sat Aug 15, 2015 2:04 pm

Cannot find any mention of this asset class in first BH search.

Found Grog's Tip #14 'Avoid Long-Term Corporate Bonds' and subsequent discussion some help.
A quote from Grok :-
but I am not really in agreement with investing in a "total corporate bond" fund. I basically agree with jginseattle that the only corporate bonds that have historically provided conmpensation for credit risk/liquidity risk are short term ones. And that even then it may not be worth it because of portfolio effect- ie the losses tend to show up at the same time as stock losses.

Supposedly 'short-term debt tends to be the most sensitive to rate rise expectations.'
But surely short-term is in sum less volatile than mid to long?

We would expect the short end to respond quickly to interest rate rises, but also be the first to benefit from incoming bonds with higher yields?

It does seem possible at present to eke out a reasonable positive real yield with short-term corporates, less so with treasuries.

What is the worst that can happen adding this narrow asset class?
and can we quantify it?
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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patrick013
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by patrick013 » Sat Aug 15, 2015 4:29 pm

magneto wrote: We would expect the short end to respond quickly to interest rate rises, but also be the first to benefit from incoming bonds with higher yields?
Easier than an stock or IRA question, your answer.
age in bonds, buy-and-hold, 10 year business cycle

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JoMoney
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by JoMoney » Sat Aug 15, 2015 4:32 pm

The problems I see would be if you don't plan on holding them to maturity (or slowly bring your duration down over time) and liquidity problems hit when you need the money. In the midst of the 2008-2009 crisis people didn't want to lend to anybody, and selling even high quality short-term bonds might have taken a loss. Below chart is Vanguard's short-term treasury fund vs short-term investment grade bond fund:
Image
For me, the money I have in bonds is more like an 'emergency fund' than part of my investment portfolio. I want the money to be there as expected when I need it. For a long time I used a short-term bond index fund (blended treasury/corporates) but I kind of got spooked awhile back when they started talking about possibly putting exit constraints on bond funds if liquidity problems came up. I decided maybe a bond fund wasn't where I wanted my money and have been moving back to a regular bank account and Series I Savings Bonds.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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wintermute
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by wintermute » Sat Aug 15, 2015 5:35 pm

I've considered short-term investment grade (VFSUX) and the higher credit-rating VBIRX. Looking at what happened to VFSUX in 2008, a nearly 2% yield does not seem adequate. Then comparing VBIRX (~1.2% SEC yield), it especially doesn't make sense when you can get close to the same yield with CDs or savings, with no interest rate risk. You can get IRA savings/CD accounts as well.

If short term rates go to 0%, you could make a few % more in cap gains. If they go up to 5%, you'd lose about 8%. Yes, they could go negative. Even assuming a 50/50 chance of -5% vs 5% short term rates, it's not worth the potential down side, at least to me.

If you do want more potential variance, then just add longer term T-bonds to those FDIC savings to barbell. You'll get higher yield for the same risk, or lower risk for the same yield as short-term bonds.

So short term bond bonds just make no sense in most cases, except, say, in a 401k with no alternatives or if you're just starting to save and don't want the hassle of multiple accounts.

grok87
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by grok87 » Sun Aug 16, 2015 3:01 pm

magneto wrote:Cannot find any mention of this asset class in first BH search.

Found Grog's Tip #14 'Avoid Long-Term Corporate Bonds' and subsequent discussion some help.
A quote from Grok :-
but I am not really in agreement with investing in a "total corporate bond" fund. I basically agree with jginseattle that the only corporate bonds that have historically provided conmpensation for credit risk/liquidity risk are short term ones. And that even then it may not be worth it because of portfolio effect- ie the losses tend to show up at the same time as stock losses.

Supposedly 'short-term debt tends to be the most sensitive to rate rise expectations.'
But surely short-term is in sum less volatile than mid to long?

We would expect the short end to respond quickly to interest rate rises, but also be the first to benefit from incoming bonds with higher yields?

It does seem possible at present to eke out a reasonable positive real yield with short-term corporates, less so with treasuries.

What is the worst that can happen adding this narrow asset class?
and can we quantify it?
Well lets look,at some numbers.
I think one key number to look at for a corporate bond fund is the option adjusted spread or OAS. Unfortunately vanguard does not seem to publish this. For the index it is 108 bps or 1.08%. you would then take off 20 bp for fund expenses, so your net spread is 88 bp or 0.88%.
That doesn't seem like a bad amount of compensation. This fund lost about 5% in 2008. So if you consider that your downside risk then your "return on downside" is 17%.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Aptenodytes
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by Aptenodytes » Sun Aug 16, 2015 3:47 pm

To me it makes sense to imagine a two dimensional space, with default risk along one axis and duration along the other. You have choices within that whole space.

If you are going to be shifting your fixed-income investments based on market signals, you want a decision rule that guides you across that whole space, not just one dimension. And you want it to be good enough to guide you consistently over time, so you can follow a plan as opposed to winging it all the time.

So I'd say you ought to be choosing a decision rule about where to locate your bond money, and making the choice based on how well it will serve you over the long term, given your attitude toward risk and so on. A worst case scenario about a choice you might make this week is not the thing to be focusing on so much as the rewards and risks over the long term of having an investment style in which you make such moves.

For what it's worth, as I read the numbers against my own preferences, short term treasuries have been inferior to short-term investment-grade corporates for a few years. It sounds like you may be leaning that way too. But you have to compare short term to medium term as well (and long-term too if you are open to those). By my reckoning, intermediate-term bonds are still superior to short-term (I use the 20 basis points / year of duration rule of thumb), both for treasuries and corporates. Sure, if I'm still holding intermediates at a time when rates spike, I'll take a bath, but I'm making a judgment that occasional baths like that are acceptable from a long-term perspective. LIkewise, if I'm heavy on corporates and we have another financial crisis, I'll also take a bath, but I'll have been rewarded along the way just the same.

I'm not advocating for my decision rule, but I am advocating for you to adopt a decision rule (or a section of your IPS covering where you will hold your bond money).

stlutz
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by stlutz » Sun Aug 16, 2015 6:21 pm

One note that is worth adding on the VG fund (VFSTX/VFSUX) is that it did trail its benchmark by 3 or 4 percentage points in 2008. So, what you see there is a combination of what the asset class did as well as the risks of active management not working out.

pascalwager
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by pascalwager » Sun Aug 16, 2015 7:13 pm

JoMoney wrote:The problems I see would be if you don't plan on holding them to maturity (or slowly bring your duration down over time) and liquidity problems hit when you need the money. In the midst of the 2008-2009 crisis people didn't want to lend to anybody, and selling even high quality short-term bonds might have taken a loss. Below chart is Vanguard's short-term treasury fund vs short-term investment grade bond fund:
Image
For me, the money I have in bonds is more like an 'emergency fund' than part of my investment portfolio. I want the money to be there as expected when I need it. For a long time I used a short-term bond index fund (blended treasury/corporates) but I kind of got spooked awhile back when they started talking about possibly putting exit constraints on bond funds if liquidity problems came up. I decided maybe a bond fund wasn't where I wanted my money and have been moving back to a regular bank account and Series I Savings Bonds.
Yes, I share this attitude regarding bonds. My investment portfolio is comprised only of equity index funds. But I also keep a large slug of near-cash: savings, checking, I-Bonds, CDs, T-Bills.

grok87
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by grok87 » Sun Aug 16, 2015 11:13 pm

pascalwager wrote:
Yes, I share this attitude regarding bonds. My investment portfolio is comprised only of equity index funds. But I also keep a large slug of near-cash: savings, checking, I-Bonds, CDs, T-Bills.
+1
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Kevin M
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by Kevin M » Mon Aug 17, 2015 1:37 am

I used to own some Vanguard Short-Term Investment-Grade bond fund, but I sold it when distribution yield dropped below what I could earn in a good 5-year CD with an inexpensive early withdrawal penalty (EWP), which I believe was in April 2013 when distribution yield dropped to about 1.8%, and SEC yield was a pitiful 1.15% or so. Since then, SEC yield has recovered to a more respectable 1.9%, and distribution yield is 2.05% (and of course price has fallen), so it's more competitive with a good 5-year CD, but a good direct CD still has higher yield (2.25%), and less risk, with downside limited to the EWP of about 1.13%. So I prefer a CD to this bond fund for the safest portion of my fixed income.

I currently limit my bond fund holdings to those that have SEC yields higher than a good 5-year CD, like intermediate-term investment-grade, with an SEC yield of 2.84% and distribution yield of 3.12%. Of course these funds have more risk, but the lower risk of the CDs more than compensates in terms of overall fixed-income term risk and credit risk.

Kevin
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btenny
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by btenny » Mon Aug 17, 2015 1:46 pm

I am long time retired so I have a low risk portfolio and a big percentage of bonds in my asset allocation. Plus I am worried about earning more than inflation. So yes I keep about 5 years of money in short term investment grade as part of my sort of cash pile. I also keep about 1-1.5 years of money in real cash money markets that I draw on as needed. I do this because I do not want to deal with CDs. I only rebalance about once a year or less. I also have a bunch of money in Intermediate term Investment grade and some in TIPS and some in munis to round out my total bond allocation. I have multiple accounts so this fund is in tax deferred.

When I set up my asset allocation way back when (before 2008) for retirement VFSTX was way less trouble to manage than CDs. I also wanted to make sure I kept a 5 year or so stash of money that was ultra low risk and almost cash to draw on if the market crashed and I did not want to sell stocks or Intermediate Term bonds when I needed money. I choose VFSTX and cash at that time for this purpose.

magneto
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by magneto » Wed Sep 02, 2015 10:54 am

Thanks for the thoughtful responses.

We have opened an initial small position, and will continue to digest comments.
Maybe add to position later.

Thanks again.
'There is a tide in the affairs of men ...', Brutus (Market Timer)

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patrick013
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Re: Short-Term Investment Grade Corporate Bond Funds

Post by patrick013 » Wed Sep 02, 2015 2:10 pm

magneto wrote: What is the worst that can happen adding this narrow asset class?
and can we quantify it?
Sure, for a bond fund with 3 year avg. maturity and 5 year duration which
currently yields 1.5% :

After a 1% interest rate rise:

Year 1 : ($100,000 prior investment and current balance)

cash yield = +1,500

duration loss = -4,000 (-5,000 + 1,000)

total = -2,500


Year 2 :

cash yield = +1,500

duration loss = +1,000 (assuming equal amortization for simplicity)

total = +2,500

2 yr. total return = 0


Now if you had a 3 year CD that yielded 1.75% your 2 year return
would be +3.5% or +3,500 dollars.

So your bond fund after 2 years is $100,000

Your CD after 2 years is $ 103,500


Please excuse a few dollars for compounding and possible roll-ups. :D
age in bonds, buy-and-hold, 10 year business cycle

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