Bond funds - pointless?

Porcupine

Ark_Welder wrote: »

But a bond fund is different because it does not have a maturity date and the bonds that it hold over time will vary - and so will the coupons that they pay. So with fund the total return cannot be determnied at the time of purchase - it can merely be wished for! But in that, it is no different to holding equities - either directly of via funds - because the returns on these cannot be determined at the time of purchase either (structured products, anyone...? ). However, the general direction of a fund's returns might be guessed at on an ongoing basis, which might be determined by economic expectations.

But it's not quite the same as equities? An equity can generate both income and capital growth. There is no 'benchmark' for an equity - it can be worth 10x tomorrow what it is today (through sustainable capital growth, not merely market fluctuations). But a bond is always trending towards its maturity value: everyone knows exactly what it will be priced at at redemption. It only generates income. So the room to make up losses if you happen to time it wrong is reduced because there's only one revenue stream and, once you've bought, the revenue stream is fixed. It doesn't matter if the yield happens to go up to 20% if you bought at 5%. But if that happens you can only make back the loss in capital value from the income at 5%, and you may not be in it long enough to wait for the capital value to come back up towards the redemption value (some of these can be 30 year or longer bonds). It seems to me as if the price fluctuations are actually hidden gearing.

And then buying these in a bond fund means you don't even know the actual numbers for what you're investing in.

(Completely neglecting defaults here, another kettle of worms)

Porcupine

Another thought... I suppose you do know the advertised return (coupon) for the bond or constituents of the bond fund. So you know if you're buying at a discount, if this is less than today's yield. That helps you with volatility on the way in - not buyiing something that's overpriced and likely to revert to mean (eventually) But there's still the problem of volatility on the way out.

Ark_Welder

I think of bond funds are acting more like an individual long-dated or un-dated bond, i.e. its shorter-term price will be affected by by interest and inflation rate expectations. And a bond can be sold before its maturity date, therefore the total return would be determined by the price at which it was sold rather than the par value received at maturity.

If a bond is bought in the secondary market then the buy price could be more than par value. holding until maturity would guarantee that loss of capital. However, if inflation and interest rates are benign - and the bond has a long enough maturity date then it is possible that its price could rise in the interveneing period and would start to fall towards par only towards the end of its life. So not holding until maturity could result in a capital gain. This is what has been happening to conventional gilts over the last few years.

So, for me, buying a bond fund (which I do) requires more of an outlook on economic expectations to try to get the return: it's as if I've bought a single long-duration bond that I don't intend to hold until maturity. On a simplistic level, the higher the interest and/or inflation rate expectations, the lower the price of conventional bonds (of the investment grade variety). Conversely, the lower the expectations, the higher the price of the bonds. And in both cases, this can be applied to bond funds that hold investment-grade assets.

The following can explain specific the in's-and-out's better than I. Plus, it also describes other types of credit that might be held in a fund, e.g. high-yield, MBS, FRNs, etc.

http://www.pimco.com/EN/Education/Pages/Everythingyouneedtoknowaboutbonds.aspx


But in answer to your 'revenue stream' observation, then: depends on whether an individual bond is held and whether it is bought a launch or in the secondary market, or whether it is a bond fund that is to be, or can be, held for a long time. With an individual bond then buying in the secondary market at the wrong time would probably result in a loss of capital if the bond is held until maturity. But remember that a 'right time' might also occur before maturity, which would enable to bond to be sold earlier. Buying a bond at launch would result in a capital loss only if it is not held until maturity. Otherwise, it would eventually be repaid at par value. All, of course, ignores default risk and inflation risk.

Buying a bond fund at the wrong time, however, would be likely ro result in a capital loss if it is sold in the shorter to medium term. But if your timescale is long enough then there is the possibility that the capital would eventually be recovered. Whilst the fund might have to buy some bonds above par now (resulting in an eventual loss of capital), they would get replaced by lower-priced bonds - and possibly at below-par prices - so when economic circumstances eventually changed round, the capital would be recovered. It is these aspects that make investing in bond funds similar to investing in equities: get your timing wrong and you could be sitting on a capital loss for a number of years, and eventually the chance that the loss will be made good. Under normal circumstamces, the wrong time for equities would be the right time for bonds, and vice-versa - but how long until normality is resumed...? The answer to that is probably where the money will be made!

Ark_Welder

Porcupine wrote: »

Another thought... I suppose you do know the advertised return (coupon) for the bond or constituents of the bond fund. So you know if you're buying at a discount, if this is less than today's yield. That helps you with volatility on the way in - not buyiing something that's overpriced and likely to revert to mean (eventually) But there's still the problem of volatility on the way out.

Another way to tell with a bond fund is the difference between the distribution yield and the redemption yield. If you use HL then a description of these can be found on the 'At a glance' tag for a fund: click the question mark on the 'Income details' section, which is towards the bottom-right of the page.

Porcupine

Ark_Welder wrote: »

Another way to tell with a bond fund is the difference between the distribution yield and the redemption yield. If you use HL then a description of these can be found on the 'At a glance' tag for a fund: click the question mark on the 'Income details' section, which is towards the bottom-right of the page.

Thanks, that's useful. Is there another source for this? For example Marlborough High Yield Fixed Interest has a distribution yield of 11.6%, but isn't showing an underlying yield. It's holding Bank of Ireland 4.625% MTN bonds, which have presumably been bought at a huge discount (since they're in trouble). But the top 10 are only 29% of the holdings, so it would be good to find out what the underlying yield is.

Ark_Welder

Can't find anything. I've had a look on Marlborough's web-site and haven't found anything there either. What it has prompted me to find out is that the AMC is deducted half from capital and half from revenue, so that has answered something for me in one of my earlier posts! What you could try is emailing the company to ask them. You would need to do this anyway, to get a copy of the long-form of the annual report for the fund: its year-end is December and the one from last year has the manager's report dated as 11th January.

http://www.marlboroughfunds.com/


Interesting thing to note about this fund is that it has the highest yield in its sector, and has been in the bottom three-or-so performers in the sector for at least 3 months now: those are two factors that raised my interest in it.

Points to note about this fund is that it carries higher risk than others in the same sector for a number of reasons:

• Around half the bonds are rated B or lower, so they are at least 3 notches below the lowest investment-grade rating.
• Just under half the bonds are from European companies - not including the UK - of which 10% are in Irish companies
• 70% of the bonds are denominated in Euros, so a either a break-up of the eurozone, or other problems there, might make things 'interesting' for a while. Otherwise, currency fluctuations should not be too much of a concern because most, if not all, of the non-Sterling holdings are hedged back into Sterling. Unless you want to think about conterperty risk too...
• 32% in the Financials sector...

There is opportunity here, but the risks of failure are higher too. Just my opinion, though!

deadpeasant

Thanks for interesting thread. My position is not what to buy, but what to hold/sell. About 8 mos ago I invested an inheritance in a broadly Tim Hale style portfolio, with big defensive chunks of Royal London IL gilt and HSBC gilt index (more the former). These have grown so much that they've more than compensated for the equity wobbles of recent months. I used some of the gains to re-balance, i.e. to buy cut-price equities. But I'm not sure what to do with the remaining (substantial) gilt holdings. The Tim Hale voice in my head says stop checking prices online, just go and kick a ball for 15 yrs. But I can't help wondering if a correction is due, and whether I should convert the gilts to cash until such a correction, then buy back in. Is this the fatal market-timing folly of the newbie? I find bonds defeat my brain - how a gilt fund can grow 30% or more annualised is beyond me. When I have a moment I'll study Ark Welder's Vigilante and Pimco links - thanks for these.

sims01

deadpeasant wrote: »

Is this the fatal market-timing folly of the newbie? I find bonds defeat my brain - how a gilt fund can grow 30% or more annualised is beyond me.

It can't on an ongoing basis. But can for a few years while interest rates are dropping and the fund holds long dated bonds. If gilt yields continue to drop (i.e. towards a Japan-style scenario), there may well be another 10% gain in there somewhere, but equally there is a risk of significant drops, if Gilt yields rise again (unless the bond you are holding switched to primarily very short term bonds).

EdGasket

Won't the Index-Linked gilts just keep rising assuming there is always positive inflation which is most likely? Or would they suffer a fall if interest rates rise (though presumably would be partly compensated by rising inflation)?

gadgetmind

deadpeasant wrote: »

But I'm not sure what to do with the remaining (substantial) gilt holdings.

I've greatly reduced my gilt holdings during 2011, and obviously started doing this too early, but it's worked out OK as the equities I bought into have gained nicely.

I'm now using two bond ETFs (SLXX and ISXF) with a smaller holding of Old Mutual Global Strategic Bond alongside. The latter is a fund that I've held before as it seems content to have multi-year above average performance even it it means that it loiters in the second quartile most of the time.

I'm then using infrastructure funds such as HICL and JLIF to add stability. These are slightly more equity like regards correlation, but I like the story and I may add BBGI alongside.