Why are bond funds 1-X and not 0-X?

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Doc
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Why are bond funds 1-X and not 0-X?

Post by Doc »

Having to sell a fixed income security just because it has less than one year to maturity makes little sense to me.
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Re: Why are bond funds 1-X and not 0-X?

Post by alex_686 »

Because anything under a year is considered cash, not a bond. We can get into a long involved nuanced discussion about the difference between bonds and those special bonds which have a very short duration. However, for practical purposes, most people carve up their asset allocation by cash and by bonds. Why double up cash? Risk and return are linked. Cash is riskless, people really don't expect any returns from their cash - after adjusting for inflation. People hold bonds for some type of return.

Is there any particular reason why you are asking? Impact is very low.
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Re: Why are bond funds 1-X and not 0-X?

Post by Stinky »

Doc wrote: Mon May 03, 2021 10:01 am Having to sell a fixed income security just because it has less than one year to maturity makes little sense to me.
Why do you have to sell it? Why not hold until maturity?
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Re: Why are bond funds 1-X and not 0-X?

Post by alex_686 »

Stinky wrote: Mon May 03, 2021 10:23 am
Doc wrote: Mon May 03, 2021 10:01 am Having to sell a fixed income security just because it has less than one year to maturity makes little sense to me.
Why do you have to sell it? Why not hold until maturity?
I am assuming Doc is referring to mutual fund and ETF portfolios, plus indexes. This is the standard operating procedure. Please correct me if this is a bad assumption.
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Re: Why are bond funds 1-X and not 0-X?

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alex_686 wrote: Mon May 03, 2021 10:17 am Because anything under a year is considered cash, not a bond. ...

Is there any particular reason why you are asking? Impact is very low.
Because I could set up a 0-3 ladder very easily that would give me income every six months instead of every month and thus ease the reinvestment of dividends hassle.

As far as less than one year being considered cash. Fine. I can sell that note with six months remining at a cost of 0.01 and have the money available in a few minutes. But I do understand the fund's reasoning.
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Re: Why are bond funds 1-X and not 0-X?

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Stinky wrote: Mon May 03, 2021 10:23 am
Doc wrote: Mon May 03, 2021 10:01 am Having to sell a fixed income security just because it has less than one year to maturity makes little sense to me.
Why do you have to sell it? Why not hold until maturity?
Yeah, I had same reaction...why is a bond fund maturing & who is making him sell?? I'm wondering now if the question is basically why are bond funds classified as over one year at lowest end versus overlapping with money market area? Kinda like why is some debt called treasury bill, note, bond?? btw, I just check Vanguard total bond fund & it showed holdings less than a year. So, I don't know they HAVE to sell before maturity or just classify as "cash" portion....One of those discussions you won't find just anywhere!!
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Re: Why are bond funds 1-X and not 0-X?

Post by not4me »

Doc wrote: Mon May 03, 2021 10:39 am
alex_686 wrote: Mon May 03, 2021 10:17 am Because anything under a year is considered cash, not a bond. ...

Is there any particular reason why you are asking? Impact is very low.
Because I could set up a 0-3 ladder very easily that would give me income every six months instead of every month and thus ease the reinvestment of dividends hassle.

As far as less than one year being considered cash. Fine. I can sell that note with six months remining at a cost of 0.01 and have the money available in a few minutes. But I do understand the fund's reasoning.
So, this came in while I was sending the other post. I'm still confused...Doc, are you wanting to build a ladder of fixed maturity funds that are timed to pay only semi-annually?
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Re: Why are bond funds 1-X and not 0-X?

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not4me wrote: Mon May 03, 2021 10:40 am I just check Vanguard total bond fund & it showed holdings less than a year. So, I don't know they HAVE to sell before maturity or just classify as "cash" portion....One of those discussions you won't find just anywhere!!
They have to sell, for for technical and practical purposes.

The Vanguard Total Bond Market Index Fund is a index fund. As such they must hold the securities listed in the index, and the index specifies bonds of 1 year or greater. There is a very limited carve out for a "Cash Account" to handle cash flow issues. Coupons, redemptions, purchases, etc.

For practical purposes fund managers - active and passive - have a high incentive to minimize "Cash Drag". It is one of the dimensions that they are judged on.
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Re: Why are bond funds 1-X and not 0-X?

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not4me wrote: Mon May 03, 2021 10:40 am I'm still confused...Doc, are you wanting to build a ladder of fixed maturity funds that are timed to pay only semi-annually?
Yes. It would cut the number of transactions each year from twelve to only three. Three being two semi-annual investments of interest and one purchase for replacing the maturing note.
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Re: Why are bond funds 1-X and not 0-X?

Post by alex_686 »

Doc wrote: Mon May 03, 2021 10:39 am
alex_686 wrote: Mon May 03, 2021 10:17 am Because anything under a year is considered cash, not a bond. ...

Is there any particular reason why you are asking? Impact is very low.
Because I could set up a 0-3 ladder very easily that would give me income every six months instead of every month and thus ease the reinvestment of dividends hassle.

As far as less than one year being considered cash. Fine. I can sell that note with six months remining at a cost of 0.01 and have the money available in a few minutes. But I do understand the fund's reasoning.
Do you mean "Income"? Because fund managers do not care about income. When I was working in fund accounting this was hardly mentioned when talking about a portfolio. It was always "Total Return" and trying to maximize that. Risk adjusted of course.

Personally, I would think that setting up a bond fund with automatic dividend reinvestment is the way to go. Higher return, lower risk, higher liquidity, less work. I can't see much advantage on such a short ladder. Yes, it gives you higher control and a high level of certainty. People think that translates into lower risk but that is mostly illusionary.
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Re: Why are bond funds 1-X and not 0-X?

Post by not4me »

Doc wrote: Mon May 03, 2021 11:06 am
not4me wrote: Mon May 03, 2021 10:40 am I'm still confused...Doc, are you wanting to build a ladder of fixed maturity funds that are timed to pay only semi-annually?
Yes. It would cut the number of transactions each year from twelve to only three. Three being two semi-annual investments of interest and one purchase for replacing the maturing note.
Got it...& while I'm not up to speed on all of these defined maturity funds, my limited experience is that they have monthly distributions anyway. Or at least up until about the time they start "maturing".
alex_686 wrote: Mon May 03, 2021 11:02 am
not4me wrote: Mon May 03, 2021 10:40 am I just check Vanguard total bond fund & it showed holdings less than a year. So, I don't know they HAVE to sell before maturity or just classify as "cash" portion....One of those discussions you won't find just anywhere!!
They have to sell, for for technical and practical purposes.

The Vanguard Total Bond Market Index Fund is a index fund. As such they must hold the securities listed in the index, and the index specifies bonds of 1 year or greater. There is a very limited carve out for a "Cash Account" to handle cash flow issues. Coupons, redemptions, purchases, etc.

For practical purposes fund managers - active and passive - have a high incentive to minimize "Cash Drag". It is one of the dimensions that they are judged on.
Well I'm not sure if overall you agree with me or not. I get that funds have to stick with their charter, but when I see words like "have to" I think you mean "have to". Later, you talked about a "cash account". In my post you seemed to be replying to, I said maybe they don't sell, just classify as cash....So unless you maintain that funds do not have cash for various purposes OR you maintain SEC requires bonds be sold on last day before their maturity is less than a year off, I'll assume there isn't really a difference of opinion. Either way I think Doc got his question addressed
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Re: Why are bond funds 1-X and not 0-X?

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alex_686 wrote: Mon May 03, 2021 11:10 am Personally, I would think that setting up a bond fund with automatic dividend reinvestment is the way to go.
I don't use automatic dividend reinvestment. I use dividends as an aid to rebalncing. But that's just a personal choice and has nothing to do with why "1-x".
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Re: Why are bond funds 1-X and not 0-X?

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not4me wrote: Mon May 03, 2021 11:33 am Well I'm not sure if overall you agree with me or not. I get that funds have to stick with their charter, but when I see words like "have to" I think you mean "have to". Later, you talked about a "cash account". In my post you seemed to be replying to, I said maybe they don't sell, just classify as cash....So unless you maintain that funds do not have cash for various purposes OR you maintain SEC requires bonds be sold on last day before their maturity is less than a year off, I'll assume there isn't really a difference of opinion. Either way I think Doc got his question addressed
Well, how strong and clear do you want the language to be? Imagine driving around with a traffic cop in the back seat. Are they going to give you a ticket for failing to use your turn signal? Normally yes, but not if you have to unexpected swerve to avoid a accident.

There is a high level of scrutiny. Managers are expected to act proactively and at a high level. So while not a absolute rule there is strong regulatory pressure.

Under SEC marketing rules a index fund has to replicate the index as best it can. For the primary holdings that means the manager must sell securities when dropped by the index manager. The portfolio manager may have to justify the level of cash since this represents a deviation from the index.
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Re: Why are bond funds 1-X and not 0-X?

Post by Svensk Anga »

I thought they sold the short-end bonds in order to realize a capital gain, at least in the normal case when the yield curve is positively sloped. The capital from that sale can now be invested at higher yield. A higher advertised yield sells more fund shares, so more revenue for the fund company.
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Re: Why are bond funds 1-X and not 0-X?

Post by Thesaints »

Bond funds have generally target durations/maturities. If they hold a substantial fraction of their assets in about-to-mature bonds, they have to compensate by increasing their holding on the longer-dated side (which are riskier).
Bonds near maturity, as other have observed, are essentially cash in term of price fluctuations.
It makes sense for them not to carry them to maturity.
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Re: Why are bond funds 1-X and not 0-X?

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Thesaints wrote: Mon May 03, 2021 12:44 pm Bond funds have generally target durations/maturities. If they hold a substantial fraction of their assets in about-to-mature bonds, they have to compensate by increasing their holding on the longer-dated side (which are riskier).
Bonds near maturity, as other have observed, are essentially cash in term of price fluctuations.
It makes sense for them not to carry them to maturity.
well stated. Just to add to that though. In my experience, the target is rarely an absolute number. For example, TBM tracks a certain index which per recent reports had on december 31 2020 a dollar weighted average maturity of 8.6 years. The market tracked by that index may cause that number to shift over time. Events occur (think bankruptcies, bonds being called, etc). Dollars flow in & out of the fund. Some bonds are easier to sell than others. Sometimes, markets have liquidity issues making it hard to sell. So, the fund manager has to keep shifting across the spectrum of holdings -- not just at the 366 day mark!

Many may be surprised that TBM for recent fiscal year showed a 79% turnover rate.
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Re: Why are bond funds 1-X and not 0-X?

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not4me wrote: Mon May 03, 2021 1:34 pm ... TBM tracks a certain index which per recent reports had on december 31 2020 a dollar weighted average maturity of 8.6 years. The market tracked by that index may cause that number to shift over time. Events occur (think bankruptcies, bonds being called, etc). Dollars flow in & out of the fund. Some bonds are easier to sell than others. Sometimes, markets have liquidity issues making it hard to sell. So, the fund manager has to keep shifting across the spectrum of holdings -- not just at the 366 day mark!

Many may be surprised that TBM for recent fiscal year showed a 79% turnover rate.
You have a fair amount of things backwards here.

TBM does not target a duration. Rather it tries replicates the holdings bloomberg barclays u.s. aggregate bond index. The index is trying to mirror the market, and the market duration moves all over the time depending on supply and demand.

You mentioned the 79% turnover rate. That is mainly driven by the high turnover in the index which is driven by liquidity. In order for a price index to work you need a high volume in trades to generate price data. Only about 10% of the bond universe meets this criteria, and that 10% changes all the time. If a bond's trading volume falls it is kicked out and replaced with another bond. Happens all of the time.
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Re: Why are bond funds 1-X and not 0-X?

Post by not4me »

alex_686 wrote: Mon May 03, 2021 2:31 pm
not4me wrote: Mon May 03, 2021 1:34 pm ... TBM tracks a certain index which per recent reports had on december 31 2020 a dollar weighted average maturity of 8.6 years. The market tracked by that index may cause that number to shift over time. Events occur (think bankruptcies, bonds being called, etc). Dollars flow in & out of the fund. Some bonds are easier to sell than others. Sometimes, markets have liquidity issues making it hard to sell. So, the fund manager has to keep shifting across the spectrum of holdings -- not just at the 366 day mark!

Many may be surprised that TBM for recent fiscal year showed a 79% turnover rate.
You have a fair amount of things backwards here.

TBM does not target a duration. Rather it tries replicates the holdings bloomberg barclays u.s. aggregate bond index. The index is trying to mirror the market, and the market duration moves all over the time depending on supply and demand.

You mentioned the 79% turnover rate. That is mainly driven by the high turnover in the index which is driven by liquidity. In order for a price index to work you need a high volume in trades to generate price data. Only about 10% of the bond universe meets this criteria, and that 10% changes all the time. If a bond's trading volume falls it is kicked out and replaced with another bond. Happens all of the time.
Clearly, what we have is a failure to communicate. I've no idea what a "fair amount" is that I have wrong. I highlighted in blue what I had in original post & don't understand the difference in what you posted. Earlier, we obviously had different understanding of what it means to "have to". I'm not trying to change your opinion & this is really a rhetorical post I guess unless someone else can point out any factual errors on my part....I don't think anything further will shed light, just garble more...so I'm done.
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Re: Why are bond funds 1-X and not 0-X?

Post by alex_686 »

not4me wrote: Mon May 03, 2021 3:20 pm Clearly, what we have is a failure to communicate. I've no idea what a "fair amount" is that I have wrong. I highlighted in blue what I had in original post & don't understand the difference in what you posted. Earlier, we obviously had different understanding of what it means to "have to". I'm not trying to change your opinion & this is really a rhetorical post I guess unless someone else can point out any factual errors on my part....I don't think anything further will shed light, just garble more...so I'm done.
I cut the quote a bit too deeply.
Thesaints wrote: Mon May 03, 2021 12:44 pm Bond funds have generally target durations/maturities. If they hold a substantial fraction of their assets in about-to-mature bonds, they have to compensate by increasing their holding on the longer-dated side (which are riskier).
Bonds near maturity, as other have observed, are essentially cash in term of price fluctuations.
It makes sense for them not to carry them to maturity.
While this can be correct for some bond funds, it is incorrect for index funds. It is like saying that the tail wags the dog.

This way my day job, and still is kind of. So I get particular about the details, causation, and nuances. If you say that I am making a mountain out of a mole hill I would not object.
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Re: Why are bond funds 1-X and not 0-X?

Post by Doc »

Thanks for all your replies. I guess it's time to let the cat out of the bag.

I have a large amount of money in 1-3 Treasury ETFs in two of our taxable accounts. Reallocating the small monthly dividend is a PITA since reinvestment of dividends every month can lead to tax complications like wash sales.

I would like to replace the positions with actual Treasury notes which could give me a larger payment but only twice a year instead of smaller payment twelve times each year. Replacing that position with actual notes with maturities either six or twelve months apart would reduce the bookkeeping.

Whether I set up a 3-1 ladder or a 3-0 ladder is probably a secondary consideration. Likewise whether the maturities are 6 months apart or 12 months apart is another probably minor aspect of the question.

Vanguard Short-Term Treasury ETF (VGSH) currently has 93 holdings three of which have coupons over 6%. I certainly don't need that kind of detail. :D
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Re: Why are bond funds 1-X and not 0-X?

Post by Northern Flicker »

VGSH is an index fund. It has to track the index. Distributing interest monthly from the fund is a different issue from whether it has to sell bonds. A significant use of bond funds is to realize income and some will want monthly income.

The issue with having to sell bonds is that it may generate capital gains distributions. Some will see that as a benefit if they are long-term gains as they are taxed more favorably than holding an appreciated bond to maturity and realizing the remaining coupon interest.

VGSH and VGIT distributed capital gains in 12/2020.
Last edited by Northern Flicker on Tue May 04, 2021 12:44 pm, edited 1 time in total.
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Re: Why are bond funds 1-X and not 0-X?

Post by Doc »

Northern Flicker wrote: Tue May 04, 2021 12:07 pm The issue with having to sell bonds is that it may generate capital gains distributions. Some will see that as a benefit it they are long-term gains as they are taxed more favorably than holding an appreciated bond to maturity and realizing the remaining coupon interest.
Good point. I hadn't though about that. But probably not a significant factor with a 0-3 or 1-3 ladder. In any case you can make the decision to hold or sell each time the remaining time to maturity of a particular rung in your ladder reaches 1 year.
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