Fallen Angel junk bonds

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boglerdude
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Fallen Angel junk bonds

Post by boglerdude » Mon Mar 23, 2020 8:52 pm

Looks like I fell for the narrative that you can get a deal on downgraded investment grade bonds because institutions are forced to sell them. I bought FALN, this chart is performance since launch June '16. Trounced by stocks and Vanguard's junk fund. Looks like the downside of stocks w/out the upside. Any reason to keep, any scenarios where it could outperform? I'll plan to dump it and put into VTI/VTSMX

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arcticpineapplecorp.
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Re: Fallen Angel junk bonds

Post by arcticpineapplecorp. » Mon Mar 23, 2020 9:00 pm

this is why it's been said, take your risk on the stock side of your portfolio. Bonds are supposed to be more for safety. The appeal of junk bonds is the high yield, but the reason they're high yield is due to the high risk (risk and return are inextricably linked). I'd say you summed up very nicely the problem with junk bonds. Sounds like you've learned some valuable lessons, hopefully it wasn't an expensive lesson.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

Theoretical
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Re: Fallen Angel junk bonds

Post by Theoretical » Tue Mar 24, 2020 1:46 am

Fallen angels are interesting concepts, because you become more diversified as the economy hits the trash bin because more decent and good companies fall on hard times, leading to downgrades and falling into junk status. Since many of them will ultimately survive, you get the upside of their re-ratings, so they're only sort of "fixed income." (with the usual problem of limited upside and unlimited downside).

I think the credit spreads to treasuries aren't quite wide enough (though they're close), though they're now reasonable instead of the measly <3% they were just a few months ago. Now it's approaching 5%, and might be higher.

Junk does have some advantages in inflationary environments because you have both the higher coupon and the increase in valuation that comes with being in a better financial position due to the debts costing less to maintain.

It's really hard to justify as a B&H investment for a stock-heavy portfolio though.

restingonmylaurels
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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Thu Mar 26, 2020 5:36 am

arcticpineapplecorp. wrote:
Mon Mar 23, 2020 9:00 pm
this is why it's been said, take your risk on the stock side of your portfolio. Bonds are supposed to be more for safety. The appeal of junk bonds is the high yield, but the reason they're high yield is due to the high risk (risk and return are inextricably linked). I'd say you summed up very nicely the problem with junk bonds. Sounds like you've learned some valuable lessons, hopefully it wasn't an expensive lesson.
Little late to this thread but felt as supporter of the right kind of junk bonds, I could not disagree with you more.

The 10-year average annual return for VG's HYC (VWEAX) is 7.03%.

The 10-year return for a safe fund, the intermediate-term Treasury fund (VFITX), is 3.40%.

That is over twice the return. And VG's fund avoids the worst of the junk market.

The fund's description states "this fund seeks to purchase what the advisor considers higher-rated junk bonds. This approach aims to capture consistent income and minimize defaults and principal loss."

I wish people would stop saying bonds are for safety, full stop. Yes, bonds should generally be less volatile than stocks but that does not mean there is not a place for VG's junk fund at the appropriate percentage in one's portfolio.

I will give a great reason why this fund should be in play for people, especially those living off their portfolios. Look out at what is happening now.

Stocks are way down, as are the supposedly safe investment grade and municipal bonds. So is my VWEAX.

But in truth, I do not care, because it will still deliver an outsized interest (dividend) payment to me at the end of the month.

I think this month to month assurance makes owning VG's HYC fund worth it (not to mention the larger return).

restingonmylaurels
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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Thu Mar 26, 2020 5:45 am

The reason I wanted to jump on this thread was to ask if anyone knows the answer to the following:

I would expect that fallen angels were BBB bonds that are re-rated as BB bonds, thereby falling into non-investment grade speculative status.

With this downgrade, would not the presence of these bonds in the highest tiers of the junk bond rating scheme serve to increase the overall credit quality of the junk bond universe and as such, on average, make junk bond funds less risky (all other factors being held constant)?

This assumes that these new BB bonds have a better chance of being re-rated as BBBs than the typical BB bonds and so are intrinsically higher quality.

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arcticpineapplecorp.
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Re: Fallen Angel junk bonds

Post by arcticpineapplecorp. » Thu Mar 26, 2020 6:18 am

restingonmylaurels wrote:
Thu Mar 26, 2020 5:36 am
arcticpineapplecorp. wrote:
Mon Mar 23, 2020 9:00 pm
this is why it's been said, take your risk on the stock side of your portfolio. Bonds are supposed to be more for safety. The appeal of junk bonds is the high yield, but the reason they're high yield is due to the high risk (risk and return are inextricably linked). I'd say you summed up very nicely the problem with junk bonds. Sounds like you've learned some valuable lessons, hopefully it wasn't an expensive lesson.
Little late to this thread but felt as supporter of the right kind of junk bonds, I could not disagree with you more.

The 10-year average annual return for VG's HYC (VWEAX) is 7.03%.

The 10-year return for a safe fund, the intermediate-term Treasury fund (VFITX), is 3.40%.

That is over twice the return. And VG's fund avoids the worst of the junk market.

The fund's description states "this fund seeks to purchase what the advisor considers higher-rated junk bonds. This approach aims to capture consistent income and minimize defaults and principal loss."

I wish people would stop saying bonds are for safety, full stop. Yes, bonds should generally be less volatile than stocks but that does not mean there is not a place for VG's junk fund at the appropriate percentage in one's portfolio.

I will give a great reason why this fund should be in play for people, especially those living off their portfolios. Look out at what is happening now.

Stocks are way down, as are the supposedly safe investment grade and municipal bonds. So is my VWEAX.

But in truth, I do not care, because it will still deliver an outsized interest (dividend) payment to me at the end of the month.

I think this month to month assurance makes owning VG's HYC fund worth it (not to mention the larger return).
all you're doing is taking higher risk to get higher return. But bonds are supposed to provide the stability to your portfolio when all hell is breaking loose. If VWEAX is falling at the same time as your stocks, where's the stability?

If you want to take risk, take it with stocks...and then get the higher returns than you do with bonds.

regarding "living off their portfolios"...I'll leave it to you to:
1. read up on how total return is the thing, people keep focusing on high dividend payers (be they stock or bond) without realizing what happens to their fund's price everytime the dividend is paid.
2. retirees wouldn't like living off their high yield bonds if they have to sell them into a downturn (i.e., if the dividend is not enough). Now people should be selling bonds, but you wouldn't want to do that with high yield bonds, would you?

if your point is to take a sliver of your total bond portion of your savings and "play" with high yield bonds, I suppose there's no harm. Like owning 5% of your portfolio in gold.

And if you must buy a high yield bond fund, I certainly would own Vanguard's instead of any other (due to the lower cost and perhaps better junk than you'l find in other funds).
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

restingonmylaurels
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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Thu Mar 26, 2020 7:04 am

arcticpineapplecorp. wrote:
Thu Mar 26, 2020 6:18 am
all you're doing is taking higher risk to get higher return. But bonds are supposed to provide the stability to your portfolio when all hell is breaking loose. If VWEAX is falling at the same time as your stocks, where's the stability?

If you want to take risk, take it with stocks...and then get the higher returns than you do with bonds.

regarding "living off their portfolios"...I'll leave it to you to:
1. read up on how total return is the thing, people keep focusing on high dividend payers (be they stock or bond) without realizing what happens to their fund's price everytime the dividend is paid.
2. retirees wouldn't like living off their high yield bonds if they have to sell them into a downturn (i.e., if the dividend is not enough). Now people should be selling bonds, but you wouldn't want to do that with high yield bonds, would you?

if your point is to take a sliver of your total bond portion of your savings and "play" with high yield bonds, I suppose there's no harm. Like owning 5% of your portfolio in gold.

And if you must buy a high yield bond fund, I certainly would own Vanguard's instead of any other (due to the lower cost and perhaps better junk than you'l find in other funds).
Well, I think some of the BH conventional wisdom has been shaken a bit in this recent market volatility.

Specifically, the problems with investment grade and municipal bonds.

But on a larger canvas, if BHs are supposed to be long term investors, then times of market volatility should not be of great concern.

Regarding total return, from Nov 1991 (the start of the treasury fund) to Feb 2020, nearly 30 years, from a starting balance of $10,000:
  • HY Corp investor shares (VWEHX) has a final balance of $67,846
  • Int Term Treasury investor shares (VFITX) has a final balance of $44,933
So which bond fund is the riskier investment over the long term?

With bonds that provide sufficient income to fund retirement, you never have to sell and do not care what the market it doing.

I am not advocating high yield for a majority of one's bond allocation or anything close to that, only sufficient amounts in tandem with other dividend and interest income producers to fund retirement expenses without having to sell fund shares.

restingonmylaurels
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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Thu Mar 26, 2020 8:24 am

restingonmylaurels wrote:
Thu Mar 26, 2020 5:45 am
The reason I wanted to jump on this thread was to ask if anyone knows the answer to the following:

I would expect that fallen angels were BBB bonds that are re-rated as BB bonds, thereby falling into non-investment grade speculative status.

With this downgrade, would not the presence of these bonds in the highest tiers of the junk bond rating scheme serve to increase the overall credit quality of the junk bond universe and as such, on average, make junk bond funds less risky (all other factors being held constant)?

This assumes that these new BB bonds have a better chance of being re-rated as BBBs than the typical BB bonds and so are intrinsically higher quality.
Today's downgrade of Ford https://www.marketwatch.com/story/fords ... =home-page to me is a perfect example of a fallen angel that clearly has the ability to re-grade back to investment grade but in the meantime increase the quality of the junk bond universe.

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firebirdparts
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Re: Fallen Angel junk bonds

Post by firebirdparts » Thu Mar 26, 2020 8:41 am

I would imagine an active manager could estimate the chance of default when he buys, but this sure seems like a lot of risk for a limited short term potential.
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WoodSpinner
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Re: Fallen Angel junk bonds

Post by WoodSpinner » Thu Mar 26, 2020 10:07 am

All,

Take a listen to this Podcast, especially his input on Junk Bonds and EM Bonds held in an index.

https://podcasts.apple.com/us/podcast/m ... 0469236755

I am passing but wish you the best.

WoodSpinner

restingonmylaurels
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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Thu Mar 26, 2020 11:01 am

WoodSpinner wrote:
Thu Mar 26, 2020 10:07 am
All,

Take a listen to this Podcast, especially his input on Junk Bonds and EM Bonds held in an index.

https://podcasts.apple.com/us/podcast/m ... 0469236755

I am passing but wish you the best.

WoodSpinner
Mohamed El-Erian has to be, and has been, about the most credible person in the financial world.

His points about indices are well noted. Luckily, VG's HY fund is an active fund, not an index.

Interestingly on the topic of fallen angels, a writer in Barron's said the following in regard to Delta Airline's downgrade to junk status, which
could put stress on the high-yield bond market. While Delta already trades like it is junk—even a distressed credit—the junk-bond market has a smaller group of institutions and is more reliant on individual retail investors.

Because the buyer base for junk bonds is smaller, downgrades of large bond issuers can exacerbate losses in the broader high-yield market. And the amount of bonds on the precipice of junk has ballooned over the past decade, which has led strategists to warn about the possibility that a wave of downgrades could swamp junk-bond markets in times of stress.
Interesting information, not sure why more quality securities becoming available in the junk market would exacerbate losses?

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Re: Fallen Angel junk bonds

Post by garlandwhizzer » Thu Mar 26, 2020 12:11 pm

Yield spreads between Treasuries and HYB/junk bonds have widened substantially during this dual crisis, CV-19 and the collapse in oil prices. Many of the HYB were issued by energy companies with shaky finances in a market where the oil prices have dropped by about 50% quickly. Defaults are very likely in the near term. The spreads between HYB and Treasuries decreased to about 2% in recent years which was laughable considering the higher risk of HYB. Spreads have ballooned now to 7%+. Vanguard's HYB fund currently yields 7.86% because investors have fled HYB and flocked to Treasuries. Meanwhile the Vanguard IT fund yields a whopping 0.83%. If the spread widens much further, HYB could become attractive for investors who focus on income. I am not one of them but many are and quality bonds are not going to produce any income real terms going forward IMO. REITS, Dividend paying stocks, and HYB/corporate bonds are what's left to produce positive real income for income oriented investors who don't want to use annuities. None of them are without risk. The days of risk-free real yields appear to be behind us. Annuities have a much lower level of risk but expected returns are very low and there is inflation risk which can diminishes their nominal returns over long periods of time.

Garland Whizzer

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arcticpineapplecorp.
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Re: Fallen Angel junk bonds

Post by arcticpineapplecorp. » Thu Mar 26, 2020 4:41 pm

restingonmylaurels wrote:
Thu Mar 26, 2020 7:04 am


Well, I think some of the BH conventional wisdom has been shaken a bit in this recent market volatility.

Specifically, the problems with investment grade and municipal bonds.

But on a larger canvas, if BHs are supposed to be long term investors, then times of market volatility should not be of great concern.

Regarding total return, from Nov 1991 (the start of the treasury fund) to Feb 2020, nearly 30 years, from a starting balance of $10,000:
  • HY Corp investor shares (VWEHX) has a final balance of $67,846
  • Int Term Treasury investor shares (VFITX) has a final balance of $44,933
So which bond fund is the riskier investment over the long term?

With bonds that provide sufficient income to fund retirement, you never have to sell and do not care what the market it doing.

I am not advocating high yield for a majority of one's bond allocation or anything close to that, only sufficient amounts in tandem with other dividend and interest income producers to fund retirement expenses without having to sell fund shares.
comparing a high yield bond fund to an intermediate treasury fund is a false equivalence. You're comparing apples to oranges.

Which is higher risk? High yield. That's why it pays the higher yield, to compensate for the extra risk. But for the amount of risk you take with high yield it hasn't compensated as much as the stock market (another false equivalence, I admit). But my point is if you want higher return and therefore are willing to take the higher risk, then just invest in stocks. Bonds are supposed to be for safety.

As an example, you only said a portion of bonds in high yield. Therefore, the majority of one's fixed income especially in retirement should be in safer instruments. It's not just my opinion though.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

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Re: Fallen Angel junk bonds

Post by WS1 » Thu Mar 26, 2020 6:58 pm

Bonds are for safety, risk on the equity side is the mantra around here. I’m dying to know who should own junk bonds? Lending money to risky companies seems to be an important feature of our economy. I need to know what people are those unique risks suitable for?

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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Fri Mar 27, 2020 4:52 am

garlandwhizzer wrote:
Thu Mar 26, 2020 12:11 pm
Yield spreads between Treasuries and HYB/junk bonds have widened substantially during this dual crisis, CV-19 and the collapse in oil prices. Many of the HYB were issued by energy companies with shaky finances in a market where the oil prices have dropped by about 50% quickly. Defaults are very likely in the near term. The spreads between HYB and Treasuries decreased to about 2% in recent years which was laughable considering the higher risk of HYB. Spreads have ballooned now to 7%+. Vanguard's HYB fund currently yields 7.86% because investors have fled HYB and flocked to Treasuries. Meanwhile the Vanguard IT fund yields a whopping 0.83%. If the spread widens much further, HYB could become attractive for investors who focus on income. I am not one of them but many are and quality bonds are not going to produce any income real terms going forward IMO. REITS, Dividend paying stocks, and HYB/corporate bonds are what's left to produce positive real income for income oriented investors who don't want to use annuities. None of them are without risk. The days of risk-free real yields appear to be behind us. Annuities have a much lower level of risk but expected returns are very low and there is inflation risk which can diminishes their nominal returns over long periods of time.

Garland Whizzer
I concur with what you have said, especially your point about the days of risk-free real yields being behind us. I think that creates a bit of a conundrum for the typical BH portfolio.

By this I mean that in a typical 50-50 (or 60-40) BH portfolio, if you follow the bonds are for safety mantra, you are invested in Treasuries funds with half of your portfolio, which will be close to dead weight and probably worse, as it will be negative in real terms.

Does it really make sense to hold half your portfolio in investments that do nothing but spring to life every 8 to 10 years when there is a crisis?

I am wondering if in the future the standard BH advice needs to change to something a bit different.

Instead of having 50% of the portfolio locked up permanently in losing bond fund investments, you would purchase a series of put options/loss limit orders to protect your risk investments when they fall.

Then instead of investing half of the portfolio in do-nothing most of the time bond funds, you invest all but your emergency fund in risk assets, protected on the downside.

Thoughts?

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Re: Fallen Angel junk bonds

Post by restingonmylaurels » Fri Mar 27, 2020 6:40 am

arcticpineapplecorp. wrote:
Thu Mar 26, 2020 4:41 pm
restingonmylaurels wrote:
Thu Mar 26, 2020 7:04 am


Well, I think some of the BH conventional wisdom has been shaken a bit in this recent market volatility.

Specifically, the problems with investment grade and municipal bonds.

But on a larger canvas, if BHs are supposed to be long term investors, then times of market volatility should not be of great concern.

Regarding total return, from Nov 1991 (the start of the treasury fund) to Feb 2020, nearly 30 years, from a starting balance of $10,000:
  • HY Corp investor shares (VWEHX) has a final balance of $67,846
  • Int Term Treasury investor shares (VFITX) has a final balance of $44,933
So which bond fund is the riskier investment over the long term?

With bonds that provide sufficient income to fund retirement, you never have to sell and do not care what the market it doing.

I am not advocating high yield for a majority of one's bond allocation or anything close to that, only sufficient amounts in tandem with other dividend and interest income producers to fund retirement expenses without having to sell fund shares.
comparing a high yield bond fund to an intermediate treasury fund is a false equivalence. You're comparing apples to oranges.

Which is higher risk? High yield. That's why it pays the higher yield, to compensate for the extra risk. But for the amount of risk you take with high yield it hasn't compensated as much as the stock market (another false equivalence, I admit).

But my point is if you want higher return and therefore are willing to take the higher risk, then just invest in stocks. Bonds are supposed to be for safety.
High yield and Treasuries are both legally bond instruments, so they are hardly apples and oranges or a false equivalence.

What risk ultimately matters to investors, periodic volatility of their funds or running out of assets during their lifetimes?

Stock returns do not show up uniformly, like monthly expenses do.

As such, one needs a source of return that matches not only the volume but the timing of expenses.

Bond funds that pay dividends timely and in amounts significant enough for those expenses meet the needs of retirees.

As for the bonds are for safety mantra, if the cost of that safety are negative real returns and the safety provided is only temporary during times of market duress, if it better to to address this once in every 5 or 10 year temporary need or the every month expenses forever need?

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