Which Intermediate Bond Fund Will Perform Best With Rising Rates

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Munir
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Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Munir » Tue Jan 09, 2018 5:22 pm

With the 10 year Treasury Rate rising today, it would be interesting to see how the various Vanguard Intermediate Bond funds will respond. Will this be a meaningful comparison to try and predict how these funds will behave in a continuing rising rates environment or is it a meaningless one-day result? What other period of time would be a better predictor if we can exclude 2008 which was a different story?
Last edited by Munir on Tue Jan 09, 2018 5:55 pm, edited 1 time in total.

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willthrill81
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by willthrill81 » Tue Jan 09, 2018 5:26 pm

I would expect that the funds with the lowest duration will perform the best in the short-term. In the longer-term, I don't think there's a meaningful or predictable difference, assuming a similar starting yield.
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Thesaints » Tue Jan 09, 2018 5:32 pm

To be sure the 10-year rate was higher last march and you are right, it is almost a meaningless comparison. In an extended rise one would have to check how the funds duration changes and that's why simply checking what happened last march is irrelevant.

For all investment grade bonds the principal predictor is their duration, but beware of the fact that the fund manager can choose to change it.
Arguably, indexed and variable rate bonds would perform better, but beware that everyone knows about it and therefore this could already be reflected into prices.

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Sandtrap » Tue Jan 09, 2018 5:36 pm

Would there be any difference for an intermediate term "tax-exempt" bond fund?
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Aptenodytes
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Aptenodytes » Tue Jan 09, 2018 6:02 pm

There's a paradox: IF you really believed it were possible to predict interest rate changes, then you would HAVE to conclude that you should never do so. Because actively managed bond funds have access to far better information than you and teams of far better-trained people than you. So if you believe in this crystal ball, invest in an actively managed bond fund.
Munir wrote:
Tue Jan 09, 2018 5:22 pm
... What other period of time would be a better predictor if we can forget about 2008?
Why would you want to forget about 2008 when choosing your bond portfolio? If bonds serve to help you weather storms, you want to stress test your bond portfolio against precisely such magnitude storms.

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by BlueEars » Tue Jan 09, 2018 6:11 pm

I had a chart of comparing intermediate and short term Treasuries during the rising rate environment of the 1950-1980 period.
See: viewtopic.php?f=10&t=234213&e=1&view=unread#unread

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Munir » Tue Jan 09, 2018 6:11 pm

Aptenodytes wrote:
Tue Jan 09, 2018 6:02 pm
There's a paradox: IF you really believed it were possible to predict interest rate changes, then you would HAVE to conclude that you should never do so. Because actively managed bond funds have access to far better information than you and teams of far better-trained people than you. So if you believe in this crystal ball, invest in an actively managed bond fund.
Munir wrote:
Tue Jan 09, 2018 5:22 pm
... What other period of time would be a better predictor if we can forget about 2008?
Why would you want to forget about 2008 when choosing your bond portfolio? If bonds serve to help you weather storms, you want to stress test your bond portfolio against precisely such magnitude storms.
2008 was a different environment where there was an equity crash. What I am curious about is how these funds would perform in a rising rate environment. I know that there are other factors that influence performance but I am just asking about a specific scenario relating to rising rates.

I include actively-managed bond funds in my question. I happen to own two actively-managed Vanguard bond funds. My question still stands.
Last edited by Munir on Tue Jan 09, 2018 6:24 pm, edited 1 time in total.

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BlueEars
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by BlueEars » Tue Jan 09, 2018 6:22 pm

The last period of rising rates was April 2004 to June 2006. 5yr Treasuries rose from 2.8% to 5.1%. Here are some CAGR's for that period:

VFIUX 0.6% intermediate Treasury
VFIDX 1.2% intermediate IG
VBTLX 1.4% Intermediate total stk mkt

VFIRX 1.2% short term Treasury
VFSUX 1.8% short term IG

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by nisiprius » Tue Jan 09, 2018 6:35 pm

They're bonds. There shouldn't be big differences.

I'm don't have the expertise to address small differences, nor do I care much about them.

In a broad sort of way, given similar term (intermediate) and similar credit quality (investment grade) the obvious "prediction" is that if things turn out to be "normal," slightly riskier bond funds will perform slightly better, and that if things turn out to be turbulent, slightly riskier bond funds will perform worse. Which tells us nothing unless we can predict whether the times will be "normal" or turbulent.

Unfortunately, there's only one SBBI data series for intermediate-term bonds (government). For long-term bonds, which are not really what we're interested in, we can compare long-term government versus corporate for 1940-1980. I'm only showing this data because I happen to have it; I don't draw any conclusions at all from it.

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by OkieIndexer » Tue Jan 09, 2018 6:38 pm

Below I charted all the Vanguard intermediate bond funds from 7/31/2012 to 12/31/2013, a period when the 10 year Treasury yield rose from 1.51% to 3.04%:

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

The 2 corporate bond funds did the best (interm corporate bond and interm investment grade). The government funds did the worst (interm Treasury and interm govt bond index).

12/31/2008 - 12/31/2009 (10 Year rose from 2.25% to 3.85%):

Corporate bonds (investment grade fund) won again, followed by Tax-Exempt. Interm Treasury fund did the worst.

May 2003 - June 2006 (10 Year rose from 3.37% to 5.15%):

Tax-Exempt won, followed by corporates (investment grade). Interm Treasury fund did the worst.

Sep 1993 - Nov 1994 (10 Year rose from 5.4% to 7.9%):

Tax-Exempt won, followed by Total Bond. Interm Treasuries did the worst.

And the big one, Dec 1976 - Sep 1981 (10 Year rose from 6.81% to 15.84%). I've overlaid the Morningstar intermediate bond indexes in the chart below since appropriate bond index funds didn't exist in Dec '76. The blue line is Vanguard Wellington which I inserted to make the chart start in Dec. '76.

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

Tax-Exempt took a shellacking, while corporates did the best, and Treasuries in the middle. Intermediate Bond (including corporates) actually came out with a 4% gain despite a 900 bp rise in the 10 Year Treasury.
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by tibbitts » Tue Jan 09, 2018 9:52 pm

Munir wrote:
Tue Jan 09, 2018 6:11 pm
Aptenodytes wrote:
Tue Jan 09, 2018 6:02 pm
There's a paradox: IF you really believed it were possible to predict interest rate changes, then you would HAVE to conclude that you should never do so. Because actively managed bond funds have access to far better information than you and teams of far better-trained people than you. So if you believe in this crystal ball, invest in an actively managed bond fund.
Munir wrote:
Tue Jan 09, 2018 5:22 pm
... What other period of time would be a better predictor if we can forget about 2008?
Why would you want to forget about 2008 when choosing your bond portfolio? If bonds serve to help you weather storms, you want to stress test your bond portfolio against precisely such magnitude storms.
2008 was a different environment where there was an equity crash. What I am curious about is how these funds would perform in a rising rate environment. I know that there are other factors that influence performance but I am just asking about a specific scenario relating to rising rates.

I include actively-managed bond funds in my question. I happen to own two actively-managed Vanguard bond funds. My question still stands.
But you don't say what rates you're talking about rising. What if very short rates, most influenced by the fed, rise, while longer rates fall? Or what if longer rates rise even faster/more than short rates?

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Munir
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Munir » Wed Jan 10, 2018 10:45 am

One-day performance results for 1/9/18 (for what they're worth):

Inter-Term Treasury Adm $11.00 –$0.02 –0.18%
Inter-Term Bond Index Adm $11.28 –$0.03 –0.27%
IT Treasury Index Admiral $21.46 –$0.06 –0.28%
Core Bond Fund Admiral $19.83 –$0.06 –0.30%
Inter-Term Invest-Gr Adm $9.69 –$0.03 –0.31%
Total Bond Mkt Index Adm $10.68 –$0.04 –0.37%

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Munir
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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by Munir » Wed Jan 10, 2018 12:59 pm

Forgot one fund to above one-day performance list on 1/9/18:

Inter-Term Corp Bnd Ix Ad $23.41 –$0.07 –0.30%

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Re: Which Intermediate Bond Fund Will Perform Best With Rising Rates

Post by grabiner » Thu Jan 11, 2018 10:44 pm

Munis should lose a bit less than taxable bonds to rising rates, because they need to stay competitive in after-tax yields.

Say that munis have the same yield as taxable bonds of comparable risk in a 25% tax bracket; this is the rule of thumb I use, although the number doesn't have any particular basis because risk is hard to quantify. In that case, if taxable yields rise from 3% to 4%, muni yields should rise from 2.25% to 3%, and thus the price will fall by only 75% as much given the same duration.

As a separate issue, the less a bond is correlated with Treasury bonds, the less it will lose value when rates rise. In particular, if inflation rises, nominal Treasury yields will increase because investors are willing to pay less for deflated future dollars, but TIPS yields will not change. Similarly, I would expect high-yield bonds to be less sensitive to changes in interest rates, but to have other risks.

We saw a version of this in the 2008 financial crisis. Treasury yields fell as the stock market crashed, but corporate yields rose as default risks increased. In the 2009 recovery, the reverse happened.
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