Gyroscopic Investing

AgAuMoney wrote: 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.

clacy wrote: 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.

rickb wrote:

AgAuMoney wrote: 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.

AgAuMoney wrote:

rickb wrote:

AgAuMoney wrote: 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 wrote: 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 wrote: 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

clacy wrote: 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.

sophie wrote:

foglifter wrote: 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

clacy wrote: 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.

rickb wrote: 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

MangoMan wrote: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.

AgAuMoney wrote:

MangoMan wrote: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 wrote:
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).

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.

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.