Why does TBM have such high turnover?

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restingonmylaurels
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Why does TBM have such high turnover?

Post by restingonmylaurels » Fri Aug 03, 2018 12:37 am

Was checking the M* stats on my VG funds and was rather surprised by one statistic. That was the turnover on the Total Bond Market index fund, which is list at 55%!

In comparison, the turnover at the Total Stock Market index fund is 3%.

As TBM is an index fund and its maturing bonds comprise a small percentage of its portfolio, I cannot account for this very large amount of activity.

Does anyone have insight as to why this index fund has such high turnover?

sfnerd
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Re: Why does TBM have such high turnover?

Post by sfnerd » Fri Aug 03, 2018 12:39 am

I imagine it's because a certain number of bonds reach their maturation date every year (for 3 year bonds that is 33% per year turnover), are called, or are traded for a better risk/reward profile. Also, to keep the desired duration of the fund you probably have to trade a bit.

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FIREchief
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Re: Why does TBM have such high turnover?

Post by FIREchief » Fri Aug 03, 2018 1:54 am

(deleted - incorrect info)
Last edited by FIREchief on Fri Aug 03, 2018 1:48 pm, edited 1 time in total.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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MossySF
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Re: Why does TBM have such high turnover?

Post by MossySF » Fri Aug 03, 2018 2:10 am

TBM does not hold bonds to maturity because once it hits 13 months, it's no longer part of the index.

Yes, the definition of "bond" does not include anything that matures within a year -- those are called "money market instruments".

And yes, it seems like an extra expense just to avoid a year's worth of money market exposure .. although most likely Vanguard doesn't actually sell but simply transfers at zero cost to the various money market funds.

typical.investor
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Re: Why does TBM have such high turnover?

Post by typical.investor » Fri Aug 03, 2018 2:25 am

If turnover wasn't that high, tracking error would be higher.

The index changes monthly and not yearly as typical of stocks.
The index sees maybe 20% of value in new additions.
The index sees maybe 15% of value in exits.
Mortgage backed securities are paid off early.
Coupons need to be reinvested.
Cash flows.
TBAs (2)
Futures contracts that need to be rolled over (3)
Mortgage dollar rolls (4)

Annual Report | December 31, 2017
Total Bond Market Index Fund
p 27

2. Futures Contracts: The fund uses futures contracts to invest in fixed income asset classes with
greater efficiency and lower cost than is possible through direct investment, to add value when
these instruments are attractively priced, or to adjust sensitivity to changes in interest rates.
The primary risks associated with the use of futures contracts are imperfect correlation between
changes in market values of bonds held by the fund and the prices of futures contracts, and the
possibility of an illiquid market. Counterparty risk involving futures is mitigated because a regulated
clearinghouse is the counterparty instead of the clearing broker. To further mitigate counterparty
risk, the fund trades futures contracts on an exchange, monitors the financial strength of its clearing
brokers and clearinghouse, and has entered into clearing agreements with its clearing brokers. The
clearinghouse imposes initial margin requirements to secure the fund’s performance and requires
daily settlement of variation margin representing changes in the market value of each contract.
Futures contracts are valued at their quoted daily settlement prices. The notional amounts of
the contracts are not recorded in the Statement of Net Assets. Fluctuations in the value of the
contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement
of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they
are recorded as realized futures gains (losses).
During the year ended December 31, 2017, the fund’s average investments in long and short
futures contracts represented 0% and less than 1% of net assets, respectively, based on the
average of the notional amounts at each quarter-end during the period. The fund had no open
futures contracts at December 31, 2017.

3. To Be Announced (TBA) Transactions: A TBA transaction is an agreement to buy or sell mortgagebacked
securities with agreed-upon characteristics (face amount, coupon, maturity) for settlement
at a future date. The fund may be a seller of TBA transactions to reduce its exposure to the
mortgage-backed securities market or in order to sell mortgage-backed securities it owns under
delayed-delivery arrangements. When the fund is a buyer of TBA transactions, it maintains cash or
short-term investments in an amount sufficient to meet the purchase price at the settlement date
of the TBA transaction. The primary risk associated with TBA transactions is that a counterparty may
default on its obligations. The fund mitigates its counterparty risk by, among other things, performing
a credit analysis of counterparties, allocating transactions among numerous counterparties, and
monitoring its exposure to each counterparty. The fund may also enter into a Master Securities
Forward Transaction Agreement (MSFTA) with certain counterparties and require them to transfer
collateral as security for their performance. In the absence of a default, the collateral pledged or
received by the fund cannot be repledged, resold, or rehypothecated. Under an MSFTA, upon a
counterparty default (including bankruptcy), the fund may terminate any TBA transactions with that
counterparty, determine the net amount owed by either party in accordance with its master netting
arrangements, and sell or retain any collateral held up to the net amount owed to the fund under the
master netting arrangements.

4. Mortgage Dollar Rolls: The fund enters into mortgage-dollar-roll transactions, in which the fund
sells mortgage-backed securities to a dealer and simultaneously agrees to purchase similar securities
in the future at a predetermined price. The proceeds of the securities sold in mortgage-dollar-roll
transactions are typically invested in high-quality short-term fixed income securities. The fund
forgoes principal and interest paid on the securities sold, and is compensated by interest earned on
the proceeds of the sale and by a lower price on the securities to be repurchased. The fund has also
entered into mortgage-dollar-roll transactions in which the fund buys mortgage-backed securities
from a dealer pursuant to a TBA transaction and simultaneously agrees to sell similar securities in the
future at a predetermined price. The securities bought in mortgage-dollar-roll transactions are used to
cover an open TBA sell position. The fund continues to earn interest on mortgage-backed security
pools already held and receives a lower price on the securities to be sold in the future. The fund
accounts for mortgage-dollar-roll transactions as purchases and sales; as such, these transactions
may increase the fund’s portfolio turnover rate. Amounts to be received or paid in connection with
open mortgage dollar rolls are included in Receivables for Investment Securities Sold or Payables for
Investment Securities Purchased in the Statement of Net Assets.

acegolfer
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Re: Why does TBM have such high turnover?

Post by acegolfer » Fri Aug 10, 2018 7:04 am

I asked this question in another thread but didn't get an answer. Can anyone help me?
Q on Vanguard Long-Term Treasury Fund Admiral Shares (VUSUX)

https://advisors.vanguard.com/web/c1/fa ... ucts/VUSUX

It says the fund holds 59 bonds and the turnover rate is 102.70%. Why would this fund need to replace 100% of its bond holdings every year? For example, a 20-yr T-bond will become 19-yr T-bond after 1 year and should still be in the fund.
Note turnover of long-term Treasury fund is 2 times higher than TBM.

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dm200
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Re: Why does TBM have such high turnover?

Post by dm200 » Fri Aug 10, 2018 12:05 pm

restingonmylaurels wrote:
Fri Aug 03, 2018 12:37 am
Was checking the M* stats on my VG funds and was rather surprised by one statistic. That was the turnover on the Total Bond Market index fund, which is list at 55%!
In comparison, the turnover at the Total Stock Market index fund is 3%.
As TBM is an index fund and its maturing bonds comprise a small percentage of its portfolio, I cannot account for this very large amount of activity.
Does anyone have insight as to why this index fund has such high turnover?
This high turnover seems to be true of all bond index funds.

restingonmylaurels
Posts: 156
Joined: Tue Apr 14, 2015 11:02 am

Re: Why does TBM have such high turnover?

Post by restingonmylaurels » Fri Aug 10, 2018 1:38 pm

MossySF wrote:
Fri Aug 03, 2018 2:10 am
TBM does not hold bonds to maturity because once it hits 13 months, it's no longer part of the index.

Yes, the definition of "bond" does not include anything that matures within a year -- those are called "money market instruments".

And yes, it seems like an extra expense just to avoid a year's worth of money market exposure .. although most likely Vanguard doesn't actually sell but simply transfers at zero cost to the various money market funds.
Here is the 6/30/2018 portfolio:

Under 1 Year 0.1%
1 - 3 Years 24.2%
3 - 5 Years 18.7%
5 - 10 Years 40.0%
10 - 20 Years 3.8%
20 - 30 Years 12.6%
Over 30 Years 0.6%
Total 100%

I can imagine that you could lose up to 10% each year with the described maturities of bonds to money markets and a bit more from calls. That hardly gets you to 55%, considering that the maturities shown are not stated maturities but are the effective maturities, defined as "Represents the percentage of assets in each maturity category based on effective maturity, which is the average length of time until fixed income securities held by a fund or ETF reach maturity and are repaid. It takes into consideration that an action such as a call or refunding may cause some bonds to be repaid before they mature. Effective-maturity methodology is then used to determine the maturity category each holding is allocated to."
typical.investor wrote:
Fri Aug 03, 2018 2:25 am
If turnover wasn't that high, tracking error would be higher.

The index changes monthly and not yearly as typical of stocks.
The index sees maybe 20% of value in new additions.
The index sees maybe 15% of value in exits.
Mortgage backed securities are paid off early.
Coupons need to be reinvested.
Cash flows.
TBAs (2)
Futures contracts that need to be rolled over (3)
Mortgage dollar rolls (4)
It is difficult to know which of these is a major component to the turnover rate beyond the two with percents, but what would cause the index to have to add 20% of its value in new additions and lose 15% of its value in exits?

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dm200
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Re: Why does TBM have such high turnover?

Post by dm200 » Fri Aug 10, 2018 1:54 pm

Are there any bond funds that have low turnover - in other words tend to keep bonds to maturity?

alex_686
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Re: Why does TBM have such high turnover?

Post by alex_686 » Fri Aug 10, 2018 1:58 pm

dm200 wrote:
Fri Aug 10, 2018 12:05 pm
This high turnover seems to be true of all bond index funds.
So, there is a problem in constructing bond indexes. A good investable index should be liquid. Lots of high quality pricing data, ability for fund managers to buy or sell to reconstruct their portfolio. For stocks this is no problem. Each of the 500 or so odd stocks in the S&P 500 trade frequently, good pricing data, low bid-ask spreads. etc. This is not true for bonds. There are issues with "off the run" Treasury bonds. Popular corporate issues stop being popular. What is an index provider supposed to do when a popular bond that is included in the index does not trade for a week? Guess at its price? Nope. They drop the bond and replace it with another similar bond. Happens all of the time.

alex_686
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Re: Why does TBM have such high turnover?

Post by alex_686 » Fri Aug 10, 2018 2:02 pm

dm200 wrote:
Fri Aug 10, 2018 1:54 pm
Are there any bond funds that have low turnover - in other words tend to keep bonds to maturity?
Yeah - but they can't be index funds. There is a good history of "semi-active" bond funds beating index funds. See my above post about the issues with index funds. "Semi-active" buys bonds that are similar to the index bonds - about the same maturity and credit quality - but are off index. Why pay for liquidity? Since there are liquidity issues, most of these funds are private and carter to pension funds and institutions which can predict their liquidity needs far into the future.

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vineviz
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Re: Why does TBM have such high turnover?

Post by vineviz » Fri Aug 10, 2018 2:15 pm

dm200 wrote:
Fri Aug 10, 2018 1:54 pm
Are there any bond funds that have low turnover - in other words tend to keep bonds to maturity?
Yes: Target maturity bond ETFs.

https://www.ishares.com/us/strategies/b ... nd-ladders

and

https://bulletshares.invesco.com/fixed-income-etfs/
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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House Blend
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Re: Why does TBM have such high turnover?

Post by House Blend » Sat Aug 11, 2018 11:35 am

acegolfer wrote:
Fri Aug 10, 2018 7:04 am
I asked this question in another thread but didn't get an answer. Can anyone help me?
Q on Vanguard Long-Term Treasury Fund Admiral Shares (VUSUX)

https://advisors.vanguard.com/web/c1/fa ... ucts/VUSUX

It says the fund holds 59 bonds and the turnover rate is 102.70%. Why would this fund need to replace 100% of its bond holdings every year? For example, a 20-yr T-bond will become 19-yr T-bond after 1 year and should still be in the fund.
Note turnover of long-term Treasury fund is 2 times higher than TBM.
I believe you are looking at a demonstration of the difference between active and passive bond fund management. Perhaps the fund managers were looking for the best spot to ride on the yield curve.

You may get a better answer by reading the material near the front of the (Semi- and) Annual Reports. Usually you can find clues about what actions the fund manager took, and the rationale.

If you do want passive management of your LT Treasury portfolio, you have the option of VLGSX: Long Term Treasury Index. Turnover has been mostly < 25% although it spiked to 54% in 2013.

acegolfer
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Re: Why does TBM have such high turnover?

Post by acegolfer » Sat Aug 11, 2018 11:47 am

House Blend wrote:
Sat Aug 11, 2018 11:35 am
I believe you are looking at a demonstration of the difference between active and passive bond fund management. Perhaps the fund managers were looking for the best spot to ride on the yield curve.

You may get a better answer by reading the material near the front of the (Semi- and) Annual Reports. Usually you can find clues about what actions the fund manager took, and the rationale.

If you do want passive management of your LT Treasury portfolio, you have the option of VLGSX: Long Term Treasury Index. Turnover has been mostly < 25% although it spiked to 54% in 2013.
You are 100% right. Didn't know the difference till now. I feel silly for assuming all Vanguard funds = index funds

VUSUX = Vanguard Long-Term Treasury Fund Admiral Shares (turnover = 103%, ER = 0.10%)
VLGSX = Vanguard Long-Term Treasury "Index" Fund Admiral Shares (turnover = 19%, ER = 0.07%)

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