Total return funds

[foglifter]

Has anybody here used one of those "total return" funds as a short-term saving vehicle? I looked at a few of them, including a couple of funds from PIMCO, with the goal to see if there are any paying good dividends with low volatility. After removing the jumpier ones my list ended up having 3 names: 

TGMNX - TCW Total Return Bond N
DLTNX - DoubleLine Total Return Bond N
MWTRX - Metropolitan West Total Return Bond M
 
All three are loaded with MBS, but mostly government-backed securities. The first two are quite similar: you probably heard the story about Jeffrey Gundlach leaving TCW along with 40 people to start his own shop DoubleLine Capital. DLTNX is interesting as it somehow managed to maintain a pretty low average duration (currently 1.59 years) and yield over 6%. MWTRX is a bit different as it also buys corporate bonds. What drew my attention was how the funds navigated the last crisis - here's a chart that shows all 3 funds and PRPFX:



While PRPFX beats them all in annualized return over 10 and 15 years, the funds are less volatile and I don't see why they could not be used for short-term saving goals. PRPFX is too volatile short-term and could be flat or even drop within one year so it may not be a good choice if the goal is to get a decent return over a period of just a few years.

Any thoughts?

[clacy]

I use BOND, which is the etf version of PTTRX, Pimco's Total Return fund as part of my cash.  I keep half in SHY and half in BOND.  When PTTRX is trading below the 10 month MA, I will switch to SHY for 100%.

This fund has such low volatility and still puts up a pretty significant return, so it makes better sense to allocate some of my "cash portion" to this fund rather than being eaten away by inflation for the once in 2-3 decades, in which we'll have a tight money recession.

[D1984]

Clacy has a pretty good idea (half in a cash equivalent and half in a total return fund). Most of the "total return funds" that have histories going back enough had down years when rates rose (in 1994 and 1999) and indeed would be expected to have down years any time rates rose enough (most of these funds hold bonds whose duration/maturity make said funds intermediate-term bond funds). The intermediate-term bond fund with the longest history I could find was FKUSX (an intermediate-term GNMA and treasury fund with return data going back to 1971). Had you held half in short-term treasuries (or sixty or ninety day CDs) and half in this fund, you would never have had a negative (nominal) year from 1971 to the present (1980 would have been the worst with a near zero return as this fund lost over 12% in the Volcker rate hikes but your STTs counteracted that since they were yielding 12-13%; 1994 would have been close too but if you held true STTs instead of 1-3 year you'd still have had a slight total positive return that year).

[AgAuMoney]

Just watch the duration of the bonds in the fund(s) you select.  Your duration doesn't matter as much as the duration of the bonds in the fund, but obviously if you don't hold it long the chances of getting hit are commensurately reduced.

The longer the term of a bond, the worse they'll be hit by rising interest rates.  This only affects you if you sell, or if you hold a bond fund.  (Selling a bond which yields less than what a current issue bond would yield requires a discount causing a loss of capital.)  Continuing to hold a sub-par bond, as long as the issuing entity does not default, poses no risk to capital, but the income may be outpaced by inflation.

With a bond fund, unlike individual bonds, somebody in the fund will want their money and the fund will be forced to sell or perhaps the fund will sell simply to realign with their strategy.  In either case, the bond fund loses as does anybody holding the fund.

[rickb]

Just watch the duration of the bonds in the fund(s) you select.  Your duration doesn't matter as much as the duration of the bonds in the fund, but obviously if you don't hold it long the chances of getting hit are commensurately reduced.

The longer the term of a bond, the worse they'll be hit by rising interest rates.  This only affects you if you sell, or if you hold a bond fund.  (Selling a bond which yields less than what a current issue bond would yield requires a discount causing a loss of capital.)  Continuing to hold a sub-par bond, as long as the issuing entity does not default, poses no risk to capital, but the income may be outpaced by inflation.

With a bond fund, unlike individual bonds, somebody in the fund will want their money and the fund will be forced to sell or perhaps the fund will sell simply to realign with their strategy.  In either case, the bond fund loses as does anybody holding the fund.

Holding shares in a bond fund that maintains a constant duration is really no different than holding individual bonds with that duration, which for individual bonds mean you'd have to sell and rebuy new bonds at that duration at least annually (just like a fund).  You can hold your individual bonds for N years (making the duration progressively shorter) or you can sell your fund and buy an equivalent amount of individual bonds (which then progressively shorten).  The notion that holding individual bonds is "safer" than a fund is essentially nonsense.  If interest rates rise X% the knock on your net worth is the same whether you're holding N year bonds or a fund.  In either case you can "get your principal back" in the same amount of time.

[dualstow]

This fund has such low volatility and still puts up a pretty significant return, so it makes better sense to allocate some of my "cash portion" to this fund rather than being eaten away by inflation for the once in 2-3 decades, in which we'll have a tight money recession.

I think this has been beaten to death, but in case someone new is reading here: it's not just about tight money recessions, right? When Harry Browne designed the portfolio, he might have thought such a case was rare, too. I hate inflation, but I like having cash at the ready in case, say, gold drops $37 in a single day, right after stocks and bonds have also been beaten down.

[AgAuMoney]

With a bond fund, unlike individual bonds, somebody in the fund will want their money and the fund will be forced to sell or perhaps the fund will sell simply to realign with their strategy.  In either case, the bond fund loses as does anybody holding the fund.

Holding shares in a bond fund that maintains a constant duration is really no different than holding individual bonds with that duration, which for individual bonds mean you'd have to sell and rebuy new bonds at that duration at least annually (just like a fund).  You can hold your individual bonds for N years (making the duration progressively shorter) or you can sell your fund and buy an equivalent amount of individual bonds (which then progressively shorten).  The notion that holding individual bonds is "safer" than a fund is essentially nonsense.  If interest rates rise X% the knock on your net worth is the same whether you're holding N year bonds or a fund.  In either case you can "get your principal back" in the same amount of time.

That's a nice theory, but your theory is nonsense in the real world.  You will not get your principal back if you hold a bond fund.  It happens over and over again, you would be foolish to not expect it to happen next time rates rise.  Just look at the behavior of TLT when rates rose 1/4 point this year.

If you hold individual bonds the choice is yours -- realize the loss of capital by selling at a discount, or continue to hold and receive your full capital at maturity.  Holding a bond fund you have no choice, there is no maturity that will return your capital.

[rickb]

With a bond fund, unlike individual bonds, somebody in the fund will want their money and the fund will be forced to sell or perhaps the fund will sell simply to realign with their strategy.  In either case, the bond fund loses as does anybody holding the fund.

Holding shares in a bond fund that maintains a constant duration is really no different than holding individual bonds with that duration, which for individual bonds mean you'd have to sell and rebuy new bonds at that duration at least annually (just like a fund).  You can hold your individual bonds for N years (making the duration progressively shorter) or you can sell your fund and buy an equivalent amount of individual bonds (which then progressively shorten).  The notion that holding individual bonds is "safer" than a fund is essentially nonsense.  If interest rates rise X% the knock on your net worth is the same whether you're holding N year bonds or a fund.  In either case you can "get your principal back" in the same amount of time.

That's a nice theory, but your theory is nonsense in the real world.  You will not get your principal back if you hold a bond fund.  It happens over and over again, you would be foolish to not expect it to happen next time rates rise.  Just look at the behavior of TLT when rates rose 1/4 point this year.

If you hold individual bonds the choice is yours -- realize the loss of capital by selling at a discount, or continue to hold and receive your full capital at maturity.  Holding a bond fund you have no choice, there is no maturity that will return your capital.

This has been discussed to death at bogleheads.  See http://www.bogleheads.org/wiki/Individu ... _Bond_Fund

The bottom line is that if interest rates go up, the net effect on a bond fund is the same as on a collection of individual bonds with the same duration.  In either case your net worth decreases by the same amount (logically this must be true or there would be an arbitrage opportunity between bond funds and individual bonds).  Whether you realize the loss or not, you've lost the same amount of money.  If you sell the fund (realizing the loss) you can buy individual bonds that will ultimately give you the same amount of money as if you had held individual bonds (incurring a future capital gain offset by the realized capital loss).  A bond fund with a constant duration (as opposed to a bond fund where the manager is allowed to adjust the duration depending on his/her crystal ball about future interest rates) is for all intents and purposes identical to a group of bonds with the same duration (for example, a perpetually rolling ladder).

[foglifter]

rickb, thanks for posting the BH Wiki link. Bogleheads did a great job putting this together.

[melveyr]

The bottom line is that if interest rates go up, the net effect on a bond fund is the same as on a collection of individual bonds with the same duration.   In either case your net worth decreases by the same amount (logically this must be true or there would be an arbitrage opportunity between bond funds and individual bonds).  Whether you realize the loss or not, you've lost the same amount of money.  If you sell the fund (realizing the loss) you can buy individual bonds that will ultimately give you the same amount of money as if you had held individual bonds (incurring a future capital gain offset by the realized capital loss).  A bond fund with a constant duration (as opposed to a bond fund where the manager is allowed to adjust the duration depending on his/her crystal ball about future interest rates) is for all intents and purposes identical to a group of bonds with the same duration (for example, a perpetually rolling ladder).

Good stuff. Now if we can only convince everyone that dividend payments come directly out of the share price 

[sophie]

Has anybody here used one of those "total return" funds as a short-term saving vehicle? I looked at a few of them, including a couple of funds from PIMCO, with the goal to see if there are any paying good dividends with low volatility. After removing the jumpier ones my list ended up having 3 names: 

TGMNX - TCW Total Return Bond N
DLTNX - DoubleLine Total Return Bond N
MWTRX - Metropolitan West Total Return Bond M

I use BOND, which is the etf version of PTTRX, Pimco's Total Return fund as part of my cash.  I keep half in SHY and half in BOND.  When PTTRX is trading below the 10 month MA, I will switch to SHY for 100%.

This fund has such low volatility and still puts up a pretty significant return, so it makes better sense to allocate some of my "cash portion" to this fund rather than being eaten away by inflation for the once in 2-3 decades, in which we'll have a tight money recession.

I've thought about this as well.  Negative real interest rates are going to be with us for at least a few years, and the Fed is most unlikely to create a tight money recession anytime soon.

The first two funds on the list look a bit risky with the concentration on mortgage backed securities, credit default swaps, and junk bonds (thus the higher yields), but MWTRX looks reasonable.  I have a similar fund, BCOSX, in my VP.  Its share price does not fluctuate much, and it behaves far more like cash than it does like, say, TLT.  The dividends return around 3% with compounding, so it is doing the job of staying ahead of inflation.

[foglifter]

Has anybody here used one of those "total return" funds as a short-term saving vehicle? I looked at a few of them, including a couple of funds from PIMCO, with the goal to see if there are any paying good dividends with low volatility. After removing the jumpier ones my list ended up having 3 names:  

TGMNX - TCW Total Return Bond N
DLTNX - DoubleLine Total Return Bond N
MWTRX - Metropolitan West Total Return Bond M

I use BOND, which is the etf version of PTTRX, Pimco's Total Return fund as part of my cash.  I keep half in SHY and half in BOND.  When PTTRX is trading below the 10 month MA, I will switch to SHY for 100%.

This fund has such low volatility and still puts up a pretty significant return, so it makes better sense to allocate some of my "cash portion" to this fund rather than being eaten away by inflation for the once in 2-3 decades, in which we'll have a tight money recession.

I've thought about this as well.  Negative real interest rates are going to be with us for at least a few years, and the Fed is most unlikely to create a tight money recession anytime soon.

The first two funds on the list look a bit risky with the concentration on mortgage backed securities, credit default swaps, and junk bonds (thus the higher yields), but MWTRX looks reasonable.  I have a similar fund, BCOSX, in my VP.  Its share price does not fluctuate much, and it behaves far more like cash than it does like, say, TLT.  The dividends return around 3% with compounding, so it is doing the job of staying ahead of inflation.

BCOSX looks like a good option, although its 45% allocation to corporate bonds is kind of high. Both MWTRX and BCOSX had a slight drop in 2008, but the latter fell more. TGMNX and PTTDX survived 2008 quite well:

       2007       2008     2009      2010        2011          YTD
BCOSX      5.79      -2.07    15.06  9.53 7.57          7.37
MWTRX     6.27   -1.47 17.08 11.53 5.19        10.39
TGMNX     6.18    0.90 19.50 10.34 3.88        11.89
PTTDX      8.73    4.48 13.50  8.52 3.86          9.23

Of all these funds PTTDX in my opinion is better diversified: it holds some foreign government bonds - both developed and emerging countries. I think emerging market government bonds are perceived riskier than they are. A small allocation to these does help the returns. Look at Fidelity's FNMIX - it deviates from the benchmark by heavily tilting to government bonds and underweighing corporates. Besides the 2008 drop its long-term performance is remarkable.

Due to its size and high turnover PIMCO Total should have difficulties with moving in and out of positions. I don't know how they avoid the market-moving effect, but so far the fund operates smoothly. Perhaps they somehow scatter the trade orders over different channels and over time.

Another good fund from PIMCO is PONDX, however it's more volatile than Total Return fund due to higher corporate bonds and non-agency MBS allocation.

Thank you folks for your input and please continue to share your thoughts.

[AgAuMoney]

The bottom line is that if interest rates go up, the net effect on a bond fund is the same as on a collection of individual bonds with the same duration.   In either case your net worth decreases by the same amount

That is a nice theory, but are wrong because that theory does not apply because people have a choice how they react to an interest rate increase, but only if they hold individual bonds.

With a bond fund you will realize the loss of principal.  There is no choice.

Holding individual bonds you can choose to realize the loss, but you are not forced to do so.  A bond has a maturity at which point you will receive your principal.

A bond fund has no maturity.  The market value varies and if interest rates rise you will lose principal.

[AgAuMoney]

doesn't the lost opportunity of investing in higher rate bonds as interest rates increase basically offset the equivalent loss in a bond fund? You may not lose principal if you don't sell, but you will be collecting a lower coupon than if you sold and reinvested at the higher rate. Isn't that what duration is all about? Please clarify if I am wrong.

No, if I understand what you're saying, you are correct.  But note that if you have an individual bond, which you sell in order to buy a higher coupon bond of the same type/rating, you will lose.  The bond market is liquid enough that the bond you sell would be discounted to provide the same return to the new owner as the bond you would buy, and discounted a little bit more to provide profit in the transaction (bid/ask spread).  Unless you need cash or are trying to change your investment in some way other than simple yield increase, it is better to sit tight.

The point is with an individual bond you get to weigh the merits and make a decision.

With a bond fund you have the manager making decisions (either discretionary or being forced by the focus of the fund) and you have a whole bunch of other investors forcing the fund manager to buy or sell.  What happens is that investors want out of the fund, so the fund manager has to sell bonds to raise cash.  Or the investors want into the fund so the manager has to buy bonds.  Investor psychology being what it is, it seems these events happen opposite when they should happen for best investment results.  Either way, the effect is that in a rising rate environment, bond funds have a strong bias to losing more money than individual bonds.  And since rates are never 100% steady but tend to oscillate around their current trend line, a bond fund tends to lose a bit of capital frequently when rates bump up, and not gain it all back when rates drop.  An investor holding individual bonds would never notice or suffer any effect from that minor oscillation.

Why own a bond fund then?  It is a lot easier.  Also a diversified fund has lower risk of default by any one issuer causing significant harm, so unless you can spread your bond dollars among 20+ issuers, be cautious of the default risk in buying individual bonds.  (Obviously for individual U.S. treasuries and U.S. treasury funds, there is change in default risk because those funds are not diversified.)

Edit:  that last line should read "...is NO change in default risk...".  And earlier in addition to the line regarding bid/ask spread, also consider the commissions you pay to sell one bond and buy another.

[rickb]

doesn't the lost opportunity of investing in higher rate bonds as interest rates increase basically offset the equivalent loss in a bond fund? You may not lose principal if you don't sell, but you will be collecting a lower coupon than if you sold and reinvested at the higher rate. Isn't that what duration is all about? Please clarify if I am wrong.

No, if I understand what you're saying, you are correct.  But note that if you have an individual bond, which you sell in order to buy a higher coupon bond of the same type/rating, you will lose.  The bond market is liquid enough that the bond you sell would be discounted to provide the same return to the new owner as the bond you would buy, and discounted a little bit more to provide profit in the transaction (bid/ask spread).  Unless you need cash or are trying to change your investment in some way other than simple yield increase, it is better to sit tight.

The point is with an individual bond you get to weigh the merits and make a decision.

With a bond fund you have the manager making decisions (either discretionary or being forced by the focus of the fund) and you have a whole bunch of other investors forcing the fund manager to buy or sell.  What happens is that investors want out of the fund, so the fund manager has to sell bonds to raise cash.  Or the investors want into the fund so the manager has to buy bonds.  Investor psychology being what it is, it seems these events happen opposite when they should happen for best investment results.  Either way, the effect is that in a rising rate environment, bond funds have a strong bias to losing more money than individual bonds.  And since rates are never 100% steady but tend to oscillate around their current trend line, a bond fund tends to lose a bit of capital frequently when rates bump up, and not gain it all back when rates drop.  An investor holding individual bonds would never notice or suffer any effect from that minor oscillation.

Why own a bond fund then?  It is a lot easier.  Also a diversified fund has lower risk of default by any one issuer causing significant harm, so unless you can spread your bond dollars among 20+ issuers, be cautious of the default risk in buying individual bonds.  (Obviously for individual U.S. treasuries and U.S. treasury funds, there is change in default risk because those funds are not diversified.)

Edit:  that last line should read "...is NO change in default risk...".  And earlier in addition to the line regarding bid/ask spread, also consider the commissions you pay to sell one bond and buy another.

The problem here is you're reinforcing the myth (ala Suze Orman) that bond funds are somehow "riskier" than an equivalent collection of bonds.  Since a bond fund is (literally) a collection of individual bonds, you're intrinsically no worse off following an interest rate increase holding the fund or holding an equivalent collection of bonds.  Either way, the knock on your net worth is the same (i.e the market value drops the same amount in either case).  You can trade shares in a bond fund for an equivalent amount of aftermarket bonds (in either direction, minus trading costs) any time you'd like, since the NAV of the fund is equal to the market value of the bonds.  There are trading costs and tax treatment differences - but if you first buy a fund and later switch to individual bonds (which is the scenario we're talking about) my guess is you paid very little to buy the fund, you'll pay the same transaction cost you would have originally paid (but later) if you sell the fund and buy individual bonds, and you'll realize a capital loss on the fund offsetting a later capital gain on the bonds.

The notion that you're better off holding individual bonds rather than a fund, because by buying individual bonds you can "recover" their principal value by holding them to maturity, is (I repeat) nonsense.  If the market value of a fund and an equivalent collection of bonds starts at X and interest rates increase, the market value of both drop to the same Y.  From this market value of Y if you want to assuredly achieve some later market value of Z+D (the maturity value of the bonds plus dividends paid by the bonds) you need to sell the fund and buy individual bonds (the bogleheads wiki suggests zeroes), but this is independent of the drop in market value you've experienced whether you hold the fund or the bonds.  What you had was worth X.  It's now worth Y.  How do you want what now has a market value of Y to act going forward?  If you want it to act like bonds rather than a fund (or a perpetually rolling ladder of bonds), sell the fund and buy bonds. 

[AgAuMoney]

The problem here is you're reinforcing the myth (ala Suze Orman) that bond funds are somehow "riskier" than an equivalent collection of bonds.  Since a bond fund is (literally) a collection of individual bonds, you're intrinsically no worse off following an interest rate increase holding the fund or holding an equivalent collection of bonds.  Either way, the knock on your net worth is the same (i.e the market value drops the same amount in either case).

It's not a problem when it's not a myth.  And as much as I hate to agree with Suze, if that is what she says, she is correct.

When holding individual bonds they mature and you will receive your entire capital.  When holding a bond fund, you there is no maturity and you can lose capital.  That's really all there is to it.

If you measure risk by loss of capital, a treasury bond fund is then by definition more risky than individual treasury bonds.  In general once you correct for risk of default, any bond fund poses more risk to capital than do the individual equivalent bonds.

The notion that you're better off holding individual bonds rather than a fund, because by buying individual bonds you can "recover" their principal value by holding them to maturity, is (I repeat) nonsense.  If the market value of a fund and an equivalent collection of bonds starts at X and interest rates increase, the market value of both drop to the same Y.

True.  But your bond does not need to be priced to market unless you sell.  The fund is priced to market, the capital is gone, and there is no guarantee it will ever recover.  A bond is guaranteed by the issuer (and perhaps by a reinsurer).

If you want it to act like bonds rather than a fund (or a perpetually rolling ladder of bonds), sell the fund and buy bonds.

Yup.  Because with individual bonds, you do have a contractual right to the return of your capital.  Period.