Index Bond Funds

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Bondman
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Index Bond Funds

Post by Bondman »

Do index bond funds like BND or BNDX or VTEB sell their bonds after buying them, or do they just ride them out to maturity?
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triceratop
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Re: Index Bond Funds

Post by triceratop »

Bondman,
The Vanguard bond funds you refer to are not "closed-end" bond funds, and trade securities to track the individual bond indices chosen as their benchmark. More information can be found in the fund prospectuses.
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lack_ey
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Re: Index Bond Funds

Post by lack_ey »

BND - Vanguard Total Bond Market Index Fund (Barclays U.S. Aggregate Float Adjusted Index)
BNDX - Vanguard Total International Bond Index Fund (Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index)
VTEB - Vanguard Tax-Exempt Bond Index Fund (S&P National AMT-Free Municipal Bond Index)

Yes, these funds cycle through bonds to match the characteristics of the underlying indexes. That means buying and selling to keep up with the evolving distribution of maturities dictated by the indexes.

A lot of people don't realize this, but most bond indexes don't cover short-term debt (under 1 year or thereabouts), the kind of stuff that you might find in money market funds, though perhaps less the case with muni funds. It really depends. But significantly, BND and BNDX have about 1% in maturities under a year, compared to close to 20% in the 1-3 years range. They eventually get around to selling almost everything before it matures. VTEB is around 4-5% under 1 year; I don't think it needs to do as much selling for maintenance. You wouldn't as much want that in the less liquid muni market. But regardless, it's not going to keep everything until maturity.
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Bondman
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Re: Index Bond Funds

Post by Bondman »

Thanks for your responses.
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abuss368
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Re: Index Bond Funds

Post by abuss368 »

A great question. My understanding is their is a certain degree of selling and buying so the fund can track the index.
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tyc
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Re: Index Bond Funds

Post by tyc »

Here is another idea. Look at the portfolio turnover rate and compare it to similar funds.
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ogd
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Re: Index Bond Funds

Post by ogd »

Bondman wrote:Do index bond funds like BND or BNDX or VTEB sell their bonds after buying them, or do they just ride them out to maturity?
Yes, they do, because bond age and the index excludes bonds too short.

However, don't get spooked by the fact that the bonds might be sold for a capital loss. In a liquid market when yields have risen, old depreciated bonds and new bonds of the same maturity are equivalent. So the decision to not hold to maturity is simply the usual decision to not have bonds < 2 years, for example. There is nothing special about holding bonds to maturity, the rewards for doing so are precisely captured in the yield, and the fund is probably signing up for better rewards by moving back up on the maturity curve.

In an illiquid market (where selling incurs large expense-like losses), you have to trust the managers to do the right thing and sell at appropriate times, or use tools like derivatives to mitigate the impact of liquidity.

To put it another way, thinking of the sale as "realizing capital losses" is the sort of thing that doesn't carry well from the world of stocks. In fact, if you imagine a series of yield increases and a bond holder who keeps selling his bond for a loss and replacing it with a fresh one of the same maturity, they would end up in the same place as if they'd held the bond to maturity (with possibly different tax consequences). This would not be a good idea with stocks, but with bonds it doesn't hurt you because bonds of different values are interchangeable if equal on the characteristics that matter, issuer and maturity.
alex_686
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Re: Index Bond Funds

Post by alex_686 »

ogd wrote:However, don't get spooked by the fact that the bonds might be sold for a capital loss. In a liquid market when yields have risen, old depreciated bonds and new bonds of the same maturity are equivalent. So the decision to not hold to maturity is simply the usual decision to not have bonds < 2 years, for example.
To extend, once you get down to 1 or 2 years left there is not much premium / discount left in a bond. So no large impact.
ogd wrote:In an illiquid market (where selling incurs large expense-like losses), you have to trust the managers to do the right thing and sell at appropriate times, or use tools like derivatives to mitigate the impact of liquidity.
I will disagree here. A portfolio manager of a index fund must follow the index pretty closely. If there is panic selling in a illiquid market, like 2008, and a fund has net outflows, the portfolio manager must sell. They some, but not much, in the way of discretion.

On the flip side, broad bond indexes tend to favor the more liquid bonds. Remember, a bond index normally only has 10% of the eligible bonds in it. I personally consider this a negative in investing in bond index funds. There is extra yield to be found in the semi-illiquid part of the market. However, in times of panic it is better to be more liquid.

I personally prefer a semi-active approach. Following the index broadly but being able to make tactical allocations.
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Seattlenative
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Re: Index Bond Funds

Post by Seattlenative »

Could someone explain the difference in methodology between the Barclays "Float Adjusted" Aggregate Bond Index used by Vanguard (BND) and the standard Barclays Aggregate Bond Index? Looking at long-term time spans for these funds using Portfolio Visualizer, there are brief periods when"Float Adjusted" BND slightly outperforms AGG but I really wonder exactly what the difference is.
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ogd
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Re: Index Bond Funds

Post by ogd »

alex_686 wrote:To extend, once you get down to 1 or 2 years left there is not much premium / discount left in a bond. So no large impact.
Plus, my point was that it doesn't matter because there are plenty of bonds with X% yield in that market and there's nothing special about holding that old bond to maturity -- it's merely the usual decision about whether or not you want to hold bonds of < 2 years in your portfolio.
alex_686 wrote:I will disagree here. A portfolio manager of a index fund must follow the index pretty closely. If there is panic selling in a illiquid market, like 2008, and a fund has net outflows, the portfolio manager must sell. They some, but not much, in the way of discretion.
I read the OP's question to be more about "normal operations" selling and not outflows. Outflows are a slightly different matter, because even when a fund sells assets in extremely unfavorable conditions -- think stocks in 2008 -- it's the outgoing shareholders that take the loss, provided that the NAV of the fund matches the prices at which assets are being sold. So it's all about that discrepancy, and bad liquidity may or may not mean that a discrepancy exists. Otherwise, if you sell 50% of the fund to meet 50% redemptions, the remaining shareholders are not affected, however low the asset values might have dipped. They only lose if you have to sell 52% to meet 50% redemptions. AFAIK, such liquidity losses in funds that aren't artificially pegged to a NAV are rare and confined to the very illiquid sectors. Also AFAIK, ETFs should not be vulnerable to this problem because the sellers bear the liquidity costs (and then some), but you'd better not be one of the sellers.
alex_686 wrote:There is extra yield to be found in the semi-illiquid part of the market. However, in times of panic it is better to be more liquid.
Considering the role of bonds in a portfolio -- e.g. that I might sell up to 50% of them at the bottom to rebalance -- I'd call the liquidity pretty important, and funds can do it better than you can. Perhaps for the "deep" part of fixed income that is unlikely to be touched, one can be a little more adventurous; for me munis and CDs fill this part. I would also note that high liquidity or not, it seems to be pretty hard to outperform in bonds as well, and for all overly-speculative funds that haven't yet run into a ditch, you have to wonder whether they're merely the ones that haven't hit it yet.
lack_ey
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Re: Index Bond Funds

Post by lack_ey »

Seattlenative wrote:Could someone explain the difference in methodology between the Barclays "Float Adjusted" Aggregate Bond Index used by Vanguard (BND) and the standard Barclays Aggregate Bond Index? Looking at long-term time spans for these funds using Portfolio Visualizer, there are brief periods when"Float Adjusted" BND slightly outperforms AGG but I really wonder exactly what the difference is.
The float-adjusted index takes the usual market cap weightings and then adjusts them for how much is available on the market (floating). Here with the Barclays index, it considers the Treasuries, agency bonds, and MBS held in Federal Reserve accounts as not free float, thus reducing their weights correspondingly to match the amount issued that's held elsewhere by the markets. Compare the Vanguard fund's sector allocation to that of a competitor that doesn't use the float-adjusted version. It's slightly riskier overall.
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