How to Understand Bond ETF Long Term Returns

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PrettyCoolWorkshop
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How to Understand Bond ETF Long Term Returns

Post by PrettyCoolWorkshop » Mon Dec 02, 2019 8:08 am

Howdy Bogleheads. I've got 2 questions about the long term returns of bond funds. For our example, let's look at BLV (https://investor.vanguard.com/etf/profile/BLV).

A naive investor might expect the total return graph would be a shallow exponential growth curve. In reality, when you look at the graph, it has a good bit of volatility up and down. I know that this volatility is because when interest rates change, the value of the bonds owned by the fund (for which the interest rate is already locked in) grows or shrinks because they will have more or less return than a newly purchased bond. It's also true that, maybe coincidentally, the price per unit has trended up over the last ~10 years. I don't know whether this is a coincidence or whether this is expected behavior.

1. Is it true that, in the long term, you should expect the yield to be equal to the average yield of all the bonds owned by the fund (minus expenses)?

2. Is it true that, in the long term, assuming no interest rate changes that change the secondary market value of the bonds owned by the fund, you would expect the price per share to be a flat graph?
Be greedy and fearful. All the time.

MotoTrojan
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Re: How to Understand Bond ETF Long Term Returns

Post by MotoTrojan » Mon Dec 02, 2019 9:05 am

Ignore price per share and just look at total return since some bond funds drift the NAV then distribute while others don’t.

The SEC yield is the best indicator of expected return and would be the return if yield doesn’t change, obviously. Duration will tell you the sensitivity of NAV to yield changes, with %NAV changing roughly equivalent to duration X change in yield. If there is a one time step change in yields then you’ll break even in earnings after holding for the duration, but yields are always changing.

ohai
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Re: How to Understand Bond ETF Long Term Returns

Post by ohai » Mon Dec 02, 2019 9:17 am

1) This would generally be true only for some cases: a) short term bonds - imagine for instance, all your bonds have 1 day duration; your total return would naturally be the average yield over the investment period. b) no rolling; if you buy only one 30y bond, you will realize only its yield over 30y. However, if you keep reinvesting in new 30y bonds, your returns will be directional based on interest rates. c) maybe other cases...

2) No - it depends on the yield of such bonds. Bonds are not even issued at par all the time.

dbr
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Re: How to Understand Bond ETF Long Term Returns

Post by dbr » Mon Dec 02, 2019 9:26 am

PrettyCoolWorkshop wrote:
Mon Dec 02, 2019 8:08 am
Howdy Bogleheads. I've got 2 questions about the long term returns of bond funds. For our example, let's look at BLV (https://investor.vanguard.com/etf/profile/BLV).

1. Is it true that, in the long term, you should expect the yield to be equal to the average yield of all the bonds owned by the fund (minus expenses)?

Yes and no. No in the sense that in the long run an intermediate term bond fund will have owned and replaced all the bonds many times over. So there is no "all the bonds." Yes in the sense that by definition the fund pays out whatever interest is paid in by the bonds the fund owns over the course of time. If you are trying to predict the payout you will get from owning this fund over long time, that can't be done. Remember yield is payout divided by price so yield can (does) change when the price changes without the payout changing.

2. Is it true that, in the long term, assuming no interest rate changes that change the secondary market value of the bonds owned by the fund, you would expect the price per share to be a flat graph?

It would, but interest rates are constantly changing so returns are volatile. The standard deviation of annual returns of intermediate bonds is probably around +/- 6%

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