What causes bond fund values to change besides interest rate changes?

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Gufomel
Posts: 556
Joined: Sat Feb 14, 2015 9:52 pm

What causes bond fund values to change besides interest rate changes?

Post by Gufomel »

I think I have a pretty decent grasp on how bond interest rates and prices work, but I feel like I’m missing something with how the price of a bond fund moves (e.g. Vanguard Total Bond Fund - VBTLX).

There seems to be a lot of concern about bond fund values dropping. Is that due to expectation of rising interest rates? Surely not in this environment. But does the price move based on something else? I struggle to understand how the price of a bond fund can get out of line with the value of all the underlying bonds.

Sorry if my question is not entirely clear. I’m not completely clear myself on what I’m trying to ask...

Edit: Obviously defaulting in loans would be a big factor. Is that basically it? Change in interest rates and rate of default? But since it’s a fund, it’s similar to stocks in the sense that the price is going to change according to the market’s assessment of the future for both of those 2 items?
alex_686
Posts: 7104
Joined: Mon Feb 09, 2015 2:39 pm

Re: What causes bond fund values to change besides interest rate changes?

Post by alex_686 »

Level of the yield curve (rates)

Steepness of the yield curve (currently very flat)

Credit Spread (Increasing)

Liquidity

Options (mainly call options, or early redemption)

I would be happy to expand on any of these points,
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
MotoTrojan
Posts: 10708
Joined: Wed Feb 01, 2017 8:39 pm

Re: What causes bond fund values to change besides interest rate changes?

Post by MotoTrojan »

I think a lot of people get confused by "interest rate changes". The Fed controls the federal funds rate which can drive the yields of new/existing bonds and funds, but does not directly control a bond funds price.

New issue bonds are purchased by the bond fund and they will have a set yield, but in general when people comment on interest rates changing it is actually the price of the bond changing, much the same way the price of a stock changes.

When stocks go up without a change in earnings we will often say the P/E of X has gone up, but it only went up because the price itself changed.

When Total Bond Index Fund's interest rate goes up or down, all that is really happening is selling or buying pressures are driving the price down or up, and because the interest payments of the underlying bonds is fixed, this ratio between the price and the future payments results in an "interest rate" (yield) change.

Total Bond and other funds with muni/corporate bond exposure had a sudden decline in price which resulted in their yields going up, due to the potential risk of default that suddenly came up.
MotoTrojan
Posts: 10708
Joined: Wed Feb 01, 2017 8:39 pm

Re: What causes bond fund values to change besides interest rate changes?

Post by MotoTrojan »

As to how the bond price can get out of line with the underlying bonds, that has to do with the expectation of interest rates of new/future bonds, as well as the credit/default risk you mentioned.

Imagine I offer to give you $1/year for 10 years if you give me $10 (a 10% yield). If the next day someone comes out and offers to give people $2/year for 10 years if they give them $10 (20% yield), you are going to have a very hard time selling your bond to anyone for $10. If you offer to sell your bond for $5 though then the same $1/year payment makes it a 20% yield, and a fair deal compared to the going rate in the market.

So if there is a perception that new bonds will be offered with much lower yields, then that can drive the price of current bonds (or funds) up, and vice versa.
Peter G
Posts: 76
Joined: Sat Apr 30, 2016 8:14 pm

Re: What causes bond fund values to change besides interest rate changes?

Post by Peter G »

What about these:
Change in duration from the fund changing its holdings?
Too many bad derivatives, being used to boost yield rather than hedge losses?
A run on the fund: too many holders selling too much too quickly, a la 2008? That's liquidity, I guess.
Credit risk changes: defaults on component bonds appearing more likely in troubled times?
Change in inflation expectation?
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