Erosion of credit quality in Total Bond

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Nittany_Lion
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Erosion of credit quality in Total Bond

Post by Nittany_Lion » Thu Nov 14, 2019 9:27 am

I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?

NL

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Thu Nov 14, 2019 9:33 am

I don't know if the quality has eroded, but the dynamic nature of "Total Bond" does concern me because its composition (gov. versus corp., avg. maturity/duration) changes as the nature of the total outstanding debt changes. While there is nothing wrong with this, backtested results are not representative of the current or future nature of the fund.

Valuethinker
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Re: Erosion of credit quality in Total Bond

Post by Valuethinker » Thu Nov 14, 2019 9:38 am

Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?

NL
This, besides the presence of mortgage backed securities with prepayment and extension risk, is why Larry Swedroe does not recommend this fund v. an investment grade US govt bond fund.

That said, I believe corporate bonds are only 25% of the total portfolio?

The way I would go at this, if I could not find the relevant annual reports on VG website, would be to look for SEC filings on EDGAR. Then do a sampling of credit rating.

Geologist
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Re: Erosion of credit quality in Total Bond

Post by Geologist » Thu Nov 14, 2019 9:47 am

I think you'd have to look over longer time periods than even 10 years (five years will tell you nothing). Annette Thau has written in The Bond Book that the ratings of corporate bonds have declined over at least the last 20 years. I don't have my copy at hand at the moment but most corporates have fairly low ratings now and almost no US corporations have AAA ratings anymore. It is the nature of how US corporations have chosen to build their financial structures.

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SimpleGift
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Re: Erosion of credit quality in Total Bond

Post by SimpleGift » Thu Nov 14, 2019 10:07 am

Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?
As others have mentioned, one not only needs to account for changes in the credit quality of corporate bonds in the Aggregate Bond Index, but perhaps more importantly, changes in the overall composition of the index over time (chart below).
  • Image
Mortgage-backed securities (in orange) play a much larger role in the index today than they did at inception.

Chicken Little
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Re: Erosion of credit quality in Total Bond

Post by Chicken Little » Thu Nov 14, 2019 10:31 am

Thanks everybody.

I'm out.

For the bucket that isn't locked into target date (no better choices available), I'm converting TBM to 50/50 STT/TIPs.

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Thu Nov 14, 2019 10:36 am

Chicken Little wrote:
Thu Nov 14, 2019 10:31 am
Thanks everybody.

I'm out.

For the bucket that isn't locked into target date (no better choices available), I'm converting TBM to 50/50 STT/TIPs.
I too recently moved my FI position from TBM to STT.

lazyday
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Re: Erosion of credit quality in Total Bond

Post by lazyday » Thu Nov 14, 2019 10:38 am

Valuethinker wrote:
Thu Nov 14, 2019 9:38 am
This, besides the presence of mortgage backed securities with prepayment and extension risk, is why Larry Swedroe does not recommend this fund v. an investment grade US govt bond fund.
He's in good company in suggesting US gvt bonds.

David Swensen in Unconventional Success discusses which asset classes are worth investing in, and, as I recall, rejects all bonds except US government (nominal) Treasuries and TIPS. (Did he discuss muni bonds?)

William Bernstein in writings and probably in interviews has suggested using Treasuries, but not long term Treasuries. Owning very safe fixed income might help one to stay the course in tough times.

Munis, CDs, and Savings Bonds also might be worthwhile.

rkhusky
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Re: Erosion of credit quality in Total Bond

Post by rkhusky » Thu Nov 14, 2019 10:45 am

AHTFY wrote:
Thu Nov 14, 2019 10:36 am
Chicken Little wrote:
Thu Nov 14, 2019 10:31 am
Thanks everybody.

I'm out.

For the bucket that isn't locked into target date (no better choices available), I'm converting TBM to 50/50 STT/TIPs.
I too recently moved my FI position from TBM to STT.
Why short term?

staustin
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Re: Erosion of credit quality in Total Bond

Post by staustin » Thu Nov 14, 2019 10:48 am

SimpleGift wrote:
Thu Nov 14, 2019 10:07 am
Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?
As others have mentioned, one not only needs to account for changes in the credit quality of corporate bonds in the Aggregate Bond Index, but perhaps more importantly, changes in the overall composition of the index over time (chart below).
  • Image
Mortgage-backed securities (in orange) play a much larger role in the index today than they did at inception.
wow... this is very insightful.

Chicken Little
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Re: Erosion of credit quality in Total Bond

Post by Chicken Little » Thu Nov 14, 2019 10:58 am

rkhusky wrote:
Thu Nov 14, 2019 10:45 am
Why short term?
disclaimer: the last thing you want to do is ask for advice from me (trust me). That said...

In the part that isn't target date, I took a position in LTT a ways back as a disaster hedge. I don't want to be sitting on that. I don't want any corporate in fixed income because of the total debt picture.

I may give up gains on the way down with STT (rates going negative), but I'll be where I want to be when it turns (inflation). In simplistic terms, I want to sanitize the bond side from corporate and duration risk (maybe look at CDs too) and will increase equity allocation for returns if necessary.

I'm an outlier (insane?): The only thing I see right now is the lumberjack almost all the way through the trunk. Right now is resonating like 2000 and 2008. If others feels differently, I envy them (the opposite of all my investing decisions is ordinarily a VERY strong position).

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Taylor Larimore
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Vanguard Total Bond Market Index Fund ?

Post by Taylor Larimore » Thu Nov 14, 2019 11:02 am

Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?
Nittany_Lion:

Vanguard Total Bond Market Index Fund GAINED +5% during the 2008 bear market for stocks. It's composition since 2008 is little changed. It is now the largest bond fund in the world for good reasons.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Thu Nov 14, 2019 11:03 am

rkhusky wrote:
Thu Nov 14, 2019 10:45 am
Why short term?
Using SIMBA to backtest, I found that STT delivers slightly better results (Sharpe, Max SWR) than ITT or LTT in an equity-FI portfolio. The difference is small, but I'd always choose the less risky asset to get the same or better results. Also, LTT and ITT to a lesser extent go through multi-decadal trends that will significantly alter the results depending on which interest-rate environment you live in. I have no idea if rates will be rising or falling going forward, but I have no interest on betting on that, unless I get significantly higher returns to compensate for that risk, which the data suggests you don't receive.

On their own, using SIMBA again, STT deliver nearly the same results as ITT and LTT with much less risk.

Code: Select all

           Tbills    STT     ITT     LTT
Avg Ret    4.06%    4.53%   4.65%   5.11%
CAGR       4.03%    4.48%   4.53%   4.83%
Real CAGR  1.93%    2.37%   2.42%   2.72%
St Dev     2.68%    3.47%   5.18%   7.94%
Sharpe              0.222   0.121   0.133
I'm not sure how relevant those long-term results are in today's low-interest rate environment (both nominally and relative to inflation), but one will notice that the spread between the average return of LTT and STT is 58 bp in that table and today it is 65bp.

Perhaps if the spread was wider, one would be tempted to lengthen the duration, but that's a different conversation for a different day...

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Doc
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Re: Erosion of credit quality in Total Bond

Post by Doc » Thu Nov 14, 2019 11:31 am

Valuethinker wrote:
Thu Nov 14, 2019 9:38 am
This, besides the presence of mortgage backed securities with prepayment and extension risk, is why Larry Swedroe does not recommend this fund v. an investment grade US govt bond fund.
IIRC Swedroe's recommendation included AA and AAA bonds but only short term corporates. (But not MBS because of the negative convexity as Valuethinker noted.)

"One of the major reasons is that as the credit rating decreases, the correlation with equity returns increases." Winning bond Strategy 1st edition 2006 p123

I don't have the short corp reference dogeared. :(
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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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Thu Nov 14, 2019 11:34 am

Doc wrote:
Thu Nov 14, 2019 11:31 am
"One of the major reasons is that as the credit rating decreases, the correlation with equity returns increases." Winning bond Strategy" 1st edition 2006 p123
It is my opinion (for whatever that's worth), that if you own corporate bonds (through TBM for example), you would then want to decrease your equity exposure since you are adding some equity/corporate/credit risk with those bonds. The numbers are small, just a few percentage points. But if you actually do that, you might as well keep the higher equity exposure and ditch the corporate bonds, i.e., invest in a Treasury bond fund instead of TBM.

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Re: Erosion of credit quality in Total Bond

Post by hudson » Thu Nov 14, 2019 1:17 pm

Chicken Little wrote:
Thu Nov 14, 2019 10:58 am
rkhusky wrote:
Thu Nov 14, 2019 10:45 am
Why short term?
disclaimer: the last thing you want to do is ask for advice from me (trust me). That said...

In the part that isn't target date, I took a position in LTT a ways back as a disaster hedge. I don't want to be sitting on that. I don't want any corporate in fixed income because of the total debt picture.

I may give up gains on the way down with STT (rates going negative), but I'll be where I want to be when it turns (inflation). In simplistic terms, I want to sanitize the bond side from corporate and duration risk (maybe look at CDs too) and will increase equity allocation for returns if necessary.

I'm an outlier (insane?): The only thing I see right now is the lumberjack almost all the way through the trunk. Right now is resonating like 2000 and 2008. If others feels differently, I envy them (the opposite of all my investing decisions is ordinarily a VERY strong position).
I have no problem with short treasuries. Personally, I would go with CDs. 5 Year CDs are out there paying 3% at times.
If I had to own a fund I would consider Vanguard GNMA Fund Admiral Shares (VFIJX). It's 100% government bonds. I know there are issues with GNMA bonds; but the principal is guaranteed.

I disregard all predictions of inflation or interest rate changes.

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Doc
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Re: Erosion of credit quality in Total Bond

Post by Doc » Thu Nov 14, 2019 1:27 pm

hudson wrote:
Thu Nov 14, 2019 1:17 pm
I disregard all predictions of inflation or interest rate changes.
I predict in the future that we will have inflation and that we will have interest rate changes.

Disregarding my prediction is of course up to you. :D
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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Re: Erosion of credit quality in Total Bond

Post by hudson » Thu Nov 14, 2019 4:59 pm

Doc wrote:
Thu Nov 14, 2019 1:27 pm
hudson wrote:
Thu Nov 14, 2019 1:17 pm
I disregard all predictions of inflation or interest rate changes.
I predict in the future that we will have inflation and that we will have interest rate changes.

Disregarding my prediction is of course up to you. :D
Your prediction falls under Catch 22. :happy
Last edited by hudson on Thu Nov 14, 2019 5:43 pm, edited 1 time in total.

stan1
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Re: Erosion of credit quality in Total Bond

Post by stan1 » Thu Nov 14, 2019 5:04 pm

hudson wrote:
Thu Nov 14, 2019 1:17 pm
Personally, I would go with CDs. 5 Year CDs are out there paying 3% at times.
Agree CDs have their place. For my mom (now 86) I was able to buy 3% 5 year CDs in Jan 2014 and 3.5% 5 year CDs in Jan 2019. Sometimes one gets lucky with timing.

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Nittany_Lion
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Re: Erosion of credit quality in Total Bond

Post by Nittany_Lion » Fri Nov 29, 2019 10:40 am

I appreciate all of the replies. The growing fraction of MBS in the index wasn't something I was aware of.

I would still be interested if anyone has any insights on how the credit quality of TB's corporate bonds has changed over time. I'm not a bond expert and am not sure if I have access to some of the sources referenced above.

Geologist
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Re: Erosion of credit quality in Total Bond

Post by Geologist » Fri Nov 29, 2019 11:09 am

Annette Thau in the 2011 3rd edition (the most recent one) of The Bond Book says “Credit quality of corporate bonds has been declining for the past couple of decades. There are very few AAA credits still left…Almost half of all corporate bonds are now classified as “junk” bonds, that is, below investment grade.” The junk corporate bonds are not in Total Bond Market, of course.

So, there has been a decline in corporate bond credit quality overall, but it is a process that has been going on for a long time.

Judging from SimpleGift’s graph, by the way, the growth in MBS as a fraction of the total occurred more than 20 years ago and MBS has been roughly constant or even decreased in the last 10 years.

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Re: Erosion of credit quality in Total Bond

Post by DaufuskieNate » Fri Nov 29, 2019 11:29 am

It seems to me that it's not good that the composition will change over time with the supply of bonds. If the government runs high deficits, the government portion could go up. If corporations start to lever up, that portion may increase. Whichever sector is growing debt the fastest gets a higher share of Total Bond. The prices should adjust to reflect the supply/demand changes, but I would rather make the decision to allocate more to a given sector as opposed to having this decision made for me by the suppliers of debt.

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Re: Vanguard Total Bond Market Index Fund ?

Post by nedsaid » Fri Nov 29, 2019 11:49 am

Taylor Larimore wrote:
Thu Nov 14, 2019 11:02 am
Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?
Nittany_Lion:

Vanguard Total Bond Market Index Fund GAINED +5% during the 2008 bear market for stocks. It's composition since 2008 is little changed. It is now the largest bond fund in the world for good reasons.

Best wishes.
Taylor
I am with Taylor here. Jack Bogle was concerned that Total Bond was too heavy with Government Bonds and thought investors should consider taking a slice of an investors bond portfolio and putting it into Intermediate Investment Grade Corporates. It seems that Jack saw things differently. All I can say is that my GNMA funds sailed right through the 2008-2009 financial crisis. I just don't see that Total Bond as a dangerous investment, even Larry Swedroe counts Total Bond as a minor sin. Venial and not Mortal, don't have to go to confession over that one! :wink: I do have other investment sins but Total Bond isn't one of them in my view.
A fool and his money are good for business.

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Fri Nov 29, 2019 12:25 pm

In backtests, a 60-40 (or thereabouts) portfolio is virtually the same whether you use intermediate-term Treasuries or Total Bond Market. Looking at the Simba spreadsheet, the numbers are literally within 0.01 of each other for CAGR, max drawdown, Sharpe, Sortino.

The real questions are whether it is best to use short, intermediate, or long term bonds in your portfolio. After that is the question of whether to include corporates and other non-government bonds.

Personally, I vote against having corporates (and other non-gov bonds) in my fixed income allocation since I already have corporate/credit risk on the equity side. That said, as noted earlier, opting for TBM instead of intermediate Treasuries or "short term gov/corp bonds (VBIRX)" instead of short-term Treasuries makes very little difference in the end.

MadHungarian
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Re: Erosion of credit quality in Total Bond

Post by MadHungarian » Fri Nov 29, 2019 12:28 pm

Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?
NL
I keep old copies of the annual reports for the Vanguard funds of interest to me, just because i like to have a token something tangible in exchange for all the money i supposedly have with them. The annual reports (prior to this last year), show the important historical stats like credit quality buckets. And yes, i've also noticed a reduction in corporate bond credit quality in Total Bond in recent years.

Note that the more recent Vanguard annual reports have been getting increasingly useless, due to Vanguard's continued cost cutting. And in last year's annual reports, Vanguard even dropped the very useful statistics page, which was the most useful part of the whole annual report. I guess Vanguard (rightly) believes that no one ever reads the annual reports anymore. And indeed, by the time you get the annual report, the stuff in it is all out-of-date anyway, except for historical purposes.

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Fri Nov 29, 2019 12:32 pm

AHTFY wrote:
Fri Nov 29, 2019 12:25 pm
That said, as noted earlier, opting for TBM instead of intermediate Treasuries or "short term gov/corp bonds (VBIRX)" instead of short-term Treasuries makes very little difference in the end.
On the other hand, if it made little difference before but the credit quality of TBM and STB have eroded, that would be good reason to choose Treasuries.

MadHungarian
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Re: Erosion of credit quality in Total Bond

Post by MadHungarian » Fri Nov 29, 2019 12:34 pm

But Total Bond is a useful compromise. Some folks think it has too much GNMA, other folks think it has too much Corporate, other folks think it has too much Government. So i guess it's probably a happy medium between them all then.

Ferdinand2014
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Re: Erosion of credit quality in Total Bond

Post by Ferdinand2014 » Fri Nov 29, 2019 12:35 pm

I sleep very well with my fixed income in 1 month T-bills. In fact it is my only fixed income holding.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

AHTFY
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Re: Erosion of credit quality in Total Bond

Post by AHTFY » Fri Nov 29, 2019 12:38 pm

Ferdinand2014 wrote:
Fri Nov 29, 2019 12:35 pm
I sleep very well with my fixed income in 1 month T-bills. In fact it is my only fixed income holding.
Besides savings/checking account money to pay bills, I prefer my fixed income in short-term Treasuries (1-3 year maturity, average duration of 2 years): VGSH or VSBSX. Right now, the yield between 1-month and 2-years is close to zero, but historically the extra yield is worth the small added term risk.

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Taylor Larimore
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TBM's biggest benefit

Post by Taylor Larimore » Fri Nov 29, 2019 1:12 pm

Bogleheads:

In my view, the biggest benefit of Total Bond Market Index fund is its low-cost diversification in high-quality bonds--the only "free-lunch" in investing.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Wise investors won’t try to outsmart the market, they’ll buy index funds for the long term, and they’ll diversify.”
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Erosion of credit quality in Total Bond

Post by garlandwhizzer » Fri Nov 29, 2019 2:09 pm

nedsaid wrote:

All I can say is that my GNMA funds sailed right through the 2008-2009 financial crisis. I just don't see that Total Bond as a dangerous investment, even Larry Swedroe counts Total Bond as a minor sin. Venial and not Mortal, don't have to go to confession over that one! I do have other investment sins but Total Bond isn't one of them in my view.
1+

Personally I have never lost one minute of sleep or had one minute of anxiety worrying about the safety of TBM. I believe it to be an excellent, extremely low risk, extremely low cost, and properly diversified choice if one wants a single bond fund. Arguments can be made for Treasuries/TIPS with or without GNMA instead of TBM. Like many investing issues, it seems to me a lot like arguing over how many angels can dance on the head of a pin. All of these choices effectively fulfill the role of bonds in a portfolio IMO.

Garland Whizzer

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Re: Erosion of credit quality in Total Bond

Post by pdavi21 » Fri Nov 29, 2019 4:01 pm

Nittany_Lion wrote:
Thu Nov 14, 2019 9:27 am
I have seen references in other threads regarding the issuance of substantial amounts of barely investment grade corporate bonds over the past decade which, it is claimed, has non-trivially reduced quality on the corporate side of Total Bond. Is there a way to see what Total Bond's portfolio looked like five or ten years ago for comparison purposes?

NL
Download the SEC filings, using this Boglehead's Wiki as a guide:
https://www.bogleheads.org/wiki/Vanguard_SEC_listings

You can also try that website time machine thing, but it probably won't work.

I recommend Total Global Bond or Total US Bond for simplicity's sake.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Nittany_Lion
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Re: Erosion of credit quality in Total Bond

Post by Nittany_Lion » Mon Dec 02, 2019 4:58 pm

I appreciate all of the replies and insights.

NL

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