Are hedged global bond funds the same as strategic bond funds?

aroominyork

So if you want to liquidate your bond holdings in five years, you buy (if such things exist) a bond fund with average maturity of five years, then after a year sell it and buy a fund with average maturity of four years, and so on until your sell the ultra-short duration fund and keep the cash?

2unlimited91

aroominyork said:

So if you want to liquidate your bond holdings in five years, you buy (if such things exist) a bond fund with average maturity of five years, then after a year sell it and buy a fund with average maturity of four years, and so on until your sell the ultra-short duration fund and keep the cash?

Yes, that's the general idea.

If you can't find a single bond fund with the exact maturity you want, you could combine 2. E.g. perhaps there's no 4-year bond fund, but you could split your capital between a 5-year and a 3-year fund, which would have a similar effect. (And 2 funds is the most you might need to hit a target average maturity.)

Michael121

bowlhead99 said:

If you had a youtube channel that puts as much effort into his vids as you do on these forums you would have a subscriber here.;)

aroominyork

2unlimited91 said:

aroominyork said:

So if you want to liquidate your bond holdings in five years, you buy (if such things exist) a bond fund with average maturity of five years, then after a year sell it and buy a fund with average maturity of four years, and so on until your sell the ultra-short duration fund and keep the cash?

Yes, that's the general idea.

If you can't find a single bond fund with the exact maturity you want, you could combine 2. E.g. perhaps there's no 4-year bond fund, but you could split your capital between a 5-year and a 3-year fund, which would have a similar effect. (And 2 funds is the most you might need to hit a target average maturity.)

So, in summary:

-              you don't think active managers add value by trying to forecast macroeconomic drivers of change to fixed interest markets

-              you don't think active managers can add value to gilts, nor that they do anything useful when buying non-UK gilts

-              you think active managers might add value in selecting individual corporate  bonds but generally you're agnostic about whether to go active or passive here

-              you agree with Linton that bonds should not be seen as a source of growth and that investors should focus on bonds' historic, pre-bull run role as a source of reliable income. 

So you advocate a 'keep it simple' strategy of mixing gilts and corporate bonds, passive for the former and passive/active for the latter, tailored to coincide their maturity with when you will need the cash. And since similar bond funds' prices broadly track each other, you can sell your five-years-to-maturity and replace it with a four-years-to-maturity fund with little impact on your capital. And if you want a dabble in high yield bonds, that should be considered a separate exercise. 

Is that about it?

2unlimited91

aroominyork said:

So, in summary:

-              you don't think active managers add value by trying to forecast macroeconomic drivers of change to fixed interest markets

-              you don't think active managers can add value to gilts, nor that they do anything useful when buying non-UK gilts

-              you think active managers might add value in selecting individual corporate  bonds but generally you're agnostic about whether to go active or passive here

-              you agree with Linton that bonds should not be seen as a source of growth and that investors should focus on bonds' historic, pre-bull run role as a source of reliable income. 

So you advocate a 'keep it simple' strategy of mixing gilts and corporate bonds, passive for the former and passive/active for the latter, tailored to coincide their maturity with when you will need the cash. And since similar bond funds' prices broadly track each other, you can sell your five-years-to-maturity and replace it with a four-years-to-maturity fund with little impact on your capital. And if you want a dabble in high yield bonds, that should be considered a separate exercise. 

Is that about it?

Great summary. You could write my posts about bonds for me now

aroominyork

OK, so say I want to one of your theories by comparing strategic bond funds and seeing if any managers add material value compared to others. Which are the most important factors that should be similar between funds, and in what order of importance, so that I know I am comparing like with like? Credit rating, underlying yield, maturity, duration...?

2unlimited91

I think there are 2 things you need to match up to have comparable funds: duration and credit risk.

Duration is similar to maturity, but duration is a bit more accurate because it takes in to account the timing of interest payments, too, not just the timing of the capital repayment. I.e. it is how long before you get your money back, as a weighted average.

Credit rating will do to measure credit risk. That may need to mean looking at the whole spread of ratings held, rather than just taking the average for the fund.

aroominyork

Duration is a bit more useful than maturity because it shows interest rate sensitivity, yes? And presumably if you know maturity/duration and credit rating, yield takes care of itself?

Linton

aroominyork said:

Duration is a bit more useful than maturity because it shows interest rate sensitivity, yes? And presumably if you know maturity/duration and credit rating, yield takes care of itself?

There are three fixed characteristics of a bond:
1) The face value which is £100 for a gilt.

2) The interest rate as a % of the face value, known as the “coupon”. The annual interest is therefore the coupon X face value as a fixed amount in £ or appropriate currency.
3) The maturity date at which point interest payments cease and you get the face value.

The current price is determined by the market.
The yield is the annual interest divided by the current price.
The yield to maturity Is the interest rate from now that would give you the same return by the maturity date as the bond taking into account the current price, the interest to be received and the face value which will be returned to you on maturity.

The credit rating is irrelevant here, though it will affect the price and whether you consider the bond worth buying.

bowlhead99

Linton said:

aroominyork said:

Duration is a bit more useful than maturity because it shows interest rate sensitivity, yes? And presumably if you know maturity/duration and credit rating, yield takes care of itself?

The current price is determined by the market.
The yield is the annual interest divided by the current price.
The yield to maturity Is the interest rate from now that would give you the same return by the maturity date as the bond taking into account the current price, the interest to be received and the face value which will be returned to you on maturity.

The credit rating is irrelevant here, though it will affect the price and whether you consider the bond worth buying.

Right, but if he was trying to see if an active manager was 'worth his salt' he is probably looking at whether the manager produced better returns (capital and yield) than an alternative portfolio of similar credit rating (creditworthiness) and maturity (interest rate sensitivity). All things being equal, it's a good manager that can find a mix of (say) BBB rated corporate bonds of seven year duration which deliver a better return than the average BBB corporate bond of seven year duration as interest rates and exchange rates fluctuate over the period.

The tricky part when benchmarking (as discussed on other aroominyork bond threads) is figuring out what you should be comparing to what. If you don't know that you definitely want international corporate bonds of BBB credit rating and seven year duration, but that's simply what your fund manager chose to hold, are you comparing his returns to the returns available from other BBB bonds with seven year duration? Or to a different fund or ETF whose average credit rating was AA- and nine year duration?

As to whether 'yield takes care of itself', the yield is part of the performance measure and will be a function of what you or your bond fund manager pays for the bond and what sort of return the market demands from a holding of that credit risk and maturity, but there is scant comfort in getting a nice high yield if the capital value has fallen by the same amount.

If you are investing for income it might be really important to you that the manager finds bond issues that pay higher yields, while capital returns could be disregarded as something that's unsustainable without changes in interest rates, exchange rates and credit ratings over time. But total return is what you'll actually get (and it could be negative), so yield in isolation is not helpful (ie just because a manager beats a benchmark yield for similar apparent credit quality, it may not translate to a better result - and if better yield has just been a function of taking more risk than the benchmark and results in capital losses, your benchmark may not be as suitable as you hoped).  And of course the total return will be a function of the manager 'getting it right' but could also be 'not really getting it right, but fortuitously getting away with it because the risk they took, paid off'.

2unlimited91 said:

Credit rating will do to measure credit risk. That may need to mean looking at the whole spread of ratings held, rather than just taking the average for the fund.

That's a useful distinction to make, because a fund manager might hold a bunch of AAA and AA+ bonds and then some higher yielding BB and other sub-investment grade or even unrated issues, in a so-called 'barbell' approach, with nothing in the middle ground, but when you look at the 'average' rating it could look like it's investing in the middle ground, while the manager is deliberately not fishing in that particular pond.