Short term bond ETF price fluctuation

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Rosencrantz1
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Short term bond ETF price fluctuation

Post by Rosencrantz1 » Tue Sep 10, 2019 12:50 pm

Hello, I've recently put a significant (to me - over $100k) amount of my retirement dollars into a short term bond fund - ISTB. I primarily chose this fund because of its low expense ratio and fairly low duration. I suspect that interest rates, at least for the next year or so, will remain stable - OR, possibly even go down from their current level (presumably allowing for some price appreciation of the bonds held in the portfolio). Here's what I'm trying to understand.... If interest rates are the same (FED) and if there's some discussion of (possibly) lowering the FED rate further, why does there seem to be so much daily price variation of ISTB? To add insult to injury, it seems the price of ISTB has generally drifted down since my purchase date. Do the laws of 'supply and demand' affect the price of any given bond ETF each day? I realize the price is typically moving in pennies....but, they tend to add up when I own 2000+ shares!
Thanks for any insight you have to offer! Rosencrantz1

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grabiner
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Re: Short term bond ETF price fluctuation

Post by grabiner » Tue Sep 10, 2019 8:41 pm

The Fed influences rates for even shorter terms than the terms of bonds in a short-term bond fund (usually 1-5 years). The price of a 3-year bond depends on rate expectations over the next three years, so it already prices in the possibility of the Fed's future moves.

Short-term bonds are less sensitive to interest rates than long-term bonds. If your bond fund has a 3-year duration, and the yields on its bonds rise by 1%, the fund will lose 3% of its value; Total Bond Market, with a 6-year duration, will lose 6% if the yields on its bonds rise by the same 1%.
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livesoft
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Re: Short term bond ETF price fluctuation

Post by livesoft » Tue Sep 10, 2019 8:52 pm

The past couple of months has been an especially volatile time for bond funds with some very unusual (in my opinion) one day swings. Anybody who is expecting the ol' same stability of years ago will find that a tweet or a tariff or an announcement will create pressure to change prices.

You may have even noticed that the relatively staid Vanguard VBTLX dropped to 11.07 from 11.23 (a 1.4% drop) in only 4 trading days, but of course it was at 11.07 a month ago anyways.

If I rebalance from equities to bonds, then I buy a bond ETF on a day that it has dropped 0.4% or more (not counting going ex-dividend).

All I can say is just get used to it.

I'll throw out another fact:
The 3-year total returns for Vanguard Total US Bond Index (VBTLX) and Vanguard Short-term corporate bond index (VSCSX) funds are almost the same: They both made about 8.5% total, not annualized. That's despite the 7.90% YTD total return of VBTLX.
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Phineas J. Whoopee
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Re: Short term bond ETF price fluctuation

Post by Phineas J. Whoopee » Wed Sep 11, 2019 5:26 pm

Without disagreeing with dbr or livesoft I'll also chime in.

The Fed (it is not an acronym, it's short for the Federal Reserve System) does not control bond yields. It has influence but not control. Yields result from the interplay of participants in fixed income markets. It's an ongoing, continuous auction.

The common use interest rates is highly misleading with respect to this topic. The right word is yield, as I linked in the prior paragraph. The wrong and easy to misunderstand term is interest rates.

It is routine for very short-term bond funds to fluctuate in value. Even money market funds do, although some retail ones are legally allowed to use an accounting fiction that makes it look like they don't. There's a regulatory backstop in case they do anyway.

I hope that's helpful.

PJW

rebellovw
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Re: Short term bond ETF price fluctuation

Post by rebellovw » Wed Sep 11, 2019 6:04 pm

Dumb question I've wanted to ask -and seems fitting in this thread:

Is the price of the bond ETF/Mutual Fund (ex Total Bond Market) based on what people are willing to pay for it - i.e. like stocks (supply/demand as the OP mentioned)? Or is it simply based on bonds themselves?

If the price is based on supply/demand - then an answer someone provided me a few weeks back - to capture the high recent increase in bond etf - you would need to sell now - if you hold to maturity - it will be a 0 gain. Which doesn't make sense if bonds are like stocks.

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Rosencrantz1
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Re: Short term bond ETF price fluctuation

Post by Rosencrantz1 » Wed Sep 11, 2019 6:33 pm

Great information - thanks.
I did place a call to an advisor I know and she concurred with the general consensus here that short term bond prices do tend to fluctuate quite a bit in price. With that said, I have to admit that I was (and, continue to be) a bit surprised that short term bond etfs seem to be currently trending down in price - given my perception that interest rates/yields seem stable (or, even weakening). I'm probably not 'seeing the forest for the trees' somewhere...

I think I read somewhere that our past Chairman of the FED, Alan Greenspan, indicated that "negative interest rates" will eventually show up in the USA (as it apparently has in some international locales) :shock:

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Re: Short term bond ETF price fluctuation

Post by Jmh04j » Wed Sep 11, 2019 6:42 pm

given my perception that interest rates/yields seem stable (or, even weakening)
This assumption is incorrect. The yield on the 10 year treasury has increased approximately 30 basis points in the last 5 days. That is a 20% increase in yield. I wouldn’t call that “stable”.

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Rosencrantz1
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Re: Short term bond ETF price fluctuation

Post by Rosencrantz1 » Wed Sep 11, 2019 7:13 pm

Jmh04j wrote:
Wed Sep 11, 2019 6:42 pm
given my perception that interest rates/yields seem stable (or, even weakening)
This assumption is incorrect. The yield on the 10 year treasury has increased approximately 30 basis points in the last 5 days. That is a 20% increase in yield. I wouldn’t call that “stable”.
Point taken. I did look at the chart for the 2 year treasury and it appears to have bounced around some over the past month - generally trending up over the past 5 days. I think this chart answers my question about my short term etf. I didn't realize these rates moved around so much on a day-to-day basis. I've mostly focused on equities in the past. I suppose some education - for me - in fixed income is needed.

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Re: Short term bond ETF price fluctuation

Post by livesoft » Wed Sep 11, 2019 7:17 pm

You might look at some other time periods to see how much rates moved on a daily basis. The past month or so has been somewhat more volatile I think.
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Phineas J. Whoopee
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Re: Short term bond ETF price fluctuation

Post by Phineas J. Whoopee » Wed Sep 11, 2019 7:24 pm

rebellovw wrote:
Wed Sep 11, 2019 6:04 pm
Dumb question I've wanted to ask -and seems fitting in this thread:

Is the price of the bond ETF/Mutual Fund (ex Total Bond Market) based on what people are willing to pay for it - i.e. like stocks (supply/demand as the OP mentioned)? Or is it simply based on bonds themselves?

If the price is based on supply/demand - then an answer someone provided me a few weeks back - to capture the high recent increase in bond etf - you would need to sell now - if you hold to maturity - it will be a 0 gain. Which doesn't make sense if bonds are like stocks.
As a grad school professor of mine once responded, there are no stupid questions. There are only stupid students. The clear implication at the time was those were the ones who didn't ask their questions.

The answer is hybrid, and it's key to how Exchange Traded Funds, ETFs, operate.

ETFs trade throughout the market day, and yes their prices rise and fall based on the orders, especially limit orders, placed by market participants, which include institutions as well as individuals.

ETFs also have a net asset value, NAV, typically published daily just like traditional mutual funds, but calculable intra-day by anybody who is interested and pays for the real-time data. It is a routine matter for the latest transaction to have occurred at a different price than the NAV. For large frequently-traded ETFs the spread is usually not very much. With some smaller or estoeric illiquid ETFs it can be bigger, but there's a control mechanism I'll get to in the next paragraph.

Should an ETF's market price differ significantly from its NAV, there are institutions, at least one and sometimes more, called authorized participants, AP, who have the privilege of driving the creation and destruction of shares of the particular ETF. Regardless of whether one thinks it's fair, that's central to the design of ETF securities.

An authorized participant can buy the underlying assets and exchange them with the ETF sponsor for newly-created shares, which they then sell on the open market. That's what happens if the market price goes significantly above NAV. It has the effect of raising the prices of the underlying assets and reducing the ETF price. In the opposite direction an AP can buy ETF shares, again on the open market, and exchange them with the fund sponsor for the underlying belongings then sell those.

That keeps the ETF share price fairly close to the NAV. The APs are motivated because EFTs have an arbitrage opportunity built in, which means they can profit from deviations.

Within that mechanism one can expect, over time, to get the earnings of the underlying securities less the expense ratio and trading costs.

Does that help?

PJW
Last edited by Phineas J. Whoopee on Wed Sep 11, 2019 7:35 pm, edited 1 time in total.

rebellovw
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Re: Short term bond ETF price fluctuation

Post by rebellovw » Wed Sep 11, 2019 7:30 pm

Phineas J. Whoopee wrote:
Wed Sep 11, 2019 7:24 pm
rebellovw wrote:
Wed Sep 11, 2019 6:04 pm
Dumb question I've wanted to ask -and seems fitting in this thread:

Is the price of the bond ETF/Mutual Fund (ex Total Bond Market) based on what people are willing to pay for it - i.e. like stocks (supply/demand as the OP mentioned)? Or is it simply based on bonds themselves?

If the price is based on supply/demand - then an answer someone provided me a few weeks back - to capture the high recent increase in bond etf - you would need to sell now - if you hold to maturity - it will be a 0 gain. Which doesn't make sense if bonds are like stocks.
As a grad school professor of mine once responded, there are no stupid questions. There are only stupid students. The clear implication at the time was those were the ones who didn't ask their questions.

The answer is hybrid, and it's key to how Exchange Traded Funds, ETFs, operate.

ETFs trade throughout the market day, and yes their prices rise and fall based on the orders, especially limit orders, placed by market participants, which include institutions as well as individuals.

ETFs also have a net asset value, NAV, typically published daily just like traditional mutual funds, but calculable intra-day by anybody who is interested and pays for the real-time data. It is a routine matter for the latest transaction to have occurred at a different price than the NAV. For large frequently-traded ETFs the spread is usually not very much. With some smaller or estoeric illiquid ETFs it can be bigger, but there's a control mechanism I'll get to in the next paragraph.

Should an ETF's market price differ significantly from it's NAV, there are institutions, at least one and sometimes more, called authorized participants, AP, who have the privilege of driving the creation and destruction of shares of the particular ETF. Regardless of whether one thinks it's fair, that's central to the design of ETF securities.

An authorized participant can buy the underlying assets and exchange them to the ETF sponsor for newly-created shares, which they then sell on the open market. That's what happens if the market price goes significantly above NAV. It has the effect of raising the prices of the underlying assets and reducing the ETF price. In the opposite direction an AP can buy ETF shares, again on the open market, and exchange them with the fund sponsor for the underlying belongings then sell those.

That keeps the ETF share price fairly close to the NAV. The APs are motivated because EFTs have an arbitrage opportunity built in, which means they can profit from deviations.

Within that mechanism one can expect, over time, to get the earnings of the underlying securities less the expense ratio and trading costs.

Does that help?

PJW
Awesome PJW - thanks a bunch!

Topic Author
Rosencrantz1
Posts: 5
Joined: Tue Sep 10, 2019 12:28 pm

Re: Short term bond ETF price fluctuation

Post by Rosencrantz1 » Wed Sep 11, 2019 8:22 pm

rebellovw wrote:
Wed Sep 11, 2019 7:30 pm
Phineas J. Whoopee wrote:
Wed Sep 11, 2019 7:24 pm
rebellovw wrote:
Wed Sep 11, 2019 6:04 pm
Dumb question I've wanted to ask -and seems fitting in this thread:

Is the price of the bond ETF/Mutual Fund (ex Total Bond Market) based on what people are willing to pay for it - i.e. like stocks (supply/demand as the OP mentioned)? Or is it simply based on bonds themselves?

If the price is based on supply/demand - then an answer someone provided me a few weeks back - to capture the high recent increase in bond etf - you would need to sell now - if you hold to maturity - it will be a 0 gain. Which doesn't make sense if bonds are like stocks.
As a grad school professor of mine once responded, there are no stupid questions. There are only stupid students. The clear implication at the time was those were the ones who didn't ask their questions.

The answer is hybrid, and it's key to how Exchange Traded Funds, ETFs, operate.

ETFs trade throughout the market day, and yes their prices rise and fall based on the orders, especially limit orders, placed by market participants, which include institutions as well as individuals.

ETFs also have a net asset value, NAV, typically published daily just like traditional mutual funds, but calculable intra-day by anybody who is interested and pays for the real-time data. It is a routine matter for the latest transaction to have occurred at a different price than the NAV. For large frequently-traded ETFs the spread is usually not very much. With some smaller or estoeric illiquid ETFs it can be bigger, but there's a control mechanism I'll get to in the next paragraph.

Should an ETF's market price differ significantly from it's NAV, there are institutions, at least one and sometimes more, called authorized participants, AP, who have the privilege of driving the creation and destruction of shares of the particular ETF. Regardless of whether one thinks it's fair, that's central to the design of ETF securities.

An authorized participant can buy the underlying assets and exchange them to the ETF sponsor for newly-created shares, which they then sell on the open market. That's what happens if the market price goes significantly above NAV. It has the effect of raising the prices of the underlying assets and reducing the ETF price. In the opposite direction an AP can buy ETF shares, again on the open market, and exchange them with the fund sponsor for the underlying belongings then sell those.

That keeps the ETF share price fairly close to the NAV. The APs are motivated because EFTs have an arbitrage opportunity built in, which means they can profit from deviations.

Within that mechanism one can expect, over time, to get the earnings of the underlying securities less the expense ratio and trading costs.

Does that help?

PJW
Awesome PJW - thanks a bunch!
+1 An excellent, understandable explanation. Thanks.

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