To extend out maturities or not?

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BlueEars
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To extend out maturities or not?

Post by BlueEars » Sun Jul 15, 2018 5:38 pm

I've compared 3 investment grade bond funds. There are:
VUSFX Ultra Short Term........Sec yield = 2.53%, avg maturity = 0.9 years
VFSUX Short Term IG...........Sec yield = 3.17%, avg maturity = 3.2 years
VFIDX Intermeditate Term IG..Sec yield = 3.59%, avg maturity = 6.0 years

I calculated the slope to extend out (numerator = yield difference, denominator = maturity difference) and get:
VUSFX to VFSUX = 28 bp/year
VFSUX to VFIDX = 11 bp/year

Based on this I am inclined to stick with VFSUX. It seems to pay to extend out to 3.2 years but not to 6.0 years.

This would be based on the assumption that a 20 bp/year slope is worth it to extend but not if we have a much flatter slope. Also in a few years where this condition held (2006 though 2008) it was more advantages to go with short term investment grade then intermediate term. Naturally other things can happen like rates going down which would make longer term the winner. I personally do not think rates will go down anytime soon because the economy is quite strong and the Fed Leading Index is in a pretty high state but this is just a guess on my part.

Your thoughts on this analysis?

mega317
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Re: To extend out maturities or not?

Post by mega317 » Fri Jul 20, 2018 11:59 am

Just seeing this older post. I think it depends on what you're trying to do. The reasoning is certainly valid about bp/year. But when you start with "personally do not think" and "just a guess" it makes me question your whole approach. No one can consistently have success timing the market. Although honestly I think trying to market time bonds isn't that big a deal within reason.

Most people are probably better served using an intermediate term fund and forgetting about it, but maybe you're nothing like most people.

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BlueEars
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Re: To extend out maturities or not?

Post by BlueEars » Fri Jul 20, 2018 7:25 pm

Thanks Mega317, I was really focusing on the slopes data. The comments at the end were a bit of speculation and for this forum might be taken the wrong way i.e. might be seen as ad hoc timing. I try to stick to the broad historical data mostly. My "neutral" position would be to have more intermediate bonds in perhaps a 2:1 ratio to short term bonds.

I actually do have a process in mind and as slopes go back towards more normal levels I would go back to intermediate bonds. So if we go from 11 bp/yr to around 18 bp/yr I would move the short term bonds to intermediate.

Here is some data I gathered from the Simba spreadsheet plus Fed that might be of interest to others. The start of year slope (1 year to 5 year Treasury) can easily be subordinated to the direction of interest rates over the yield curve.

Image
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BlueEars
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Re: To extend out maturities or not?

Post by BlueEars » Sat Jul 21, 2018 3:01 pm

It occurred to me that I could sort the data by the slope (bp/yr on right axis). Below is that sort. Ignore the 1944-1953 zeros which appear in the chart. The arrow points to the beginning 2018 slope of 11 bp/yr.

Image


It seems the slope effect is not all that strong. Perhaps one should just stick with a standard Boglehead strategy of selecting a few bond funds and sticking with them.

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Re: To extend out maturities or not?

Post by Doc » Sun Jul 22, 2018 6:23 pm

BlueEars wrote:
Sun Jul 15, 2018 5:38 pm
This would be based on the assumption that a 20 bp/year slope is worth it to extend but not if we have a much flatter slope.
Other than a short quote in Swedroe's bond book I have not been able to find other references to this idea or even to Swedroe's reasoning for making the statement. Do you have any other sources?

Caveat: My location in my name plate refers to street directions not philosophy. :wink:
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

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BlueEars
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Re: To extend out maturities or not?

Post by BlueEars » Sun Jul 22, 2018 7:04 pm

I haven't seen anything besides the Swedroe mention. He had said that DFA used this but the manner they used it was not discussed. I've tried various schemes with Treasury data but never found anything that I felt was worth it.

Looking at that chart of sorted slopes above, if I take the years that had slope is < 15bp/yr then the results in favor of short term Treasuries were 18 to 9 in favor of ST Treasuries over IT Treasuries. I think maybe that is not quite good enough for me to use. Plus we are long into the business cycle so if one starts the timer from now, the possibility is good that we have a recession in the next 5 years i.e. during the duration of intermediate bonds. That means that intermediate bonds could do decently if rates are pulled down during a slowdown or recession even if they go up for a few years.

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Re: To extend out maturities or not?

Post by jhfenton » Sun Jul 22, 2018 7:20 pm

BlueEars wrote:
Sun Jul 15, 2018 5:38 pm
Your thoughts on this analysis?
I've done the same sort of analysis on but on the corporate bond index funds and the treasury bond index funds. I don't like the investment grade active funds because they mix the two and muddy the waters.

On the treasury side, the curve is so flat, that it seems reasonable to pick short-term over intermediate:

VSBSX (Short Term Treasury Index) - 2.50% SEC Yield - 1.9 years duration
VSIGX (Intermediate Treasury Index) - 2.71% - 5.1 years

On the corporate side, it's not quite as flat:

VSCSX (Short Term Corporate Index) - 3.37% - 2.8 years
VICSX (Intermediate Corporate Index) - 4.05% - 6.4 years

That's 21 bp for 3.2 years on the treasury side, or 6.6 bp/year. That's 68 bp for 3.6 years on the corporate side, or 18.8 bp/year.

So I've kept my intermediate corporate fund, but I've moved to short-term treasuries. I don't jump back and forth based on interest rate forecasts, but I will move some based on the current most attractive spot on the yield curve.

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Re: To extend out maturities or not?

Post by BlueEars » Sun Jul 22, 2018 8:05 pm

jhfenton wrote:
Sun Jul 22, 2018 7:20 pm
...

That's 21 bp for 3.2 years on the treasury side, or 6.6 bp/year. That's 68 bp for 3.6 years on the corporate side, or 18.8 bp/year.

So I've kept my intermediate corporate fund, but I've moved to short-term treasuries. I don't jump back and forth based on interest rate forecasts, but I will move some based on the current most attractive spot on the yield curve.
Have you done any backtesting to see if this is an effective strategy in the past? That is what the sorted slope chart above was intended to do. It turned out that it did seem to work in the past but not 90% of the time. More like 67% of the time.

Suppose you choose ST Treasuries because of the flatness in the yield curve. If a business slowdown occurs, might you miss the move down in intermediate rates? Just some of my concerns for myself. I do hold some ST bonds in addition to IT bonds and perhaps that is what you are doing while adjusting the ratio of your holdings.

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Re: To extend out maturities or not?

Post by jhfenton » Mon Jul 23, 2018 6:54 am

BlueEars wrote:
Sun Jul 22, 2018 8:05 pm
Have you done any backtesting to see if this is an effective strategy in the past? That is what the sorted slope chart above was intended to do. It turned out that it did seem to work in the past but not 90% of the time. More like 67% of the time.

Suppose you choose ST Treasuries because of the flatness in the yield curve. If a business slowdown occurs, might you miss the move down in intermediate rates? Just some of my concerns for myself. I do hold some ST bonds in addition to IT bonds and perhaps that is what you are doing while adjusting the ratio of your holdings.
I have not done any back-testing. I don't think you would see much of a difference one way or the other.

I have no idea which way interest rates will go from here, so I just view it as a buying decision based on current rates. For the previous several years, with short-term treasuries yielding close to zero. I held no short-term treasuries. The sweet spot seemed to be out around 7 years. Now, the sweet spot is around 2 years, so I am holding short-term treasuries. To me it's no different than if I were deciding which CDs to include in a ladder or deciding between a CD and a money market account.

I also added some of the Vanguard Short-Term TIPS Admiral Shares (VTAPX). At a duration of 2.6 years and an SEC yield of 0.60% + inflation, they look reasonably attractive. I remember a couple of summers ago wondering why in the world anyone would invest in the fund at significantly negative real rates.

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BlueEars
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Re: To extend out maturities or not?

Post by BlueEars » Mon Jul 23, 2018 8:58 am

VTAPX is an interesting thought. Thanks.

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