Why is long bonds yielding less than short bonds?

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yesac13
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Why is long bonds yielding less than short bonds?

Post by yesac13 » Tue Jun 12, 2018 7:28 pm

I was looking at EDV (Vanguard Extended Duration Treasury ETF) which has a yield of 3.08% as of 6/12/2018.

This surprised me and is very confusing for me.

The reason I am confused and surprised...

BND (Vanguard's Total Bond Market ETF) currently yields at 3.12%. BIV (Vanguard Intermediate Term Bond ETF) yields 3.42%. The various shorter term ETFs like VGIT (Intermediate Term Treasury ETF), VGSH (Short Term Treasury ETF) and so on... are closing on EDV as yields goes.

EDV has longer effective maturities and average duration yet is yielding surprisingly low while the other ETFs with shorter maturities and duration is yielding higher and higher.

What does this mean? By all rights, EDV should be yielding closer to 4% (like BLV is right now - 4.00%) but is not. Vanguard's own website says EDV is very risky. Vanguard has a 1 to 5 scale, 1 being less risky, less reward while 5 is more risky but more reward. EDV is at 5 while BIV or BND is at 2. Yet BIV and BND yields more than EDV.

I researched in this and did not find a good answer... only canned blah blah on longer duration more risky higher yield yet as you can read above, some of the shorter term ETFs now are yielding more than EDV.

Can you help me understand why things are the way they are today? I find EDV yielding less than BND or BIV more irrational than the bloated stock market to be honest.

stlutz
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Re: Why is long bonds yielding less than short bonds?

Post by stlutz » Tue Jun 12, 2018 7:36 pm

Funds like BND or BIV are making substantial investments in corporate bonds. With those bonds, there is a lot more risk that you won't get all of your interest payments or all of your principal back because the company goes bankrupt. As such, such bonds have a yield premium over treasuries.

If you just look at Treasury funds, EDV>VGLT>VGIT>VGSH.

Crushtheturtle
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Re: Why is long bonds yielding less than short bonds?

Post by Crushtheturtle » Tue Jun 12, 2018 7:48 pm

yesac13 wrote:
Tue Jun 12, 2018 7:28 pm
Why is long bonds yielding less than short bonds?
*are

lack_ey
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Re: Why is long bonds yielding less than short bonds?

Post by lack_ey » Tue Jun 12, 2018 8:01 pm

For Treasury yields generally, you may want to check here (or elsewhere):
https://www.treasury.gov/resource-cente ... data=yield

The yield curve is currently upwards sloping, just not all that much past a few years out. Sometimes the yield curve is inverted, generally happening when short rates get pushed up and people don't expect that to last. We're not close to that yet. We're just at a point where intermediate-term funds with mid-low credit risk can have higher yields than long-term Treasury funds, and even though credit spreads are relatively low as well too.

Longer maturities don't guarantee higher yields. There are a lot of factors that could reduce long-term yields relative to short-term and intermediate-term yields. If people don't think that rates in the longer term are not likely to rise much, this can keep long yields down. If they don't worry much about inflation rising above expectations (think it's range bound, predictable), then there's not much reason to price long-term bonds as that risky with higher yields to compensate. If there's a lot of demand on that part of the yield curve, and not necessarily from investors like us but maybe foreign governments and insurance companies and all kinds of other players, then that could bring the yields relatively lower. If long-term government bonds are perceived as a safe haven and liable to go up when equity markets tank, maybe they're priced more like insurance and a hedge and thus command a lower yield. And so on.

In a world where rates are going to 5% and staying there, the current rates don't really make sense. But in a world where short rates don't break 3% in this cycle before coming down again to a degree in the next recession, and with secular trends towards lower rates in the longer term, the current term structure could be pretty reasonable.

AlohaJoe
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Re: Why is long bonds yielding less than short bonds?

Post by AlohaJoe » Tue Jun 12, 2018 8:48 pm

stlutz wrote:
Tue Jun 12, 2018 7:36 pm
Funds like BND or BIV are making substantial investments in corporate bonds. With those bonds, there is a lot more risk
To see what stlutz is talking about here go to the ETF's page on Vanguard and scroll down to "Portfolio Composition"

https://investor.vanguard.com/etf/profile/edv

is 100% US Government

https://investor.vanguard.com/etf/profile/BND

is only 64% US Government. (The rest is invested in things that are higher risk -- and thus higher yield.)

Long bonds aren't yielding less than short bonds. Lower risk bonds are yielding less than higher risk bonds, which is what you'd expect.

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Kevin M
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Re: Why is long bonds yielding less than short bonds?

Post by Kevin M » Tue Jun 12, 2018 8:57 pm

stlutz wrote:
Tue Jun 12, 2018 7:36 pm
Funds like BND or BIV are making substantial investments in corporate bonds. With those bonds, there is a lot more risk that you won't get all of your interest payments or all of your principal back because the company goes bankrupt. As such, such bonds have a yield premium over treasuries.

If you just look at Treasury funds, EDV>VGLT>VGIT>VGSH.
To illustrate this graphically, here is a chart from the Fidelity yield summary page for Treasuries, AAA corporate, and AA corporate bonds, out to 10-year maturity.

Image

Note that the 1-year AA corporate yield is about the same as the 5-year Treasury yield, and the 2-year AA corporate yield is higher than the 10-year Treasury yield.

The AAA corporate yield is pretty close to Treasury yield out to about 3-year maturity, but the 5-year AAA corporate yield is higher than the 10-year Treasury yield. Credit risk increases with increasing maturity, since there is more time for downgrades and defaults.

One caveat here is that Fidelity shows the highest yield for a given bond type + credit rating at a given maturity, so this chart may be exaggerating the credit spreads, but it still makes the point that you can't compare bond funds based only on average maturity or duration, but also must consider credit risk (aka default risk).

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

venkman
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Re: Why is long bonds yielding less than short bonds?

Post by venkman » Tue Jun 12, 2018 10:25 pm

EDV invests in long-term zero-coupon bonds. The bonds themselves pay out no regular interest, but the fund pays out some dividends as it gets money from bonds that mature. In terms of income, I don't know how close a match you can expect to get, compared to regular long-term Treasuries.

I've always been a bit intrigued by EDV. It's extremely volatile on its own, but since 2010 it has a stock market correlation of -0.55. Rebalanced annually, an 80/20 mix of VTSAX/EDV has a CAGR only .25% lower than 100% VTSAX, but a MUCH lower Stdev. (Sharpe ratio of 1.56, compared to 1.08 for 100% VTSAX).

Link to PV backtest:
https://www.portfoliovisualizer.com/bac ... ion2_3=100

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JoMoney
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Re: Why is long bonds yielding less than short bonds?

Post by JoMoney » Wed Jun 13, 2018 4:20 am

Still looks like a progressive yield to me...
Image
http://www.wsj.com/mdc/public/page/mdc_ ... nav_2_3021
"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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