A Brand New Bond World

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Doc
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A Brand New Bond World

Post by Doc »

A very interesting article form Morningstar's Eric Jacobson on the current and future bond market.

I think this link will get you around the paywall. (You may need to accept a free trial.)

https://www.morningstar.com/articles/10 ... ource=link

I've cut it up a lot to avoid "copyright problems.

"A Brave New Bond World
Most of us have never seen a bond market like this."

...

"A Tectonic Shift
Most core bond funds use the Bloomberg Barclays U.S. Aggregate Bond Index or similar high-quality indexes as benchmarks for "the market," and they all began to slowly morph after the 2008 global financial crisis."

...

(duration spiking - Mortgage component dropping)

...

"These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.

That's not the same thing as asking whether investors should ditch benchmarking and dive into unconstrained strategies.
"

...

"Might you be better off with a benchmark that still holds those sectors, but puts more emphasis back on mortgages, or maybe less concentration in the longest of long maturity, low-coupon debt.

There's no easy answer."

...

"Change is Hard…and Scary
Either way, the industry isn't likely to address those questions anytime soon."

...

"Mixing core funds with shorter-maturity, high-quality portfolios, though, might be just one of many options for coping with the market's new reality."
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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Doc
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Re: A Brand New Bond World

Post by Doc »

Moderators: The reference to "get around the paywall" is a link that Morningstar itself provides to enable sharing of articles.
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.
petulant
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Re: A Brand New Bond World

Post by petulant »

I'm sympathetic, but the deal is, what are the odds of a full 1% increase in rates across the whole yield curve? The Fed was rather ineffective in forcing long-term rates up a few years ago, and on the shorter end the duration is low enough for the pain to be much reduced. And if the longer-term rates go up 1%, these benchmarks don't actually have that much exposure the longest of longs, so what are the odds of a big hit? I'm as concerned as the next person, but...
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Re: A Brand New Bond World

Post by nisiprius »

These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.
A 6% drawdown instead of a 4% drawdown? Oh, the humanity.
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Re: A Brand New Bond World

Post by Rowan Oak »

nisiprius wrote: Wed Sep 09, 2020 5:54 pm
These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.
A 6% drawdown instead of a 4% drawdown? Oh, the humanity.
LOL
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000
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Re: A Brand New Bond World

Post by 000 »

nisiprius wrote: Wed Sep 09, 2020 5:54 pm
These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.
A 6% drawdown instead of a 4% drawdown? Oh, the humanity.
A 6% drawdown on a fund yielding 1% is a big deal.
Explorer
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Re: A Brand New Bond World

Post by Explorer »

000 wrote: Wed Sep 09, 2020 6:26 pm
nisiprius wrote: Wed Sep 09, 2020 5:54 pm
These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.
A 6% drawdown instead of a 4% drawdown? Oh, the humanity.
A 6% drawdown on a fund yielding 1% is a big deal.
I hold bond (funds) NOT for yield, I need a ballast to my stocks - pure and simple. The Agg Index does a very fine job of that (for the most part). Just as the interest rates have drifted lower over 3 or 4 decades, they may go up eventually. But, the headwinds for higher interest rates are too many to make that happen quickly.

With the Fed more lenient on inflation (read "we won't raise rates even if inflation drifts over 2%"), unlikely that the yield curve is moving much for a significant period of time (measurable in years).

Just remind yourself why you (want to) hold bonds, and hopefully it is not for the yield.
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Re: A Brand New Bond World

Post by Elysium »

000 wrote: Wed Sep 09, 2020 6:26 pm
nisiprius wrote: Wed Sep 09, 2020 5:54 pm
These changes raise a question of whether anchoring bond portfolios to market-like benchmarks makes as much sense when their durations are six years or longer, and a 100-basis-point upward yield shift can lose you 6% or 6.5%, when a shorter duration and the same shift used to mean a 4% to 5% drawdown.
A 6% drawdown instead of a 4% drawdown? Oh, the humanity.
A 6% drawdown on a fund yielding 1% is a big deal.
After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
000
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Re: A Brand New Bond World

Post by 000 »

Explorer wrote: Wed Sep 09, 2020 6:40 pm I hold bond (funds) NOT for yield, I need a ballast to my stocks - pure and simple. The Agg Index does a very fine job of that (for the most part). Just as the interest rates have drifted lower over 3 or 4 decades, they may go up eventually. But, the headwinds for higher interest rates are too many to make that happen quickly.

With the Fed more lenient on inflation (read "we won't raise rates even if inflation drifts over 2%"), unlikely that the yield curve is moving much for a significant period of time (measurable in years).

Just remind yourself why you (want to) hold bonds, and hopefully it is not for the yield.
I don't hold bonds. But the yield does matter. The value of the ballast becomes less as interest rates are lower.

I think most holders of intermediate term nominal bond funds are succumbing to recency bias.

There is really no reason to believe such funds will necessarily continue to provide ballast in real terms.
000
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Re: A Brand New Bond World

Post by 000 »

Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
ChiGuy
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Re: A Brand New Bond World

Post by ChiGuy »

000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
Do you have any alternative suggestions to the typical total bond/intermediate bond index fund portfolio?
000
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Re: A Brand New Bond World

Post by 000 »

ChiGuy wrote: Wed Sep 09, 2020 8:08 pm
000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
Do you have any alternative suggestions to the typical total bond/intermediate bond index fund portfolio?
My only use for fixed income is short term liquidity, which I keep in cash.

If I were to use bonds as a longer term investment, I would probably build a duration-matching ladder of TIPS and possibly Treasuries and high grade Corporates. This would minimize interest rate risk.
rockstar
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Re: A Brand New Bond World

Post by rockstar »

000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
I agree.
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Re: A Brand New Bond World

Post by willthrill81 »

000 wrote: Wed Sep 09, 2020 8:16 pm
ChiGuy wrote: Wed Sep 09, 2020 8:08 pm
000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
Do you have any alternative suggestions to the typical total bond/intermediate bond index fund portfolio?
My only use for fixed income is short term liquidity, which I keep in cash.

If I were to use bonds as a longer term investment, I would probably build a duration-matching ladder of TIPS and possibly Treasuries and high grade Corporates. This would minimize interest rate risk.
Yes, duration matching is the key to minimizing interest rate risk, which includes both price risk and reinvestment risk. Most retail investors are only concerned about the price risk component of interest rate risk. Over the long-term, fixed income investors should be praying hard for higher interest rates. Rising interest hurts cause short-term pain, but they lead to higher total returns in the end.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: A Brand New Bond World

Post by corp_sharecropper »

ChiGuy wrote: Wed Sep 09, 2020 8:08 pm
000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
Do you have any alternative suggestions to the typical total bond/intermediate bond index fund portfolio?
Short low quality/high beta equities. I'm talking about the absolute crappiest crap companies laden with debt and horrible management. Yes, you'll have to go find those yourself but I bet it would likely save your bacon as an imitation long treasury fund. I'm actually serious. I think it's pretty much the idea behind QMJ, which seems to have worked in it's infant long life so far (I say "seems" b/c I've only done a cursory amount of reading on it, so no guarantees). Long treasuries have really been the most underrated asset of the last 30+ years, not really to savvy investors but to the general public that just heard news regarding this stock or that stock. A mix of equities and long term treasuries absolutely trashes 100% stocks for most time periods in the past 35 years. I'm not at all saying those days are over but I do find it disheartening that it's impossible to have the same confidence in them in Sept 2020 as was possible less than a year ago.
000
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Re: A Brand New Bond World

Post by 000 »

willthrill81 wrote: Wed Sep 09, 2020 8:29 pm Yes, duration matching is the key to minimizing interest rate risk, which includes both price risk and reinvestment risk. Most retail investors are only concerned about the price risk component of interest rate risk. Over the long-term, fixed income investors should be praying hard for higher interest rates. Rising interest hurts cause short-term pain, but they lead to higher total returns in the end.
Indeed. For a duration-matched bond accumulator, rising interest rates mean new bonds are being bought at the higher interest rate.

The trouble comes when people assume BND will always work like it has in the past.
Elysium
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Re: A Brand New Bond World

Post by Elysium »

000 wrote: Wed Sep 09, 2020 7:43 pm
Elysium wrote: Wed Sep 09, 2020 6:41 pm After the rate increase a fund yielding 2%. Drawdown will be 4% after one year of interest posts, then another 2 years to break even. Rates could also go down 1% after that. Nobody knows nothing is especially true with interest rates. Stay the course.
I prefer not to stay on a bad course.

Yields matter.

Expecting anything other than the contractually provided yield on a bond is speculation.
I like guarantee of higher yield.
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Forester
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Re: A Brand New Bond World

Post by Forester »

All that matters are real interest rates, in a sense bonds are the ultimate risk asset because future inflation is an arbitrary decision.
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