Classic Example of ETF Market Generated Information - Junk Bond Investors

Oct 17, 2016 in Bonds | Ratio

Every recession has something in common:  investors flee junk bonds.   You do NOT have to predict this, you only need to monitor it.

Junk bond investors got worried in late 2014 and much of 2015 -- and the stock market went effectively nowhere during that time (while High-Quality and Low Volatility segments outperformed strongly).

Most of 2016 has seen a decent bull market in junk bonds.   Since fixed-income investors are very sensitive to their income actually being fixed --- and not variable,  this group of investors is a very useful group to track.


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When Rates Go Up, Which Sectors Do Relatively Better

May 31, 2013 in Bonds | Sectors

1202 days in past 10 years that TLT went down.



Now applying the 10-Year Data to Current Situation --  May 2013 (1 day prior to end of month):




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Yield To Maturity vs Holding Period Return

Nov 27, 2012 in Bonds

For more volatile bonds (those with at least intermediate duration),  yield to maturity is not a valid forecast of what you will get during time periods spanning far less the average maturity.   What does that mean?

We constantly read about how low yields are -- and we agree, fixed-income yields are low.    But this has been said for many years now and many people seem to draw conclusions and try to forecast based on misinformation.

For more volatile bonds, the return you get will relate to the duration of the bonds and the change in interest rates.   You are not required to hold bonds until maturity.   Individual bonds are often held to maturity because it is difficult to sell them at a reasonable bid.   Trading INDIVIDUAL bonds is very difficult, if not impossible for smaller accounts  ---- and still very difficult for large accounts.   However, ETFs have changed this dynamic.   You can now (somewhat amazingly) do bond strategies with no transaction restrictions.   No purchase fees, no redemption fees.    You can even trade things like Junk Bonds at TD Ameritrade for no commission.   And JNK very often has just a one penny spread.  This is not your grandfathers bond market.

But let's take a very basic case -- not even a long-duration example.   Below is the stated Yield-to-Maturity of Barclays Aggregate Index on specific dates.   The 2nd bar (in green) shows the actual 12-month realized return of AGG, a bond ETF that tracks that index.    As you can see, there is a fair bit of difference between the 1-year return and the stated YTM at the starting date.    Importantly, these differences increase dramatically if you go out to ETFs with longer durations.    Note that Barclays Aggregate index has a stated effective duration of just 4.5 years.   This is much more dramatic the longer you go out in maturity/duration.




To stay balanced, just keep in mind what has happened to the YTM for Barclays Aggregate Index.   Should it rise materially, you should expect the total return for an ETF like AGG to come in well below the index YTM.   The point is --- YTM is not a good 'forecast' of near-term total return UNLESS maturity/duration is short.   



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Junk Bonds vs Treasury Bonds Backtest

Aug 31, 2012 in Bonds | Ratio

Credit markets don't appear to be too concerned about recession in United States.   Junk Bonds have been outperforming Treasury Bonds lately.

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ETF Bond Market Performance Since QE Began

Jun 07, 2012 in Bonds

The Federal Reserve has made a lot of money on its Treasury Bond purchases.  However, that is dwarfed by what high-yield bond investors have received over the last few years:

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A Look At Some Bond Market Segments

Mar 14, 2012 in Bonds

Let's take a look at some bond market action.   The bond market it far larger than the stock market so this should not be a topic you should just skip -- this is what 'the world' actually owns with majority of its money -- the bond market.   Even if you are primarily an equity person -- understanding some bond market basics will help you to understand what is going on overall in the markets.

While bonds mature at par and always pay a positive (nominal) return to maturity, intermediate and long-term bonds are very much subject to material drawdowns.

If we define the bond market to be the Barclays Aggregate index, let's take a logical look at what has happened when this key index drops.   That is, let's calculate how each segment does on both a relative and absolute basis when bonds get nailed.

As you can see in the table below, through last nights close, the bond market has lost at least -0.23% in daily total return change 101 times over the past 3 years (we effectively solved for the last 100 here).    Obviously, longer-maturities do worse and investment grade bond ETFs are not immune to this -- LQD has dropped on 89 of those 101 days and show a slightly larger loss than the overall Barclays Aggregate ETF return.

We prefer to show many of our big picture themes in our Allocation Board portfolios -- as talk is ultimately cheap.   On Feb 16, we lowered duration further than we were and mentioned in the dated comment the overvaluation of intermediate and long-duration bonds.  We moved incrementally towards a very defensive bond position.    In both E-ETFRE and E-ETFRS, allocations that both hit new all-time highs yesterday -- we are essentially all junk-bonds with a mix of very low duration fixed-income ETFs.  Junk bonds are down slightly today -- but that shouldn't be a big shock as the correlation of junk bonds to the overall bond market is not strongly negative on big down days.   Indeed, while junk bonds tend to rise on big bond market loss days -- as seen below, it's not a vastly dominant percentage of the time --- and that is certainly reasonable and very much consistent with very low correlated assets. 


The screenshot above is from the tools page app called Down Day Stats. It is on the Tools page with a number of other useful apps (some of which are free). Try it for other key markets --- like treasury bonds (TLT) vs Gold (GLD) vs Silver (SLV).   Or see how emerging markets act on days the dollar rallies (UDN goes down).  What is 'normal' behavior?   You need to have facts to understand what is 'not normal' as this can be very helpful in understanding what is actually going on.    If it all seems complex, that is because it is kind of complex.    The Euro, junk bonds, bank stocks, tech stocks -- how do they all interact??   Basing your investing on these key ideas is what money management is about, in our opinion --- not gambling on the next Netflix (NFLX) or Green Mountain Coffee (GMCR) earnings report.

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PIMCO Total Return Comparison

Mar 01, 2012 in Bonds

2011 was a dreadful year for PIMCO Total Return.  How bad?  Of ten major indexed intermediate bond ETFs (all with significant assets), PIMCO beat none of them.  These are essentially pure-play segments so this indicates very poor rotation by Gross during 2011.   Clearly the main problem was during Q3 when Treasuries (and the US Dollar) rallied very hard against them.


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Nov 03, 2011 in Bonds

Junk Bonds back at/near multi-year highs.   If treasury rates are going up, you want to be overweight high-yield to neutralize effects of duration risk.

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Low Interest Rates Hurt? Reality Check

Sep 24, 2011 in Bonds

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


Bond ETF Snapshot

May 17, 2011 in Bonds

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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