Larry Swedroe: Active Falls Short With Bonds Too

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Random Walker
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Larry Swedroe: Active Falls Short With Bonds Too

Post by Random Walker » Mon Aug 07, 2017 12:01 am

http://www.etf.com/sections/index-inves ... -bonds-too

No surprise to Bogleheads; active management is the loser's game in the bond market as well.

Dave

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nedsaid
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by nedsaid » Mon Aug 07, 2017 9:25 am

Very interesting. One of my biggest holdings is Vanguard Total Bond Market Index and I have been very pleased with it.
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Random Walker
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by Random Walker » Mon Aug 07, 2017 10:22 am

I do find the information interesting. The more I learn about bonds (especially munis) the more complex and opaque they appear. Thus the more I learn, the more potential I expect to see for someone to take advantage of inefficiencies. But apparently the bond market is way too efficient for active management to provide benefit.

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nedsaid
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by nedsaid » Mon Aug 07, 2017 12:01 pm

Contrary to what most people believe, bonds are very complex instruments. Things like call dates, order of priority for payment in event of bankruptcy, bond covenants make them complex securities. A lot of fine print. Many bonds are also a lot more illiquid than what most people realize. The transaction costs are not 100% transparent, you know the commission you pay, not necessarily the bid/ask spread. You can have transaction costs of 3% buying or selling a bond.
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by Call_Me_Op » Mon Aug 07, 2017 12:17 pm

This is interesting, since I recall Larry suggesting in the past that there are several things he doesn't like about a "Total Bond" (index) fund, such as its investment in MBS's.
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by Artsdoctor » Mon Aug 07, 2017 1:02 pm

Just remember that nearly all of Vanguard's municipal bond funds are actively managed. So there would probably be some caveats with this and other arguments involving "active" management.

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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by iamlucky13 » Mon Aug 07, 2017 1:12 pm

Call_Me_Op wrote:This is interesting, since I recall Larry suggesting in the past that there are several things he doesn't like about a "Total Bond" (index) fund, such as its investment in MBS's.
I don't think that's inconsistent. He can like index investing in bonds without liking all indexes equally.

If I remember right, he prefers intermediate term bonds to a total bond fund - very similar average duration and other characteristics but without the mortgage backed securities.

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nedsaid
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by nedsaid » Mon Aug 07, 2017 2:00 pm

iamlucky13 wrote:
Call_Me_Op wrote:This is interesting, since I recall Larry suggesting in the past that there are several things he doesn't like about a "Total Bond" (index) fund, such as its investment in MBS's.
I don't think that's inconsistent. He can like index investing in bonds without liking all indexes equally.

If I remember right, he prefers intermediate term bonds to a total bond fund - very similar average duration and other characteristics but without the mortgage backed securities.
Larry likes the short and medium term US Treasuries. In times of crisis, the flight to safety is to Treasuries which is why they give you a better diversification effect. He calls the Total Bond Market Index a misdemeanor and not a felony. ;o) He does not like mortgage backed securities like GNMAs, primarily because of extension risk. That means people won't refinance when interest rates go up and they are less likely to move. So pretty much in a time of rising interest rates, duration and average maturity effectively goes up. It used to be that people moved about every seven years so most 30 year mortgages were not kept to maturity. When interest rates fall, people tend to refinance.
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by stlutz » Mon Aug 07, 2017 8:28 pm

Unfortunately, Swedroe didn't say why actively-managed mutual funds underperform, which is fees.

In reality, a lot more "active" choices have to be made in bond investing. And his recommendations have varied a lot depending upon the situation.

For example, if one held 90% stocks, he sometime advocated for holding long-term treasury bonds for your bond holding.

He has been an advocate of brokered CDs but not direct-from-the-bank CDs.

He has been an advocate of purchasing individual muni bonds over a fund, in order to better manage credit and call risk, and to allow for TLH of individual bond holdings.

He doesn't like call risk in any type of bond as he didn't believe the risk is appropriately priced.

And he would change his holdings based on what he thought was attractive at the time, for example selling all of his CDs in favor of P2P lending (through an actively managed fund).

All of these are very active decisions/recommendations.

And even for the person not following his views, nobody is really buying the whole bond market. "Total Bond" excludes munis, TIPS, and high yield bonds, for example. Many people only include bonds of certain maturities. And how does one weight direct CDs or even savings accounts?

In this case, the article should have focused more on low-cost investing, as Swedroe has never been an advocate of trying to be as passive as possible with bonds. Actually Rick Ferri was a lot closer to a more passive, market-weight approach.

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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by grabiner » Thu Aug 10, 2017 10:46 pm

stlutz wrote:Unfortunately, Swedroe didn't say why actively-managed mutual funds underperform, which is fees.
I confirmed this with Vanguard's own active bond funds. Vanguard has 22 active bond funds with a 10-year history. 8 of those 22 outperformed the index (using Admiral shares if available). 6 underperformed by less than their expense ratio, for a net of 14 out of 22 that beat the index before expenses. 8 underperformed by more than their expense ratio. Since the indexes also have expenses (only one of Vanguard's four bond index funds with a 10-year record has beaten its index, and Intermediate-Term Bond Index did so only by one basis point), it's essentially break-even.

The biggest losers were Intermediate-Term Treasury and Intermediate-Term Investment-Grade; while they are index-like in their behavior, their duration is significantly shorter than the benchmark duration, which gives them less risk than the benchmark but lower returns when rates are stable or falling. I would expect that Intermediate-Term Treasury would track very well to an index of Treasury bonds with duration 3-9 years to approximate its current holdings, rather than the 5-10 of its benchmark.
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Taylor Larimore
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The Bond Market

Post by Taylor Larimore » Thu Aug 10, 2017 11:26 pm

Bogleheads:

In my view, it is a mistake to select bond funds on the basis of past returns (as Morningstar does).

* The bond market is VERY efficient. Higher yield nearly always means higher risk (no one knowingly buys a bond or bond fund with lower yield and higher risk).

* Bonds are primarily for safety in a portfolio (they let us sleep well). Stocks are are primarily for higher returns (they let us eat well).

* Buy bonds and bond funds for safety--not high returns.

* Bond diversification is the only "free-lunch" in bond funds. This is one reason why diversified Vanguard Total Bond Market Index fund is the largest bond fund in the world.

Best wishes.
Taylor
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RetireBy55
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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by RetireBy55 » Fri Aug 11, 2017 7:53 pm

Disagree. Wish I knew how to embed a chart from M*, but go compare PONDX to VBTLX. PONDX (active) absolutely annihilates VBTLX over every time period going back 10+ years.

I own both and PONDX absolutely smashes VBTLX in terms of performance.

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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by Explorer » Sat Aug 12, 2017 7:14 pm

While I agree that PONDX smashed VBTLX, one must understand exactly what PIMCO is doing to achieve those returns. We broadly know that PONDX is a multi-sector bond fund (includes HY and EM debt), they use leverage, they employ derivatives and interest rate swaps to "manage" duration etc each of those instruments carries risk that has NOT been fully tested over an extended period of time (and in rising interest rate environment).

I own both VBTLX and PIMIX (lower fee version of PONDX) and happy with both. PONDX has more risk than VBTLX no matter how you slice it.

For those investors who are less invested in equities (like myself) it is prudent to use active, well managed bond funds like PONDX to get more juice out of their investments rather than simply relying on VBTLX (or such).
RetireBy55 wrote:
Fri Aug 11, 2017 7:53 pm
Disagree. Wish I knew how to embed a chart from M*, but go compare PONDX to VBTLX. PONDX (active) absolutely annihilates VBTLX over every time period going back 10+ years.

I own both and PONDX absolutely smashes VBTLX in terms of performance.

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Re: Larry Swedroe: Active Falls Short With Bonds Too

Post by lack_ey » Sat Aug 12, 2017 9:47 pm

For reference there have been a lot of previous threads about PIMCO Income, including
viewtopic.php?t=224300
viewtopic.php?t=206375

There are a lot of contributing pieces behind the exceptional return since inception and since the financial crisis, some of which has to do with assets that Total Bond-style funds do not invest in substantially (parts of non-agency MBS, HY, EM, etc.).


In any case, as for the original article I would like to see performance persistence data on bond funds, as well as comparisons of fund alpha against term/credit (and maybe other) factors to do a real attribution, not just the SPIVA category results. In some categories, the average exposure of the funds may be significantly different from the benchmark SPIVA used, so it may not really be apples-to-apples. Also it's better to examine a little more granularly—maybe there's some short-intermediate term fund that gets compared against the intermediate-term core category and loses there but actually achieves higher Sharpe than the short-term and intermediate-term benchmarks. Or perhaps there's performance persistence in active bond fund managers, either as a result of different exposures or perhaps even alpha, meaning that even if the average fund is bad, you can identify the good ones beforehand with a high enough probability to be useful. (In stock funds, you don't see much performance persistence between high and low performers.)

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