Catch 22 with Bond Funds

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tylerrr
Posts: 679
Joined: Tue Dec 13, 2011 3:32 am
Location: Boston

Catch 22 with Bond Funds

Post by tylerrr »

I'm looking for some thoughts on this....

We all know that owning TLT or EDV right now is probably a losing proposition with interest rates going up and the price of EDV/TLT going down in the future years.

So a lot of people say it's stupid to buy into long term bonds right now...And they don't feel comfortable holding Long Term Bonds in a 4 part Permanent Portfolio.

But aren't these same people forgetting the Yield will be going UP as the prices fall so that offsets a lot of your losses on these bond funds and provides an income stream into your Cash position.

When I consider the possibility of rising rates, I'm a lot more comfortable holding and occasionally buying into something like EDV/TLT.

Am I wrong?

Thanks

Dragline
Posts: 4436
Joined: Wed Aug 24, 2011 1:50 am

Re: Catch 22 with Bond Funds

Post by Dragline »

Yes, these funds tend to hold a "laddered" series of bonds and replace them over time, rolling over old issuances with new issuances. So TLT, for example, holds about 35 different treasury bonds with interest rates from 2.5% - 5% right now.

See page 26 at https://www.ishares.com/us/library/stre ... -02-28.pdf

So although the "face value" of the notes and the funds will vary widely and in inverse correlation to the stock market, the cash payment stream is going to be extremely steady over time and will tend to increase slowly in a rising interest rate environment.

Kriegsspiel
Posts: 952
Joined: Fri Aug 03, 2012 9:05 pm

Re: Catch 22 with Bond Funds

Post by Kriegsspiel »

This link has a good explanation. The durations of TLT and EDV are pretty high so it would take a long time for the increased coupons to make up for the hit, but the hope is that another part of the PP is carrying the weight. However, rates could just bounce around low levels for a while. With their high durations, rates would only need to bounce around a couple % for your PP to hit rebalancing bands.

BlueNote
Posts: 501
Joined: Sat Jun 08, 2013 6:26 pm
Location: Toronto, Canada

Re: Catch 22 with Bond Funds

Post by BlueNote »

I agree with you. The bond market is reasonably efficient and has interest rate increase probabilities baked into prices. Therefore there's no good reason to try to time the bond market. LTB's do well in a deflationary economic environment and I can't think of any good substitute that could carry the weight of the rest of the PP during a recessionary period.

The PP will probably always have at least one component that is uncomfortable to hold. Stocks would probably feel like anchors in the PP during a big recession.

George the original one
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Joined: Wed Jul 28, 2010 3:28 am
Location: Wettest corner of Orygun

Re: Catch 22 with Bond Funds

Post by George the original one »

Don't forget there are short term bond funds. Take a look at PGX as an example.

Lucky C
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Joined: Sat Apr 16, 2016 6:09 am

Re: Catch 22 with Bond Funds

Post by Lucky C »

I don't see it as a Catch-22. It's not like if prices go down but yields go up you start making more money from the same initial investment. You earn the same income except now you could have bought the bonds at a cheaper price, so you bought in too early. You could have been getting a higher yield with the same initial investment. And if you want to sell, now you have to sell at a loss. No matter how you slice it, you would have been better off holding cash or an asset that appreciated over the same time period.

That's not to say you should wait to buy just because you expect prices to go down. What's important is if the yield will meet your investment objectives. I'm not holding or buying any LT US govt bonds because I don't want such a low yield for such a long time, and I certainly am not going to speculate that prices will go up so I could sell at a profit. For other people, bonds may make perfect sense even with today's low yields, either to reduce portfolio volatility, or because they think rates will stay low, or because the bonds are part of a momentum or trend-following strategy.

If you expect yields to rise by a certain % over a certain amount of time, you can calculate what the effect would be on your bond holdings depending on when you buy in. Then you could see how different scenarios would play out, depending on how much rates change or when you buy. It would be a good exercise to try out in Excel.

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