Are Actively Managed Bond Funds Worth a Look?

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thenextguy
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by thenextguy »

Northern Flicker wrote: Sun May 02, 2021 1:08 pm
thenextguy wrote: Sun May 02, 2021 11:28 am
vineviz wrote: Sun May 02, 2021 10:41 am
thenextguy wrote: Sat May 01, 2021 11:58 am So there’s PIMCO Total Return and DODIX as two bond funds that have smoked Vanguard Total Bond fund even on a risk-adjusted basis for over 30 years.
This is true for DODIX, but not for the PIMCO fund.
This is where I got that from. Higher total return and higher Sharpe ratio. What did you use to calculate it?
Some Sharpe ratios. Note also the max drawdowns:

https://www.portfoliovisualizer.com/bac ... tion4_3=45

But you should hold bonds to diversify risk, not as a primary source of return. Once uou establish a risk tolerance, using the higher risk PTTRX or DODIX as a bond allocation requires lowering your equity allocation to compensate for their higher risk:

https://www.portfoliovisualizer.com/bac ... tion4_3=50
Your time frames are much, much shorter. Also, VGIT is not the same class of fund we’re talking about.
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

thenextguy wrote: Sun May 02, 2021 1:28 pm
Northern Flicker wrote: Sun May 02, 2021 1:08 pm
thenextguy wrote: Sun May 02, 2021 11:28 am
vineviz wrote: Sun May 02, 2021 10:41 am
thenextguy wrote: Sat May 01, 2021 11:58 am So there’s PIMCO Total Return and DODIX as two bond funds that have smoked Vanguard Total Bond fund even on a risk-adjusted basis for over 30 years.
This is true for DODIX, but not for the PIMCO fund.
This is where I got that from. Higher total return and higher Sharpe ratio. What did you use to calculate it?
Some Sharpe ratios. Note also the max drawdowns:

https://www.portfoliovisualizer.com/bac ... tion4_3=45

But you should hold bonds to diversify risk, not as a primary source of return. Once uou establish a risk tolerance, using the higher risk PTTRX or DODIX as a bond allocation requires lowering your equity allocation to compensate for their higher risk:

https://www.portfoliovisualizer.com/bac ... tion4_3=50
Your time frames are much, much shorter. Also, VGIT is not the same class of fund we’re talking about.
The analysis would produce the same conclusion with a longer time period.

And the fact that VGIT doesn’t invest exactly like PTTRX is pretty much the point: ultimately what matters is the behavior of the overall portfolio, not any particular fund in isolation.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
thenextguy
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by thenextguy »

vineviz wrote: Sun May 02, 2021 2:01 pm
thenextguy wrote: Sun May 02, 2021 1:28 pm
Northern Flicker wrote: Sun May 02, 2021 1:08 pm
thenextguy wrote: Sun May 02, 2021 11:28 am
vineviz wrote: Sun May 02, 2021 10:41 am

This is true for DODIX, but not for the PIMCO fund.
This is where I got that from. Higher total return and higher Sharpe ratio. What did you use to calculate it?
Some Sharpe ratios. Note also the max drawdowns:

https://www.portfoliovisualizer.com/bac ... tion4_3=45

But you should hold bonds to diversify risk, not as a primary source of return. Once uou establish a risk tolerance, using the higher risk PTTRX or DODIX as a bond allocation requires lowering your equity allocation to compensate for their higher risk:

https://www.portfoliovisualizer.com/bac ... tion4_3=50
Your time frames are much, much shorter. Also, VGIT is not the same class of fund we’re talking about.
The analysis would produce the same conclusion with a longer time period.
Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

thenextguy wrote: Sun May 02, 2021 2:38 pm Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
Yes, really.

You can swap the funds around if you want, but and you'll see the same conclusion.

https://www.portfoliovisualizer.com/bac ... tion3_3=35
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
thenextguy
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by thenextguy »

vineviz wrote: Sun May 02, 2021 2:48 pm
thenextguy wrote: Sun May 02, 2021 2:38 pm Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
Yes, really.

You can swap the funds around if you want, but and you'll see the same conclusion.

https://www.portfoliovisualizer.com/bac ... tion3_3=35
Okay, it didn't hold up.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

thenextguy wrote: Sun May 02, 2021 2:51 pm
vineviz wrote: Sun May 02, 2021 2:48 pm
thenextguy wrote: Sun May 02, 2021 2:38 pm Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
Yes, really.

You can swap the funds around if you want, but and you'll see the same conclusion.

https://www.portfoliovisualizer.com/bac ... tion3_3=35
Okay, it didn't hold up.
It holds up if you don't put your thumb on the scale: you've constructed three portfolio with different amounts of risk and volatility.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by thenextguy »

vineviz wrote: Sun May 02, 2021 3:12 pm
thenextguy wrote: Sun May 02, 2021 2:51 pm
vineviz wrote: Sun May 02, 2021 2:48 pm
thenextguy wrote: Sun May 02, 2021 2:38 pm Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
Yes, really.

You can swap the funds around if you want, but and you'll see the same conclusion.

https://www.portfoliovisualizer.com/bac ... tion3_3=35
Okay, it didn't hold up.
It holds up if you don't put your thumb on the scale: you've constructed three portfolio with different amounts of risk and volatility.
Speaking of putting your thumb in the scale, you went and swapped in an ETF with a longer duration (IEF) than the other funds being discussed.
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

thenextguy wrote: Sun May 02, 2021 3:43 pm Speaking of putting your thumb in the scale, you went and swapped in an ETF with a longer duration (IEF) than the other funds being discussed.
I think in all the back and forth you might be losing sight of the main conclusions.

1) The only reasonable way to evaluate manager skill is against a benchmark which is exposed to the same systematic risks as the active fund.
2) The only reasonable use for the Sharpe ratio is at the overall portfolio level.

The managers of PTTRX have produced higher returns than VBMFX purely because they've taken more risk than VBMFX. That's the important point.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by thenextguy »

vineviz wrote: Sun May 02, 2021 3:52 pm
thenextguy wrote: Sun May 02, 2021 3:43 pm Speaking of putting your thumb in the scale, you went and swapped in an ETF with a longer duration (IEF) than the other funds being discussed.
I think in all the back and forth you might be losing sight of the main conclusions.

1) The only reasonable way to evaluate manager skill is against a benchmark which is exposed to the same systematic risks as the active fund.
2) The only reasonable use for the Sharpe ratio is at the overall portfolio level.

The managers of PTTRX have produced higher returns than VBMFX purely because they've taken more risk than VBMFX. That's the important point.
Yes, but what portfolio. In an equity heavy portfolio, long treasuries are more valuable because they are more negatively correlated to stocks than some of the corporates and short treauries in a total bond fund. But what if you're not constructing an equity-heavy portfolio?

Consider the following:
In a 60/40 portfolio, VUSTX (Vanguard Long-Term Treasuries) is a superior bond holding compared to VBMFX (Total Bond). (Sharpe ratio: 0.83 vs. 0.71)
But switch that to a 20/80 portfolio and VBMFX is superior to VUSTX. (Sharpe ratio: 0.98 vs. 0.71)

So can we conclude that one bond fund is better than the other? No, as suggested, it depends on the whole portfolio.

You're absolutely right that the only way to evaluate the skill of an active manager is against a benchmark, but that benchmark is the benchmark of the fund. Not how it might perform when paired with a given level of equities, because the answer will change depending on the amount of equities being held. Whereas if you compare the performance of a Total Bond Fund to another fund that is Benchmarked to the Total Bond Market (assuming it tracks well), you will know which fund is better to hold when you're looking at a stocks/bond ratio where Total Bond is the favorable bond holding.
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

thenextguy wrote: Sun May 02, 2021 4:26 pm

You're absolutely right that the only way to evaluate the skill of an active manager is against a benchmark, but that benchmark is the benchmark of the fund.
Only if the fund’s chosen benchmark accurately reflects the risks the fund ACTUALLY takes.

Unsurprisingly, funds often choose benchmarks that reflect less risk than the funds themselves take. This makes the benchmarks inordinately easy to beat.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

thenextguy wrote: Sun May 02, 2021 3:43 pm
vineviz wrote: Sun May 02, 2021 3:12 pm
thenextguy wrote: Sun May 02, 2021 2:51 pm
vineviz wrote: Sun May 02, 2021 2:48 pm
thenextguy wrote: Sun May 02, 2021 2:38 pm Really. So we just lucked out that the backtest period of January 2010 through April 2021--one that was chosen simply because it was the start date of VGIT--is perfectly representative of what one should expect over all time frames? That's extraordinary. How fortuitous!!
Yes, really.

You can swap the funds around if you want, but and you'll see the same conclusion.

https://www.portfoliovisualizer.com/bac ... tion3_3=35
Okay, it didn't hold up.
It holds up if you don't put your thumb on the scale: you've constructed three portfolio with different amounts of risk and volatility.
Speaking of putting your thumb in the scale, you went and swapped in an ETF with a longer duration (IEF) than the other funds being discussed.
The point is not a game of dueling backtests. Moving a little equity risk into substantial credit exposure in a bond portfolio transfers the source of the risk. In some periods the credit risk premium was more valuable and in some periods the additional equity risk premium exposure was more valuable. That really is all there is to it. There is no magic in the active management used in PTTRX. It just takes more risk than a total bond market index fund which in turn takes more risk than an intermediate duration treasury fund. Overall portfolio risk should be your primary concern.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

I am not a big fan of bond funds that hold disparate bond subclasses, particularly active ones. I want to know the allocation across bond subclasses so that portfolio risk can be managed. A bond index fund is ok because the relative weights of bond subclasses don't change much.

A fund like PIMCO PTTRX is actively managing the portfolio duration, amount of leverage, and allocation across bond subclasses, in addition to some fundamental active management. This means that the bond portfolio you hold changes over time, and your overall portfolio risk changes over time. This happens opaquely-- you don't actually know what your portfolio looks like on a daily basis.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by secondopinion »

vineviz wrote: Sun May 02, 2021 4:52 pm
thenextguy wrote: Sun May 02, 2021 4:26 pm

You're absolutely right that the only way to evaluate the skill of an active manager is against a benchmark, but that benchmark is the benchmark of the fund.
Only if the fund’s chosen benchmark accurately reflects the risks the fund ACTUALLY takes.

Unsurprisingly, funds often choose benchmarks that reflect less risk than the funds themselves take. This makes the benchmarks inordinately easy to beat.
I have seen this a lot. I remember having a bond fund once that outperformed at times the total market bond fund and was pretty uncorrelated to bonds but correlated to stocks over time; but it was highly correlated to junk bonds and had shorted positions. It was not bad; but it was not predictable as to when it would do well. Not worth it in my mind so I sold; I can manage my risks taken myself for cheaper.
It is better to be half-wrong than have a 50% chance of being all-wrong. With the former, you will learn and have money to try again. Otherwise, you will never learn and will have nothing eventually.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

Also, when they charge more ER to take more risk to juice returns, some of the risk premium may be flowing to the fund company in the ER. You may not be fully compensated for the risk being taken.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by nisiprius »

vineviz wrote: Sun May 02, 2021 10:41 am
thenextguy wrote: Sat May 01, 2021 11:58 am So there’s PIMCO Total Return and DODIX as two bond funds that have smoked Vanguard Total Bond fund even on a risk-adjusted basis for over 30 years.
...This is true for DODIX, but not for the PIMCO fund.

Sharpe ratio is not a valid measure of risk-adjusted return for individual funds....
So what do you use as a "valid" measure?

In order to go back to inception of PTTRX, I used the Vanguard 500 Index Fund for "stocks," and omitted international stocks. I compared two 60/40 portfolios, using VBMFX for the bond part of one and PTTRX for the other.

I happen to hold VBMFX, and I don't hold PTTRX. In a way PTTRX is "the fund I love to hate," because I've yet to see anything wrong in its past behavior.

Source

It appears to me that not only did PTTRX have a higher Sharpe ratio itself, but that including it in a 60/40 portfolio would have improved the Sharpe ratio of the portfolio.

Image
Last edited by nisiprius on Mon May 03, 2021 4:45 pm, edited 3 times in total.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

Actually, the Sharpe ratio was created to apply to an individual investment. It extends to a portfolio of individual investments. How that portfolio is packaged in mutual fund or ETF containers is irrelevant.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

nisiprius wrote: Mon May 03, 2021 4:18 pm
vineviz wrote: Sun May 02, 2021 11:54 am Sharpe ratio is not a valid measure of risk-adjusted return for individual funds.
So what do you use as a "valid" measure?
The short answer is that, for the funds I use, I don't use any.

I virtually never use actively managed funds, so really I'm evaluating funds for their systematic risk exposures (e.g. market beta, value factor, duration, etc.) and the costs (both explicit, like management fees, and implicit, like turnover).
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

Northern Flicker wrote: Mon May 03, 2021 4:41 pm Actually, the Sharpe ratio was created to apply to an individual investment. It extends to a portfolio of individual investments. How that portfolio is packaged in mutual fund or ETF containers is irrelevant.
William Sharpe appears to disagree with this characterization.
“The Sharpe Ratio, in its traditional form, ought to be used primarily for one’s whole portfolio,” Dr. Sharpe says.

True to his professorial core, he forwarded me reading material, including his 1994 paper published by the Journal of Portfolio Management. In it, he stresses the importance of correlation to manager selection and explains why a fund with a low Sharpe Ratio might be the better investment choice for client portfolios.

“It is entirely possible that a fund with a smaller Sharpe Ratio could have sufficiently smaller correlation with the investor’s other assets that it would provide a higher expected return on assets for any given level of overall asset risk,” he wrote in the paper.
source

Furthermore, you can follow the link to his 1994 paper and see that the so-called "Sharpe Ratio" in its most commonly used form is virtually always calculated incorrectly based the differential between a fund's return and the risk-free rate. The proper formulation uses the differential between the fund's return and a closely-matched benchmark. This permits you to compare two funds with the same systematic risk exposures to each other, but does permit you to compare two funds with different systematic risk exposures. Nor does it permit the comparison of a fund to its own benchmark. And neither way does it help you build a better overall portfolio.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by nisiprius »

vineviz wrote: Mon May 03, 2021 5:04 pm...“It is entirely possible that a fund with a smaller Sharpe Ratio could have sufficiently smaller correlation with the investor’s other assets that it would provide a higher expected return on assets for any given level of overall asset risk...
Certainly it is possible, but I showed just above that that possibility did not materialize in the case of portfolios including either VBMFX or PTTRX together with stocks.

We can of course also take our improvement in the form of return if we wish. Here, I've equalized the standard deviation of the two portfolios to within PortfolioVisualizer's roundoff error. Same standard deviation, but the portfolio using PTTRX would have a higher return. After its higher expenses.

Source

Image

So I'm not sure why you say that improving the Sharpe ratio "is true for DODIX, but not for the PIMCO fund."

PTTRX has outperformed--in return, in risk-adjusted return by itself, and in risk-adjusted return for portfolios including it. It is has done so during and after Bill Gross's tenure.

Personally, my own take is that the difference between the results obtained using Total Bond versus PTTRX isn't very great, and I'm willing to settle for an index fund so that I don't need to carry the burden of deciding whether or not Bill Gross has or has not lost his edge, is or is not behaving erratically, and does or does not deserve credit for the performance of the fund.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

nisiprius wrote: Mon May 03, 2021 5:37 pm
vineviz wrote: Mon May 03, 2021 5:04 pm...“It is entirely possible that a fund with a smaller Sharpe Ratio could have sufficiently smaller correlation with the investor’s other assets that it would provide a higher expected return on assets for any given level of overall asset risk...
Certainly it is possible, but I showed just above that that possibility did not materialize in the case of portfolios including either VBMFX or PTTRX together with stocks.
That might be true, but at best it’s tangential to the discussion. I’d say it’s irrelevant.
nisiprius wrote: Mon May 03, 2021 5:37 pm
So I'm not sure why you say that improving the Sharpe ratio "is true for DODIX, but not for the PIMCO fund."
I did not say that, actually.

nisiprius wrote: Mon May 03, 2021 5:37 pm
PTTRX has outperformed--in return, in risk-adjusted return by itself, and in risk-adjusted return for portfolios including it. It is has done so during and after Bill Gross's tenure.
It hasn’t outperformed a risk-adjusted benchmark actually. VBMFX is not an appropriate benchmark because it doesn’t match the risks taken by PTTRX.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

vineviz wrote: Mon May 03, 2021 5:04 pm
Northern Flicker wrote: Mon May 03, 2021 4:41 pm Actually, the Sharpe ratio was created to apply to an individual investment. It extends to a portfolio of individual investments. How that portfolio is packaged in mutual fund or ETF containers is irrelevant.
William Sharpe appears to disagree with this characterization.
“The Sharpe Ratio, in its traditional form, ought to be used primarily for one’s whole portfolio,” Dr. Sharpe says.

True to his professorial core, he forwarded me reading material, including his 1994 paper published by the Journal of Portfolio Management. In it, he stresses the importance of correlation to manager selection and explains why a fund with a low Sharpe Ratio might be the better investment choice for client portfolios.

“It is entirely possible that a fund with a smaller Sharpe Ratio could have sufficiently smaller correlation with the investor’s other assets that it would provide a higher expected return on assets for any given level of overall asset risk,” he wrote in the paper.
source
Saying that it ought to be used to measure an entire portfolio is rather different from saying it is invalid for other portfolios. The former is just a statement that risk management should be done for one's entire portfolio. Dr. Sharpe defined what we call the Sharpe ratio for an individual asset, and extended it to a portfolio of individusl assets.

The Sharpe ratio is defined using excess return beyond the risk-free rate. At its core it is a measure if whether an asset delivered a premium that compensated an investor for the risk taken.

Because risk is not additive, as noted by Markovitz, risk should be assessed and managed for an entire portfolio, which is why Sharpe ratio should be used on an entire portfolio.

But suggesting it has no meaning if not applied to my entire portfolio is not a logically coherent statement:

If I hold portfolio A and switch to holding portfolio B does the Sharpe ratio for A suddenly become invalid, while becoming valid for B? What if I want to compare A and B?

If I choose to hold a portfolio that consists of a single mutual fund, does the Sharpe ratio become valid for that mutual fund, but then become invalid for that mutual fund if I add a 2nd fund to my portfolio?

There are limitations to the Sharpe ratio, to be sure. It is very sensitive to time period bias. Volatility may not be the most appropriate risk measure for a given investor or their situation. And it is an imperfect measure to begin with. But it always was intended to measure whether risk was compensated for an investment or active strategy, whether an individual asset, portfolio of assets you hold or portfolio of assets you don't hold.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Dave55 »

LMK5 wrote: Thu Apr 29, 2021 5:28 pm Stock index funds have certainly proven their mettle over time, but how about bond index funds? Is it worth investing in an actively managed fund that may hold a portion of the portfolio securities in junk bonds or other instruments? Most of the time these funds seem to outperform their more conservative index brethren, albeit at a higher expense ratio. With the higher expense ratios, lower credit quality, and the assumption of greater volatility, is it still worthwhile, on a risk adjusted basis, to own these funds instead of or as a complement to bond index funds?
Doesn't hurt to look at actively managed bond funds. There are core plus actively managed bond funds that do take slightly more risk to beat the AGG. BCOIX Baird Core Plus and Dodge and Cox DODIX are 2 examples and both have expense ratios under .50 and both are run by teams, not a single individual. The trailing returns for both funds have beaten the AGG
for 1, 3, 5, 10 & 15 years. Not bad.

Dave
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

Northern Flicker wrote: Mon May 03, 2021 7:26 pm Saying that it ought to be used to measure an entire portfolio is rather different from saying it is invalid for other portfolios. The former is just a statement that risk management should be done for one's entire portfolio. Dr. Sharpe defined what we call the Sharpe ratio for an individual asset, and extended it to a portfolio of individusl assets.

The Sharpe ratio is defined using excess return beyond the risk-free rate. At its core it is a measure if whether an asset delivered a premium that compensated an investor for the risk taken.
That's not the way that Sharpe defines it, and IF you're going to try to use it on an individual asset then you need to define it the way Sharpe defined it for that purpose. The denominator isn't the risk-free rate, it's a benchmark asset with the same systematic risk exposures. I refer you once more to his 1994 paper for a clear explanation of the mathematics and the the rationale.
Northern Flicker wrote: Mon May 03, 2021 7:26 pm If I hold portfolio A and switch to holding portfolio B does the Sharpe ratio for A suddenly become invalid, while becoming valid for B? What if I want to compare A and B?
Yes to the first question, unless the two portfolios are exposed to the same systematic risks.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

vineviz wrote: Mon May 03, 2021 7:44 pm
Northern Flicker wrote: Mon May 03, 2021 7:26 pm Saying that it ought to be used to measure an entire portfolio is rather different from saying it is invalid for other portfolios. The former is just a statement that risk management should be done for one's entire portfolio. Dr. Sharpe defined what we call the Sharpe ratio for an individual asset, and extended it to a portfolio of individusl assets.

The Sharpe ratio is defined using excess return beyond the risk-free rate. At its core it is a measure if whether an asset delivered a premium that compensated an investor for the risk taken.
That's not the way that Sharpe defines it, and IF you're going to try to use it on an individual asset then you need to define it the way Sharpe defined it for that purpose. The denominator isn't the risk-free rate, it's a benchmark asset with the same systematic risk exposures. I refer you once more to his 1994 paper for a clear explanation of the mathematics and the the rationale.
Northern Flicker wrote: Mon May 03, 2021 7:26 pm If I hold portfolio A and switch to holding portfolio B does the Sharpe ratio for A suddenly become invalid, while becoming valid for B? What if I want to compare A and B?
Yes to the first question, unless the two portfolios are exposed to the same systematic risks.
Both the 1966 version and 1994 version are valid measures. Both are imperfect. Both are highly susceptible to sample bias if estimated using outcome samples, a point that dwarves the difference in quality of the measures based on whether the 1966 or 1994 version is used.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

Northern Flicker wrote: Mon May 03, 2021 9:55 pm
vineviz wrote: Mon May 03, 2021 7:44 pm
Northern Flicker wrote: Mon May 03, 2021 7:26 pm Saying that it ought to be used to measure an entire portfolio is rather different from saying it is invalid for other portfolios. The former is just a statement that risk management should be done for one's entire portfolio. Dr. Sharpe defined what we call the Sharpe ratio for an individual asset, and extended it to a portfolio of individusl assets.

The Sharpe ratio is defined using excess return beyond the risk-free rate. At its core it is a measure if whether an asset delivered a premium that compensated an investor for the risk taken.
That's not the way that Sharpe defines it, and IF you're going to try to use it on an individual asset then you need to define it the way Sharpe defined it for that purpose. The denominator isn't the risk-free rate, it's a benchmark asset with the same systematic risk exposures. I refer you once more to his 1994 paper for a clear explanation of the mathematics and the the rationale.
Northern Flicker wrote: Mon May 03, 2021 7:26 pm If I hold portfolio A and switch to holding portfolio B does the Sharpe ratio for A suddenly become invalid, while becoming valid for B? What if I want to compare A and B?
Yes to the first question, unless the two portfolios are exposed to the same systematic risks.
Both the 1966 version and 1994 version are valid measures. Both are imperfect. Both are highly susceptible to sample bias if estimated using outcome samples, a point that dwarves the difference in quality of the measures based on whether the 1966 or 1994 version is used.
If by “valid” you mean “useless, misleading, and contradictory” then sure.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Northern Flicker
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

As long as you compare two similar investments over identical time periods and use the Sharpe ratio as a relative measure, it provides some useful information. Just like other backtest sample statistics, it may not generalize to the future, but this is an issue of sample bias that plagues all performance statistics in a backtest. If you've ever included a backtest as part of a posting to make a point, the data used was subject to the same defect.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

Northern Flicker wrote: Tue May 04, 2021 1:03 pm As long as you compare two similar investments over identical time periods and use the Sharpe ratio as a relative measure, it provides some useful information.
This fallacy never becomes more correct, no matter how often it is repeated and restated.

It's not sufficient that the investments be "similar". They'd have to be identical in two crucial respects: their variance and their correlation with the rest of the portfolio.

If you don't keep those things identical, the Sharpe ratio is an indeterminate measure.

And if you do keep those things identical, the Sharpe ratio is superfluous.

If a measure is either indeterminate or superfluous, I can't see how it can argued to be anything other than useless.
Last edited by vineviz on Tue May 04, 2021 1:55 pm, edited 1 time in total.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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HanSolo
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by HanSolo »

"Are Actively Managed Bond Funds Worth a Look?"

Yes, they are for me. I don't know if they are for you. You and I may have different objectives in the bond portion of our portfolios, as I might surmise from your original post...
LMK5 wrote: Thu Apr 29, 2021 5:28 pm Stock index funds have certainly proven their mettle over time, but how about bond index funds? Is it worth investing in an actively managed fund that may hold a portion of the portfolio securities in junk bonds or other instruments?
If my objective were purely maximizing long-term total return, then I'd probably shift the bond money over to the stock side of my portfolio. On the bond side, I consider stability important, so I have little to no junk bond exposure.

Since I use a portion of the bond side of my portfolio to actively rebalance against the stock side, I'm looking for bond funds that don't tank when stocks tank. This is why I prefer Short-Term Federal (VSGDX) over, say, Short-Term Bond Index (VBIRX).

Another portion of my bond portfolio is to act as a higher-yielding substitute for money market. The Ultra-Short fund (VUSFX) is my choice for that.

For those who want to consider past performance, sometimes active funds are worth a look on that basis as well. The actively-managed Long-Term Treasury (VUSUX) shows a history of slight outperformance against Long-Term Treasury Index (VLGSX).

So my answer is, "yes, for me", and I vote with my feet. I hold the actively-managed funds mentioned above.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

vineviz wrote: Tue May 04, 2021 1:22 pm
Northern Flicker wrote: Tue May 04, 2021 1:03 pm As long as you compare two similar investments over identical time periods and use the Sharpe ratio as a relative measure, it provides some useful information.
This fallacy never becomes more correct, no matter how often it is repeated and restated.

It's not sufficient that the investments be "similar". They'd have to be identical in two crucial respects: their variance and their correlation with the rest of the portfolio.

If you don't keep those things identical, the Sharpe ratio is an indeterminate measure.

And if you do keep those things identical, the Sharpe ratio is superfluous.

If a measure is either indeterminate or superfluous, I can't see how it can argued to be anything other than useless.
Looking at variance of an individual investment in a portfolio is of limited value. Portfolio variance is what matters. That is true whether looking at sample variance or looking at a statistic drpendent on sample variance, such as the 1966 Sharpe ratio.

Your comment about the correlation with the entire portfolio seems to overlook that we agree that risk-adjusted return should be computed for an entire portfolio.

It is a standard procedure to scale a normal distribution by mean and variance. If X is a normally distributed random variable with mean m and standard deviation s, then (X-m)/s is a normally distributed random variable with mean 0 and standard deviation 1. The 1994 version of the Sharpe ratio is doing this same type of scaling on the outcome sample outcome of return, but using the reference benchmark return as an estimator for the mean across portfolios drawn from benchmark universe. The 1966 version of Sharpe ratio only scales by variance.

The risk-free rate is a part of the numerator and denominator of the 1994 version of the statistic-- but it cancels out when you subtract the excess return of the benchmark from the excess return of the portfolio.

Interpretation of sample statistics from backtests is a can of worms. The samples are highly susceptible to sample bias, and we don't really know whether results are even statistically significant-- stats like the t-statistic are not interpretable for non-random samples. These properties of backtest statistics, whether return, volatility, 1966 Sharpe ratio, or 1994 Sharpe ratio should be a much bigger concern when trying to interpret these statistics.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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vineviz
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by vineviz »

Northern Flicker wrote: Tue May 04, 2021 4:46 pm
vineviz wrote: Tue May 04, 2021 1:22 pm
Northern Flicker wrote: Tue May 04, 2021 1:03 pm As long as you compare two similar investments over identical time periods and use the Sharpe ratio as a relative measure, it provides some useful information.
This fallacy never becomes more correct, no matter how often it is repeated and restated.

It's not sufficient that the investments be "similar". They'd have to be identical in two crucial respects: their variance and their correlation with the rest of the portfolio.

If you don't keep those things identical, the Sharpe ratio is an indeterminate measure.

And if you do keep those things identical, the Sharpe ratio is superfluous.

If a measure is either indeterminate or superfluous, I can't see how it can argued to be anything other than useless.
Looking at variance of an individual investment in a portfolio is of limited value. Portfolio variance is what matters. That is true whether looking at sample variance or looking at a statistic drpendent on sample variance, such as the 1966 Sharpe ratio.
That’s why I pointed out that both the correlation and variance of the two assets must be identical in order for the relative Sharpe ratios of the two individual assets to have any meaning.

And as you say, at that point we don’t need to consider the Sharpe ratios of the individual assets at all since we can just look at the whole portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
sfmurph
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by sfmurph »

HanSolo wrote: Tue May 04, 2021 1:40 pm
On the bond side, I consider stability important, so I have little to no junk bond exposure.

Since I use a portion of the bond side of my portfolio to actively rebalance against the stock side, I'm looking for bond funds that don't tank when stocks tank. This is why I prefer Short-Term Federal (VSGDX) over, say, Short-Term Bond Index (VBIRX).

Another portion of my bond portfolio is to act as a higher-yielding substitute for money market. The Ultra-Short fund (VUSFX) is my choice for that.
I agree. The bond portion of my portfolio has 3 parts:
  1. Stability
  2. Rebalancing
  3. Yield
I don't think that there's a single bond fund that could possibly do all three, so I think of these 3:
  1. Cash
  2. Treasuries
  3. Corporates, etc
As for managed or unmanaged, I think that ER/costs are more important, but active management would only be useful with #3.
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Re: Are Actively Managed Bond Funds Worth a Look?

Post by Northern Flicker »

sfmurph wrote: Tue May 04, 2021 6:40 pm
HanSolo wrote: Tue May 04, 2021 1:40 pm
On the bond side, I consider stability important, so I have little to no junk bond exposure.

Since I use a portion of the bond side of my portfolio to actively rebalance against the stock side, I'm looking for bond funds that don't tank when stocks tank. This is why I prefer Short-Term Federal (VSGDX) over, say, Short-Term Bond Index (VBIRX).

Another portion of my bond portfolio is to act as a higher-yielding substitute for money market. The Ultra-Short fund (VUSFX) is my choice for that.
I agree. The bond portion of my portfolio has 3 parts:
  1. Stability
  2. Rebalancing
  3. Yield
I don't think that there's a single bond fund that could possibly do all three, so I think of these 3:
  1. Cash
  2. Treasuries
  3. Corporates, etc
As for managed or unmanaged, I think that ER/costs are more important, but active management would only be useful with #3.
Cash just shortens the duration of the portfolio. You can achieve the same effect without it. It is just a matter of targeting duration.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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