How to determine which bond funds are undervalued/overvalued

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postaldaytrader
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How to determine which bond funds are undervalued/overvalued

Post by postaldaytrader »

Hi,

Is there a way to check quickly which bonds/bond funds are overvalued or undervalued? I remember reading a post on M* forum where someone said if the Yield-to-maturity (YTM) > current yield, then the bond fund is undervalued and vice versa. Is there any truth to this? It would seem so if the underlying bonds in the fund were bought at a discount if the YTM is greater than the current yield.
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Post by chaz »

Timing is risky.
Chaz | | “Money is better than poverty, if only for financial reasons." Woody Allen | | http://www.bogleheads.org/wiki/index.php/Main_Page
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Taylor Larimore
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Re: How to determine which bond funds are undervalued/overva

Post by Taylor Larimore »

postaldaytrader wrote:Hi,

Is there a way to check quickly which bonds/bond funds are overvalued or undervalued? I remember reading a post on M* forum where someone said if the Yield-to-maturity (YTM) > current yield, then the bond fund is undervalued and vice versa. Is there any truth to this? It would seem so if the underlying bonds in the fund were bought at a discount if the YTM is greater than the current yield.
Hi day trader:

Welcome to the Bogleheads Forum!

24 hours a day, 7 days a week, thousands of professional bond traders are seated at computers all over the world looking for under-valued bonds to buy and over-valued bonds to sell. I have seen this in bond trading rooms with my own eyes.

It is a very competitive market with no "free lunch."

Good luck with your quest.
"Simplicity is the master key to financial success." -- Jack Bogle
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gotherelate
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Post by gotherelate »

Does a bond fund have a yield to maturity? I know it holds bonds that have such. Is there some measure of average yield to maturity?

-Grandpa
-Grandpa | I'd rather see where I'm going than see where I've been.
InvestingMom
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Post by InvestingMom »

Let me know when you find out the secret.
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Post by Valuethinker »

gotherelate wrote:Does a bond fund have a yield to maturity? I know it holds bonds that have such. Is there some measure of average yield to maturity?

-Grandpa
You could calculate a weighted average to maturity

%age of the bond in the total portfolio X YTM for each bond then add them up

I am not sure, mathematically, how meaningful it would be?

Here's my concern. When interest rates change, different bonds would change YTM by different amounts, depending on their maturity date and their coupon and other factors.

There is 'SEC Yield' which is a calculation defined by SEC and there is 'Distribution Yield' which is another calculation vanguard makes.

Those seem the best to go on.
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Post by Richard123 »

One way to look at a bond fund is to determine the fund's high and low NAV. If you are purchasing the shares near the "high" you are taking on a lot of risk.

Unfortunately ALL bond fund NAVs are at or near their highs so there is no "deal" in any bond funds today. How long the present situation (Fed Policy) will persist is unknown but at some point there has to be a crash in NAVs with longer duration bond funds getting hurt much worse that shorter duration funds.

In my opinion it is not a good time to buy any bond funds. They are all over priced.

Edited 1 time for Fed Policy
Last edited by Richard123 on Fri Sep 25, 2009 2:01 pm, edited 1 time in total.
JasonR
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Post by JasonR »

Richard123 wrote:In my opinion it is not a good time to buy any bond funds. They are all over priced.
So, I'll just put my money into...what? Sorry, rhetorical question, I guess. It's just pretty depressing.
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Post by Richard123 »

If I were to purchase any bond fund today it would be Vanguard's Short Term Investment Grade (vfstx and vfsux). It would have the least amount of risk.

Best of luck.
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Post by InvestingMom »

JasonR wrote:
Richard123 wrote:In my opinion it is not a good time to buy any bond funds. They are all over priced.
So, I'll just put my money into...what? Sorry, rhetorical question, I guess. It's just pretty depressing.
Jason,
If you are investing for the long term I don't think you should be depressed?

Read this:
https://personal.vanguard.com/us/Vangua ... 04_ALL.jsp

The OP sounds like a market timer and so I suppose if that is what you are, then you should be depressed.

Investing mom
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Doc
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Post by Doc »

gotherelate wrote:Does a bond fund have a yield to maturity? I know it holds bonds that have such. Is there some measure of average yield to maturity?

-Grandpa
Yes. Barclays shows an "Average Yield to Maturity" for it's credit ETF's. Fund companies might not be able to report it because they have to comply with the SEC 30 day yield reporting.
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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Post by JasonR »

InvestingMom wrote:
JasonR wrote:
Richard123 wrote:In my opinion it is not a good time to buy any bond funds. They are all over priced.
So, I'll just put my money into...what? Sorry, rhetorical question, I guess. It's just pretty depressing.
Jason,
If you are investing for the long term I don't think you should be depressed?

Read this:
https://personal.vanguard.com/us/Vangua ... 04_ALL.jsp

The OP sounds like a market timer and so I suppose if that is what you are, then you should be depressed.

Investing mom
I-Mom, no market timer here. I'm not really that depressed. It's just way more fun watching stuff go up.
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alvinsch
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Post by alvinsch »

Doc wrote:
gotherelate wrote:Does a bond fund have a yield to maturity? I know it holds bonds that have such. Is there some measure of average yield to maturity?

-Grandpa
Yes. Barclays shows an "Average Yield to Maturity" for it's credit ETF's. Fund companies might not be able to report it because they have to comply with the SEC 30 day yield reporting.
Vanguard also lists a YTM for their bond funds. Look up the fund at Vanguards and click on the "portfolio and management" tab.

https://personal.vanguard.com/us/funds/ ... st=tab%3A2
- Al
kenner
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Re: How to determine which bond funds are undervalued/overva

Post by kenner »

postaldaytrader wrote:Hi,

Is there a way to check quickly which bonds/bond funds are overvalued or undervalued? I remember reading a post on M* forum where someone said if the Yield-to-maturity (YTM) > current yield, then the bond fund is undervalued and vice versa. Is there any truth to this? It would seem so if the underlying bonds in the fund were bought at a discount if the YTM is greater than the current yield.
http://ezinearticles.com/?Yield-To-Matu ... &id=660354

As others have pointed out, it is easy to obtain current yield and YTM data on Vanguard bond funds. I imagine the same data is readily available for other bond funds and for individual bonds. The information is also readily available to bond investors and traders and, if relevant, would already be priced into the market.

Most VG funds are probably currently yielding substantially less than their collective yields to maturity. That does not mean they are undervalued. It is probably due in large part to the fact that we have been operating in a stable to falling interest rate environment for some time and the broader bond markets have stabilized to some extent after the financial panic last fall.

As Taylor mentioned, current market values for bonds are set every hour of every day by billions of trades on the worlds credit markets, with professionals and others taking into account all market factors, such as interest rate fluctuations, credit risk, etc.

Just knowing whether a bond or fund is trading with YTM higher or lower than current yield is unlikely to the uncover the types of mispricings that might allow profitable trades in such efficient markets, IMHO.

Best wishes,
Ken
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joe8d
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Post by joe8d »

Richard 123 wrote:
One way to look at a bond fund is to determine the fund's high and low NAV. If you are purchasing the shares near the "high" you are taking on a lot of risk.

Unfortunately ALL bond fund NAVs are at or near their highs so there is no "deal" in any bond funds today. How long the present situation (Fed Policy) will persist is unknown but at some point there has to be a crash in NAVs with longer duration bond funds getting hurt much worse that shorter duration funds.

In my opinion it is not a good time to buy any bond funds. They are all over priced.

If I were to purchase any bond fund today it would be Vanguard's Short Term Investment Grade (vfstx and vfsux). It would have the least amount of risk.
Yes and Yes.
All the Best, | Joe
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Post by jsnbrnd »

Richard123 wrote:If I were to purchase any bond fund today it would be Vanguard's Short Term Investment Grade (vfstx and vfsux). It would have the least amount of risk.
Best of luck.
How about VGNMX?
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nisiprius
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Post by nisiprius »

Thinking out loud here, not an expert.

1) It seems to me that the bond market must be efficient, and I don't understand how an outsider would be likely to know anything a professional bond trader wouldn't know. In the case of stocks, there are a thousand factors about the company's business to know. It's akin to the fantasy of finding a valuable antique at a lawn sale, but in theory an amateur could conceivably know something real about some particular business that everyone else is overlooking.

But in the case of a bond, the value is determined by only four things: coupon, maturity date, chance of default, and assumed future interest rate. The ratings agencies figure the chance of default for you, and for investment grade bonds it should be negligible. The only variable is what the interest rate will be. And it affects all bonds of similar maturity similarly.

2) Recent weirdnesses have raised the possibility that there could be cases where extreme supply-and-demand might distort pricing in some way that could be exploited. It's just a core belief of mine--and I need to stress I'm not an expert and my core beliefs have changed with time!--that you can't find such situations by looking at price data, you have to know what's actually going on.

In the sort of situation I'm describing, what you would be looking for is some fairly specific class of bonds that, say, a) you knew that some humongous market-moving set of sellers were being forced to dispose of, and yet this particular class of bonds was nevertheless highly suitable for an ordinary small retirement saver's "safe" assets.

Obviously I'm thinking of the TIPS I didn't buy last year, because I just have a personal principle of never doing anything sudden ever. I missed out but I don't feel too bad about it because, and this is the really really important point:

3) It's just not that big an effect. Reposting two pictures I put up recently, here are the hypothetical growth charts to date for the Vanguard Inflation Protected Securities Fund, deliberately chosen for its big swings, and the NASDAQ index (reinvestment not included). What I ask you to do is draw your own arrows, choose your own path for what you think these securities "should" have done if they hadn't been overbid to inappropriate heights, and then you tell me how overvalued you think the NASDAQ was in 2000 and how overvalued the TIPS fund was in early 2007.

To my eyeball the NASDAQ was overvalued by a factor of three. The TIPS fund has been overvalued by at most 10%? 15%? 20%?

If you pay 20% too much for something and you hold it for twenty years, it reduces your average return 1.1%, pretty bad but there are funds with ERs higher than that. If you pay 3X what something is worth and hold it for twenty years you have reduced your average return by 5.6% per year, and that, folks, is serious.

And of course if you DCA into a bond fund it reduces the problem of "buying at the wrong time" even more. In fact because the wiggles are so small, it's all approximately a linear situation and you can just shrug and say it averages out.

Bonds in 2009 are not tech stocks in 2000.

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Post by InvestingMom »

JasonR wrote:
InvestingMom wrote:
JasonR wrote:
Richard123 wrote:In my opinion it is not a good time to buy any bond funds. They are all over priced.
So, I'll just put my money into...what? Sorry, rhetorical question, I guess. It's just pretty depressing.
Jason,
If you are investing for the long term I don't think you should be depressed?

Read this:
https://personal.vanguard.com/us/Vangua ... 04_ALL.jsp

The OP sounds like a market timer and so I suppose if that is what you are, then you should be depressed.

Investing mom
I-Mom, no market timer here. I'm not really that depressed. It's just way more fun watching stuff go up.
Agree that watching the market go up is fun (but a bit nerve wracking....I am sort of glad that we took a correction last week...would rather see small corrections than large ones ;-)
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Post by stratton »

There is nothing "cheap" left. If you wanted cheap you needed to look in Oct, Nov, Dec, Jan almost a year ago.

Even TIPS where were inexpensive relative to treasuries are getting bid up. Muni new issues are at 42 year low interest rates according to at least one post on this board.

Paul
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Post by Valuethinker »

stratton wrote:There is nothing "cheap" left. If you wanted cheap you needed to look in Oct, Nov, Dec, Jan almost a year ago.

Even TIPS where were inexpensive relative to treasuries are getting bid up. Muni new issues are at 42 year low interest rates according to at least one post on this board.

Paul
When there is 'no cheap' go short (not short sell, but short term investments) and wait.

ST investment grade bond fund, for example. TIPS are always in season in a sense, but generally you have benefited if you bought them above a 2% real return, and less so if bought below.

Markets tend to provide new opportunities. Give them time. As Warren Buffett has often pointed out, patience is a virtue in financial markets.
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postaldaytrader
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Market Timing

Post by postaldaytrader »

Based on the logic some of you use, anyone not strictly buying a total market fund is "market timing." For example, when you buy a short term treasury bond fund instead of a total market bond fund, you are actively avoiding the corporate bond segment of the market. You are also betting the long term treasury bonds will not outperform the short term treasury bonds.

Is it "market timing" if someone assumes interest rate can't fall below zero and that the treasury market is overvalued because of it?
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Re: Market Timing

Post by fluffyistaken »

postaldaytrader wrote:Based on the logic some of you use, anyone not strictly buying a total market fund is "market timing." For example, when you buy a short term treasury bond fund instead of a total market bond fund, you are actively avoiding the corporate bond segment of the market. You are also betting the long term treasury bonds will not outperform the short term treasury bonds.

Is it "market timing" if someone assumes interest rate can't fall below zero and that the treasury market is overvalued because of it?
Only short-term treasuries have rates close to zero. Intermediate and long-term are in 2-4% range, so their rates still have room to fall if we end up in Japan-like scenario. And going back to short-term treasuries... even if their rates shoot way up the actual value of the treasuries will barely budge since the duration is so short. So, there's no upside in shorting them. So, yes, this would be market timing and it can go wrong.
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Post by woof755 »

Richard123 wrote:If I were to purchase any bond fund today it would be Vanguard's Short Term Investment Grade (vfstx and vfsux). It would have the least amount of risk.

Best of luck.
VFSTX is up 12.44% year to date. I think it's a little late for that boat. Trying to time is meaningless.

If you want to buy short term, high credit quality, this is a great option for you. So is short-term treas and so is short term bond index.

larryswedroe has said here that the bond market might be more efficient than the stock market.
"By singing in harmony from the same page of the same investing hymnal, the Diehards drown out market noise." | | --Jason Zweig, quoted in The Bogleheads' Guide to Investing
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Doc
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Re: Market Timing

Post by Doc »

postaldaytrader wrote:Based on the logic some of you use, anyone not strictly buying a total market fund is "market timing."
No, not at all. You can have sector weights and/or durations that differ from TBM. For example I underweight MBS and long term bonds wrt TBM but I don't time my purchases/sales. As Valuethinker noted, keeping new money or rebalancing money on the short end when the market is in turmoil I would not consider market timing either. Just prudent.
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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Post by bmb »

It seems to me that bonds should be even more efficient than stocks, so if you believe the EM theory for equities at all, you should believe it for bonds as well.
OTH, there are a few big differences among individual bonds that you do not find among equities, such as maturity/duration and tax treatment, so what is attractive to the general bond market may be less than for the individual, who has specific needs. For example, it does one no good if the market thinks a 30 year bond is a good deal if you need the money in 10 years, or if it favors a tax-free bond since the average marginal tax bracket is 25% but your tax bracket is 10%. These things are not applicable or less relevant if you are buying stocks. Furthermore, bonds may be held for various reasons - income, diversification, or capital preservation - while the purpose of holding equities is growth of capital, so the general equity market is more likely to be aligned with the needs of each individual investor than the general bond market.
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