Bonds - Throw it all on the table!!!

[raven15]

Why do you want to shorten your duration? The only correct answer is you have grown old and your investing horizon has shortened below EDV's duration, and so holding an ultra-long bond fund no longer suits your needs. And if this were the case, you would have seen significant total return from the previous 20-30 years that you held EDV, very little chance of a loss over that long of a holding period.

If you want to shorten duration because you think interest rates are going up, that is pure market timing and not worthy of discussion on Bogleheads. How many people were convinced interest rates had nowhere to go but up for the next several years? And all of a sudden last week the Fed comes out and says we are "within spitting distance" of neutral rates. So much for market timing...

Good points. However, Im becoming convinced that the proper thing to do is to leverage the short end. And I completely understand why this is not appealing or feasible for most ppl. H

I don’t know what HedgeFundie is thinking. This is the actual answer. Say you have 10% in EDV. You want 50% bonds when you retire. When you are 10 years out you start converting 4% per year to ibonds, CD’s, short term TIPS, and the like. Keep EDV. After 10 years you will have 50% in bonds which will be 80% short term /safe (let’s say average duration 2 years), 20% EDV (duration 25 years). Weighted duration will be 25*.2 + 2*.8 = 6.6 years the same duration as any intermediate or total bond fund. So the answer is to add short term instruments until you get your target interest rate sensitivity.

[HEDGEFUNDIE]

Why do you want to shorten your duration? The only correct answer is you have grown old and your investing horizon has shortened below EDV's duration, and so holding an ultra-long bond fund no longer suits your needs. And if this were the case, you would have seen significant total return from the previous 20-30 years that you held EDV, very little chance of a loss over that long of a holding period.

If you want to shorten duration because you think interest rates are going up, that is pure market timing and not worthy of discussion on Bogleheads. How many people were convinced interest rates had nowhere to go but up for the next several years? And all of a sudden last week the Fed comes out and says we are "within spitting distance" of neutral rates. So much for market timing...

Good points. However, Im becoming convinced that the proper thing to do is to leverage the short end. And I completely understand why this is not appealing or feasible for most ppl. H

I don’t know what HedgeFundie is thinking. This is the actual answer. Say you have 10% in EDV. You want 50% bonds when you retire. When you are 10 years out you start converting 4% per year to ibonds, CD’s, short term TIPS, and the like. Keep EDV. After 10 years you will have 50% in bonds which will be 80% short term /safe (let’s say average duration 2 years), 20% EDV (duration 25 years). Weighted duration will be 25*.2 + 2*.8 = 6.6 years the same duration as any intermediate or total bond fund. So the answer is to add short term instruments until you get your target interest rate sensitivity.

How did what I say contradict anything you wrote here?

Absolutely when you get closer to retirement you should supplement/replace EDV with shorter term bond funds...

Only thing I would add, though, is that your investment horizon includes retirement. So hitting retirement age means you still have an investment horizon of 20-30 years...

[spdoublebass]

I’m not too proud....

I don’t understand the case where one would prefer STRIPS (or an ETF like EDV) over long treasuries.

Help on understanding that would be appreciated.

The duration of EDV is 24.3 yrs compared to VUSTX which is 16.6 yrs; duration is how long it takes for the bondholder to get repaid, zero coupon bonds make no regular interest payments and so it makes sense the duration should be longer.

This means EDV has much higher volatility and slightly higher returns than “ordinary” long treasuries (6.5% CAGR vs 4.9% CAGR over past 10 years).

When paired with TSM in a portfolio, EDV’s higher volatility actually produces a portfolio with higher Sharpe ratio due to its negative correlation with stocks.

What I still do not understand, even though many have explained it to me, is how you exit these funds.

I agree 100% with what you stated above. You stated facts.

My problem is if I'm 20 or 30 years old with a 90/10 AA, holding 10% in EDV. When I want to shorten my duration what do I do?

Why do you want to shorten your duration? The only correct answer is you have grown old and your investing horizon has shortened below EDV's duration, and so holding an ultra-long bond fund no longer suits your needs. And if this were the case, you would have seen significant total return from the previous 20-30 years that you held EDV, very little chance of a loss over that long of a holding period.

If you want to shorten duration because you think interest rates are going up, that is pure market timing and not worthy of discussion on Bogleheads. How many people were convinced interest rates had nowhere to go but up for the next several years? And all of a sudden last week the Fed comes out and says we are "within spitting distance" of neutral rates. So much for market timing...

You are assuming you will be rewarded by holding the bond fund to the duration. However, it's a fund, not a bond. You could very easily show a negative return 20 years from now holding EDV.

Holding for Twice the duration, yeah, I would think that would show a positive return. Which is what I read here on this forum often.

You are assuming I want to shorten duration because I'm market timing. I'm not, I just do not know what interest rates will do. EDV, I just do not understand how you exit the fund if you are going to adjust your AA as you age. I guess if you start with 10% then always hold that much adding other bond funds that makes sense.

[hdas]

How did what I say contradict anything you wrote here?

Absolutely when you get closer to retirement you should supplement/replace EDV with shorter term bond funds...

Only thing I would add, though, is that your investment horizon includes retirement. So hitting retirement age means you still have an investment horizon of 20-30 years...

I'm not the person you are asking the question, however, the big point you seem to be ignoring is the negative convexity of bonds, this is why you are better off leveraging the short end. The mechanics of this can be slightly more complex relative to buying and holding an etf, but I believe is the right thing to do. I've yet to hear a good reason against. H

[columbia]

How did what I say contradict anything you wrote here?

Absolutely when you get closer to retirement you should supplement/replace EDV with shorter term bond funds...

Only thing I would add, though, is that your investment horizon includes retirement. So hitting retirement age means you still have an investment horizon of 20-30 years...

I'm not the person you are asking the question, however, the big point you seem to be ignoring is the negative convexity of bonds, this is why you are better off leveraging the short end. The mechanics of this can be slightly more complex relative to buying and holding an etf, but I believe is the right thing to do. I've yet to hear a good reason against. H

Is that because there’s not a (reasonable) leveraged short bond fund?

[HEDGEFUNDIE]

How did what I say contradict anything you wrote here?

Absolutely when you get closer to retirement you should supplement/replace EDV with shorter term bond funds...

Only thing I would add, though, is that your investment horizon includes retirement. So hitting retirement age means you still have an investment horizon of 20-30 years...

I'm not the person you are asking the question, however, the big point you seem to be ignoring is the negative convexity of bonds, this is why you are better off leveraging the short end. The mechanics of this can be slightly more complex relative to buying and holding an etf, but I believe is the right thing to do. I've yet to hear a good reason against. H

I’m not ignoring it at all. The practical impact of negative convexity on a bond fund is higher price volatility. When you buy a long term bond fund you have already decided to take on high volatility. And also, if you buy long bonds because of their negative correlation to stocks, higher volatility is not necessarily a bad thing.

[hdas]

I’m not ignoring it at all. The practical impact of negative convexity on a bond fund is higher price volatility. When you buy a long term bond fund you have already decided to take on high volatility. And also, if you buy long bonds because of their negative correlation to stocks, higher volatility is not necessarily a bad thing.

I just started looking deep into this, so this could be subject to revision. Like you, I favor long term bonds (unlevered) over total or intermediate IF THOSE WERE MY ONLY OPTIONS. However, I hypothesize that by leveraging a shorter maturity, I would get all the goodies of negative correlation with stocks + higher returns by capitalizing on the low volatility anomaly. I'm open to hear any educated criticism to this strategy. H

[HEDGEFUNDIE]

I’m not ignoring it at all. The practical impact of negative convexity on a bond fund is higher price volatility. When you buy a long term bond fund you have already decided to take on high volatility. And also, if you buy long bonds because of their negative correlation to stocks, higher volatility is not necessarily a bad thing.

I just started looking deep into this, so this could be subject to revision. Like you, I favor long term bonds (unlevered) over total or intermediate IF THOSE WERE MY ONLY OPTIONS. However, I hypothesize that by leveraging a shorter maturity, I would get all the goodies of negative correlation with stocks + higher returns by capitalizing on the low volatility anomaly. I'm open to hear any educated criticism to this strategy. H

My guess is the cost of margin outweighs the leveraged returns, especially at the short end.

[hdas]

I’m not ignoring it at all. The practical impact of negative convexity on a bond fund is higher price volatility. When you buy a long term bond fund you have already decided to take on high volatility. And also, if you buy long bonds because of their negative correlation to stocks, higher volatility is not necessarily a bad thing.

I just started looking deep into this, so this could be subject to revision. Like you, I favor long term bonds (unlevered) over total or intermediate IF THOSE WERE MY ONLY OPTIONS. However, I hypothesize that by leveraging a shorter maturity, I would get all the goodies of negative correlation with stocks + higher returns by capitalizing on the low volatility anomaly. I'm open to hear any educated criticism to this strategy. H

My guess is the cost of margin outweighs the leveraged returns, especially at the short end.

Fair enough. You wont be hearing much from me about this topic If I find out your guess is not true. H