On another thread, I replied to a post about the potential behavior of EDV in two specific hypothetical scenarios. This prompted me to compare its behavior to a

consol (a perpetual bond). The result of the comparison is quite intriguing.

First, here's my post on that other thread:

longinvest wrote: ↑Fri Dec 28, 2018 12:58 pm

longinvest wrote: ↑Fri Dec 28, 2018 10:56 am

boglerdude wrote: ↑Fri Dec 28, 2018 2:53 am

Say you buy EDV. $10k 2% rate when you buy it. So you have a "bond" and the duration is always 25 years

What's your return if rates go to 10% and stay there for 20 years?

What if rates go to 1% for 20 years?

Is there a web calculator where you plug in different hold times and average rates over that timeframe. Total return including dividends

If you're up to it, just enter a full range of yields across the curve for every year of your scenario into our

bond fund simulator and tell us about the outcome. Luckily, the newly released 1.18 version has added a simulation for an EDV-like fund.

OK. I did the exercise.

Scenario 1

Let's assume that yields, across the yield curve, from 1 year to 30 years, are initially 2% for all maturities. One year later, yields , across the yield curve, from 1 year to 30 years, have increased to 10% for all maturities. An EDV-like bond fund, making no distributions (as it's composed of zero-coupon strips) would lose

-83.38% of its value during that year. It would immediately start returning

+10%, annually, for as long as yields remain fixed at 10%.

So, that's a cumulative

(((1 - 0.8338) X (1.10 ^ 20)) - 1) = +11.81% gain in 21 years (

+0.53% annualized).

Scenario 2

Let's assume that yields, across the yield curve, from 1 year to 30 years, are initially 2% for all maturities. One year later, yields , across the yield curve, from 1 year to 30 years, have decreased to 1% for all maturities. An EDV-like bond fund, making no distributions (as it's composed of zero-coupon strips) would gain

+29.69% in value during that year. It would immediately start returning

+1%, annually, for as long as yields remain fixed at 1%.

So, that's a cumulative

(((1 + 0.2969) X (1.01 ^ 20)) - 1) = +58.25% gain in 21 years (

+2.21% annualized).

What's important to me, in this post, are the 1-year impact of the 2% to 10% increase in yields (

-83.38%) and the 1-year impact of the 2% to 1% decrease in yields (

+29.69%).

If, instead of holding an EDV-like fund, in such hypothetical scenarios, our investor held a consol with a $100 annual coupon. What would have happened?

Initially, yields are 2% across the yield curve. The consol pays $100 per year. The price of the consol is:

($100 / 0.02) = $5,000.

Scenario 1

Yields increase to 10% during the year: At the end of the year, the consol pays its $100 coupon. Its price has changed. It has become:

($100 / 0.10) = $1,000. The 1-year total return of the consol is thus: ((($1,000 + $100) / $5,000) - 1) =

-78.00%.

Scenario 2

Yields decrease to 1% during the year: At the end of the year, the consol pays its $100 coupon. Its price has changed. It has become:

($100 / 0.01) = $10,000. The 1-year total return of the consol is thus: ((($10,000 + $100) / $5,000) - 1) =

+102.00%.

Comparison

In scenario 1, the EDV-like fund lost a little more (

-83.38%), on a total return basis, than the consol (

-78.00%). Yet, in scenario 2, it gained significantly less (

+29.69%) than the consol (

+102.00%).

I found this intriguing. Given a choice of investing into either EDV or a consol, what would you choose? Why? (Please provide numerical justifications).