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Why investment grade bond fund/ETF fall so much?

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All:

I know many posters here are very knowledge about the market. Can someone explain to me why investment grade bond fund/ETF fall so much this past month?

e.g. LQD

thanks,

 

Ben

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Re: Why investment grade bond fund/ETF fall so much?

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Hi again Ben...let's try some more...see if you understand how a Fund NAV can decline, even with no change in interest rates.

Fund "Bondking" owns only one bond...with a coupon of 3%, 6 year maturity, high quality.  The bond was bought at face value, $1000, three years ago.

Due to declining rates, the bond is now selling at $1110 on the open market.  Bondking manager duly shows this mark-to-market, and the fund NAV is elevated, reflecting the $1110 value.  Dividend paid is constant at $30/year.  Bondking also duly lists in reports the "price to par" for his holdings at 111.00...meaning the underlying assets are 11% above par face value.

However, the bond is a contractual instrument, meaning the borrower will only pay back $1000 at maturity.  So, in the next three years, the bond open-market value will drop to $1000...(barring default).  Thus the fund NAV price will fall by 11% over three years as well...regardless of interest rates.

Now, you could say why shouldn't the fund manager sell the bond today, capturing the cap gain?  Sure...but he now loses the 3% annual coupon rate, and he/she must reinvest the proceeds into the low rate bonds current with today's rates.  Either NAV drops, or the dividend is lowered...you can't have both.

So when you look up a bond fund on Morningstar, you will see "price to par"...or "average weighted price".  Like BCOIX is well above 100, meaning it has a built in NAV loss if bonds are held to maturity.  

No escaping the math...but I am a senior citizen and maybe I'm wrong here!

R48

Edit to add:  BTW this is how most negative yield situations work.  You don't have a negative coupon (meaning the lender pays the borrower interest.)  Rather, the decline in price at maturity will be more, in percentage/dollars, than the bond's annual remaining coupon payments.  Thus a negative total return.

 

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Re: Why investment grade bond fund/ETF fall so much?

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LQD with duration=9 has been affected by rising rates.

If you want to own Corp bond, try VCIT instead with duration=6 and lower volatility.

Or why not mix and use 50/50 treasuries/Corp BIV.  If you have a vanguard account I would buy VBILX which is equal to BIV.  When markets are wild ETF can have higher volatility

See one month chart of all 4 funds.  You can change to YTD, 1-3 years and more

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Re: Why investment grade bond fund/ETF fall so much?

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VBILX is on my A list along with short-term bond funds. Vanguard is an excelent choice for low cost mutual funds.

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Re: Why investment grade bond fund/ETF fall so much?

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Ben1, not sure what your investment savvy is, but based upon your initial post -

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.

And then generally, looking at the yield curve for Treasuries –

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=y...

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Re: Why investment grade bond fund/ETF fall so much?

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@PN wrote:

Ben1, not sure what your investment savvy is, but based upon your initial post -

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.

And then generally, looking at the yield curve for Treasuries –

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=y...


That rule isn't accurate and why I never mention it because bond funds have different categories and duration, if rates change slowly and/or fluctuate the fund will adjust and the change is not one-sided.  

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Re: Why investment grade bond fund/ETF fall so much?

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Thanks FD, FatCat, PN.

 

It seems to me bond funds are falling because equity is so hot.

Ben

 

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Re: Why investment grade bond fund/ETF fall so much?

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@ben1 wrote:

Thanks FD, FatCat, PN.

 

It seems to me bond funds are falling because equity is so hot.

Ben

 


Hi Ben...equity being hot or not has nothing to do with bond funds falling.

Rising interest rates does...regardless of cause.

But your perception of larger magnitude changes in NAV prices is correct.  This is because of a mathematical aspect of bonds called CONVEXITY.  You see, as interest rates approach small or zero, the impact on bond prices (NAV) for small changes (up or down) in interest rates is magnified.  Study this article and charts on convexity here:

https://portfoliocharts.com/2019/05/27/high-profits-at-low-rates-the-benefits-of-bond-convexity/

IOW a one percent rise in rates from here, means a very large decline in bond prices...especially for Treasuries at 0.6% yield on the ten year bond.

Meaningful duration bonds are risky at these rate levels.

Good day.

R48

 

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Re: Why investment grade bond fund/ETF fall so much?

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@SlipSliding wrote:

PN said:


@PN wrote:

Ben1, not sure what your investment savvy is, but based upon your initial post -

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.

And then generally, looking at the yield curve for Treasuries –

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=y...


Decent rule for generic plain vanilla gov’t/corp bond funds.  Not so much for the more exotic funds, like high yield, multi-sector, non traditional, bank loan, etc. 

At this point, my bond funds are strictly short duration generic.  Any high yield and longer duration I hold are being managed by the pros in allocation funds.  Not a strategy for everyone, but works for me.

"The good thing about science is that it’s true whether or not you believe in it." Neil DeGrasse Tyson


Easy to prove the rule DOES NOT work.

From 1/1/2020 to 3/9  the 10 years treasury went down from 1.88 to 0.5 = 1.38 fall.

LQD duration=9.56 (link)

LQD should be up 9.56 * 1.38 = 13.2%

How much LQD was up? only 4.4%

oops, the rule was off by over 65% what happened to your "science"?

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Re: Why investment grade bond fund/ETF fall so much?

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credit quality is always a factor; sometimes when interest rstes fall, lower rated bonds suffer. Best to stay with higher quality bond funds to perserve and increase fund value. 

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Re: Why investment grade bond fund/ETF fall so much?

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@SlipSliding wrote:

@FD1001 wrote:

@SlipSliding wrote:

PN said:


@PN wrote:

Ben1, not sure what your investment savvy is, but based upon your initial post -

As a general rule, for every 1% change in interest rates (increase or decrease), a bond’s price will change approximately 1% in the opposite direction, for every year of duration.

And then generally, looking at the yield curve for Treasuries –

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=y...


Decent rule for generic plain vanilla gov’t/corp bond funds.  Not so much for the more exotic funds, like high yield, multi-sector, non traditional, bank loan, etc. 

At this point, my bond funds are strictly short duration generic.  Any high yield and longer duration I hold are being managed by the pros in allocation funds.  Not a strategy for everyone, but works for me.

"The good thing about science is that it’s true whether or not you believe in it." Neil DeGrasse Tyson


Easy to prove the rule DOES NOT work.

From 1/1/2020 to 3/9  the 10 years treasury went down from 1.88 to 0.5 = 1.38 fall.

LQD duration=9.56 (link)

LQD should be up 9.56 * 1.38 = 13.2%

How much LQD was up? only 4.4%

oops, the rule was off by over 65% what happened to your "science"?


The word I used was "decent", not exact.

LQD is neither a mutual fund, nor is it generic plain vanilla gov’t/corp bond fund.  It's strictly corporate bonds, and fairly lousy corporate bonds at that - hardly a AAA rated bond in the portfolio: almost 90% are A and BBB.

When I use the term "generic plain vanilla gov’t/corp bond fund," I'm talking about VBMFX and ABNDX in the IT category; VBIRX and AIBAX in the ST category.

Do you honestly equate fund investing with hard science of the kind Tyson is referring to?  That's most amusing to me.


Let's use one of your funds and recommended by many.  VBMFX-Us Tot bond fund index

From 1/1/2020 to 3/9  the 10 years treasury went down from 1.88 to 0.5 = 1.38 fall.

VBMFX duration=6.6 (link)

VBMFX  should be up 6.6 * 1.38 = 9.1%

How much VBMFX was up? only 5.3%

oops, the rule was off by over 40% what happened to your "science"? What happened to a decent rule?

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Re: Why investment grade bond fund/ETF fall so much?

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No problem, let's use VBMFX with 5 year rates.

From 1/1/2020 to 3/9  the 5 years treasury (link) went down from 1.67 to 0.29 = 1.38 fall.

VBMFX duration=6.6 (link)

VBMFX  should be up 6.6 * 1.38 = 9.1%

How much VBMFX was up? only 5.3%

oops, the rule was off by over 40% what happened to your "science"? What happened to a decent rule?

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Re: Why investment grade bond fund/ETF fall so much?

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Re: Why investment grade bond fund/ETF fall so much?

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Another explanation is the Fed have the power to change the rules and they did.

 

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Re: Why investment grade bond fund/ETF fall so much?

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@FD1001 wrote:

Another explanation is the Fed have the power to change the rules and they did.

 


Umm ... no.

Highly suggest circling back to what R48 wrote about bond convexity to better understand why "rules of thumb" get increasing less rule-like as bond rates approach smaller yields. It doesn't make the broad-based "rule" worthless, but it makes it less accurate.

https://www.investopedia.com/articles/bonds/08/duration-convexity.asp

There are formulations to correct the "rule of thumb" for convexity but they would require effort and a bit of education to understand and it's much easier to just sling mud .....

https://financetrain.com/sensitivity-analysis-duration-and-convexity/

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@SlipSliding wrote:

@FD1001 wrote:

No problem, let's use VBMFX with 5 year rates.

From 1/1/2020 to 3/9  the 5 years treasury (link) went down from 1.67 to 0.29 = 1.38 fall.

VBMFX duration=6.6 (link)

VBMFX  should be up 6.6 * 1.38 = 9.1%

How much VBMFX was up? only 5.3%

oops, the rule was off by over 40% what happened to your "science"? What happened to a decent rule?


Well, you got me there.  Congratulations!  I officially declare you the winner of this pi$$ing contest.  Well done.  Nice job.  Way to go. 

But seriously, it's still not science.  Rule of thumb, ballpark approximation, general hypothesis, broad guideline, rough-order-of-magnitude estimate - yes.  But it is science in no one's mind but yours.


So now after I proved you wrong you get upset?  LOL

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FD, now don't you get upset, but as has kind of been stated already, your "proof" is of course worthless.

VBMFX is a Total Bond fund with only about 40%-45% gov't bonds and the rest corporate and securitized. 

Next thing you know you'll be trying to "prove" that SEMMX is a great "cash substitute." 

Oh wait...

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Re: Why investment grade bond fund/ETF fall so much?

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@VA-Tech wrote:

@FD1001 wrote:

Another explanation is the Fed have the power to change the rules and they did.

 


Umm ... no.

Highly suggest circling back to what R48 wrote about bond convexity to better understand why "rules of thumb" get increasing less rule-like as bond rates approach smaller yields. It doesn't make the broad-based "rule" worthless, but it makes it less accurate.

https://www.investopedia.com/articles/bonds/08/duration-convexity.asp

There are formulations to correct the "rule of thumb" for convexity but they would require effort and a bit of education to understand and it's much easier to just sling mud .....

https://financetrain.com/sensitivity-analysis-duration-and-convexity/


Even with higher rates it's not accurate. As I said before it depends on the speed and others facts too.

Example one:

From 6/4/2007 to 10/15/2008  The 5 year rate fell from 5% to 1.35 that's a huge one at 3.65.

VBMFX with 6.6 duration should be up at 6.6 * 3.65 = 24.1

Do you know how much it was up? just 9.6% far, far away.

Example two:

From 3/1989 to 10/1993  The 5 year rate fell from 9.5% to 4.8 that's a huge one at 4.7.  

VBMFX with 6.6 duration should be up at 6.6 * 4.7 = 31

Do you know how much it was up? more than double but up 67% and far, far away.

No convexity here after all these are high rates.

=============

Another proof why you should never use this rule and I will keep a copy of this for years to come

My work is done.  

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Re: Why investment grade bond fund/ETF fall so much?

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"Can someone explain to me why investment grade bond fund/ETF fall so much this past month? e.g. LQD"

I'm not sure convexity will explain this. Duration might as it measures small moves. LQD has longer duration than similar funds so will be more interest rate sensitive, but we're in a sustained low interest rate environment. You could check Morningstar's analyst report for clues and credit ratings for downgrades. I don't think the move is significant, but you might want to keep an eye on it as there is a divergence. Ordinarily, you might expect this but we are not in a normal market. The bond market is behaving strangely, and many investors have completely forsaken it. So, expect unexplainable events.

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Are we talking about Vanguard Total Bond fund?

I thought VBMFX was officially retried? Isn't it only VBTLX now, or am I mixed up?

 

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Re: Why investment grade bond fund/ETF fall so much?

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Hi again Ben...let's try some more...see if you understand how a Fund NAV can decline, even with no change in interest rates.

Fund "Bondking" owns only one bond...with a coupon of 3%, 6 year maturity, high quality.  The bond was bought at face value, $1000, three years ago.

Due to declining rates, the bond is now selling at $1110 on the open market.  Bondking manager duly shows this mark-to-market, and the fund NAV is elevated, reflecting the $1110 value.  Dividend paid is constant at $30/year.  Bondking also duly lists in reports the "price to par" for his holdings at 111.00...meaning the underlying assets are 11% above par face value.

However, the bond is a contractual instrument, meaning the borrower will only pay back $1000 at maturity.  So, in the next three years, the bond open-market value will drop to $1000...(barring default).  Thus the fund NAV price will fall by 11% over three years as well...regardless of interest rates.

Now, you could say why shouldn't the fund manager sell the bond today, capturing the cap gain?  Sure...but he now loses the 3% annual coupon rate, and he/she must reinvest the proceeds into the low rate bonds current with today's rates.  Either NAV drops, or the dividend is lowered...you can't have both.

So when you look up a bond fund on Morningstar, you will see "price to par"...or "average weighted price".  Like BCOIX is well above 100, meaning it has a built in NAV loss if bonds are held to maturity.  

No escaping the math...but I am a senior citizen and maybe I'm wrong here!

R48

Edit to add:  BTW this is how most negative yield situations work.  You don't have a negative coupon (meaning the lender pays the borrower interest.)  Rather, the decline in price at maturity will be more, in percentage/dollars, than the bond's annual remaining coupon payments.  Thus a negative total return.

 

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