One thing we hear is that today’s low rates are bad for savers that own bonds.    What?    Last time I checked, a nice return is good for a saver.

Bonds do not return just their stated yield-to-maturity (unless it’s both a zero coupon bond and held to maturity). As any credible fiduciary is well aware, there has been significant appreciation in the prices of various bonds recently.    Any bond-market investor is sitting on a strong return right now.

Complaining about low yields is a bit odd.    It is a lesser version of having owned Apple all the way up and then complaining that the market cap is so high it leaves little room for more upside. Reality check -- already made an outsize profit.   Low yields now mean that bond investors just made a lot of money on the capital appreciation side. People barking at Bernanke for keeping rates low and not allowing savers to make money is almost comedic --- the YTD total return of IEF is +14.7%.    Maybe savers should celebrate by getting their duration down and be happy with making 2 years of 7% return in just the last 6 months.  Perhaps they should consider gradually moving towards lower credit-quality bonds --  where rates have gone UP recently, not down.    Markets are dynamic, smart rotation is necessary to achieve a good return.

It seems to us that a stunning amount of investors just don’t understand the bond market. It is not a monolithic market that can be summarized with mentioning the current 10-year treasury yield.   Bonds with very long maturities are risky --- they are often more risky than a typical stock index.   Look at EDV or ZROZ or TLT--- these funds are extremely volatile. Just because they are labeled bonds absolutely does not make them conservative investments.Conv ersely, ultra short-term bonds have no sensitivity to interest rates -- they mature so fast that higher rates means higher re-investment rates for these maturing bonds --- these funds have obviously not appreciated much this year.

We like focusing mostly on the intermediate duration segments.   You get all the non-correlation benefit when things like equities are not attractive (like recently)--- you also get a decent lower-risk return while you wait for this equity market downtrend to run its course. And perhaps most importantly, short and intermediate bonds won’t get the large drawdowns when TLT and other long-duration bonds eventually tank (yields rise).

See also:

Yield To Maturity Charts Don't Tell The Full Story

With the bond market assuming the role of leading segment this month, lets take a look at the structure of the market.    

The top 25 fixed-income ETFs have roughly $125 billion in assets.   If we weight this by the durations of each product,  this group has an overall duration of 4.8 years, which is in-line with the Barclays Aggregate Bond Index.   This highlights our recent focus on 5-year bond yields

While some think that the bond market means 10 or 30-year treasuries, you will see that only 1 ETF in the top 25 has a duration of 10 years or longer (TLT). From a bond market investment standpoint, investors on average own 5 year bonds, not 10-30 year bonds.  Below is the breakdown by product:

For a comparison, we use the Pimco Total Return mutual fund --- which also keeps a lid on its portfolio duration.    While many in the media like to speculate about how Pimco is short US Treasuries and so forth --- they seem to fail to understand the exposure of the OVERALL fund.   Pimco Total Return fund is LONG bonds.   While it may hold some things that trade inversely to certain bond segments, the overall fund trades WITH the bond market.   Here is a look at YTD performance of the above 25 ETFs, weighting by their assets and the performance of that overall portfolio vs the Pimco Total Return Fund:

For fun, here is how it ranks vs these 25.    Not surprisingly, it is trading about in the range you would expect given its structure (duration of Pimco is under the aggregate index but it does own some stronger performing Int'l bonds).  Pimco Total Return currently ranks 15th out of 26 (25 bond ETFs plus PTTRX).

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Something to consider with bond funds.

You will often see charts in blogs and articles of 10 or 30-year bond yields plotted over time -- but from an investment perspective and when considering portfolio performance, realize that the 'meat' of the bond market is only remotely related to the 30-year.   The AGGREGATE bond market is a collection of bonds with an average maturity in the 4-5 year range.    There actually is not a single bond in the iShares Aggregate (AGG) with a stated duration anything approaching even 20 years.   None.

The 5-year yield is a good place to focus.   As of yesterday, this was 1.95%.  We scanned the history and found that on June 7, 2010 -- the yield was the same at 1.95%.   So we have unchanged TREASURY yields since then.  

But treasury bonds are just one piece of the landscape (an important piece but there are of course many others).   Below is a comparison of a few bond funds total return series since June 7, 2010.    Viewing the total return chart is not the same thing as viewing a yield to maturity time series.     We would say that the total return is much more applicable in terms of understanding movement --- as this does not strip out the distributions you earn along the way and will reflect changes in credit spreads automatically.   Total return charts are not just for bond funds obviously -- they are better for any investment that produces a cash flow.   The total return series (which is what indexes are) is a cleaner reflection of how investments perform --- and performance is what matters.

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This particular ETF, Barclays 3-7 Year Treasury Bond ETF (symbol IEI) with a stated effective duration of approximately 4.5 years, had daily standard deviation of 5.5% in 2009. While yields on treasuries are low -- duration management below 5 years is inherently low relative risk.