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Thread: Bonds/Bond Funds: Buy, Sell, or Hold ?

  1. #1
    Featured Member minnow's Avatar
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    Question Bonds/Bond Funds: Buy, Sell, or Hold ?

    Things seem very quiet here with our long time denizen on an exten (ded??) (sive??) absence. I'll take a crack at keeping thread from dying out by posing this question: Should one buy, hold, or sell their bond funds ? My quick answer is- "it depends". Depends on several factors, not the least of which is whether you already have bond funds, or you don't have any bonds, but are thinking of getting some.

    Before I delve further into this, I'll acknowledge that interest rates are at an all time low. Great if you're getting a loan, stinks if you're a saver. (Glancing at todays money section shows average 1 yr. CD yield to be 0.25%. That is a lousy $25 for $10K invested.).

    If you look at bond yields, they look more attractive than bank/CD, but come with risks. One being the risk of default. Which is one reason why more people own bond funds than buy an individual bond - spreads out the risk more. Another downside is interest rate fluctuation effect on bond price. The longer the time to bond maturity (aka- term), the greater the fluctuation. If interest rates rise higher than your bond yield, the price will go down. Sometimes, the interest paid by bond is insufficient to offset the price erosion. Conversely, having interest rates decline to lower than your bonds yield will result in higher bond price ( and a capital gain if you sell the bond, or fund shares.)

    S-o-o-o: With interest rates at all time lows, the potential for price appreciation is essentially nil, but with downside risk whenever interest rates rise. In the short term, I'd say bonds are a "hold". (Disclaimer- I am not a financial advisor. I am not a meteoroligist either, but I feel a certain confidence in telling people whether or not to bring a coat for a proposed visit to Chicago.). For someone who doesn't already own a bond fund, they'll probably do "OK" . (One short term bond fund yield in the last year has mostly been in the ~1.7% - 1.9% range with a price range fluctuation of 4c/share, share price ~ $5). The big question is, how much longer can rates stay this low ? They don't show signs of rising anytime soon. I've been privately singing "rates might rise in a couple of years" for the last 3-4 years. I won't delve into the hows and whys that the rates are this low, except to be prepared to sell whenever rates rise, and buy more shares (lower cost average) after selling.

    Your turn, Eric, etal.
    Last edited by minnow; 05-16-2013 at 01:37 PM. Reason: key word ommision
    I'm right 96% of the time. I don't sweat the other 5% .......................

  2. #2
    Banned Eric Stoner's Avatar
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    Default Re: Bonds/Bond Funds: Buy, Sell, or Hold ?

    Great topic. Excellent points. Exactly what Dollar Den is supposed to be.

    My own personal view, and it is nothing more than that, is that for the most part I am either holding or selling bonds. There are too many rumblings from the Fed that there will be some sort of contraction in M1 and a rise in rates. Rather than have a robotic steady incremental approach a la Greenspan ( raise rates a quarter point every month ) or have any quantum leaps ( aka "shock and awe " ) the Fed will try and take a nimble and responsive approach. In other words they will try and ease on the brakes and then gauge the reaction and effect of same before taking further action. The Fed will try to walk the tightrope and maintain growth without generating too much inflation. Can they do it ? Maybe ? Will they do it ? I have some doubts and concerns simply based on the classic "too many cooks " construction of the current Fed Bd. of Governors. So far , Bernanke has managed to herd the cats and keep everyone on the same page but what about if and when he leaves ? Obama doesn't have a conservative bone in his body and I just can't see him appointing a Volcker as Carter did. I hope I am wrong.

    What type of bonds ? Triple tax free munis are nice but which ones ? Cal-Trans ? No thanks. Chicago Transit ? Naah. Revenue bonds ? Certainly a better chance of getting paid or at least getting paid first. Those are the only individual muni's that I'm holding and the rest is in a mixed bond fund with nothing below a AA rating. I have zero in Federal paper and zero in individual state and muni General Obligation bonds. Altogether bonds are less than 10 % of my portfolio. Way less. Imho, now is the time to be in the stock market and my best educated guess is that there is still at least a couple months of juice left in the Dow. At least and probably more. So why be in bonds ? Income ? Corporate bonds ? Triple A's aren't paying too much. Even "junk" is paying as low as 4 % and it's ALL taxable. A number of high quality stocks are paying juicy dividends so why be in bonds ?

    A general bellwether for me is the rate on the Federal 10 Year Note. It's been creeping up and is now 1.95% when I last looked. The last big bond sell off happened about 3 years ago when the 10 yr. rate hit 3 %.

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    Banned Eric Stoner's Avatar
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    Default Re: Bonds/Bond Funds: Buy, Sell, or Hold ?

    The rate on the 10 Year Note is now 2.12 %.

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    Default Re: Bonds/Bond Funds: Buy, Sell, or Hold ?

    presented without further comment ...

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    Default Re: Bonds/Bond Funds: Buy, Sell, or Hold ?

    also presented without further comment...





    (snip)Via Bloomberg,

    SLM Corp. (SLM) dealt bondholders a blow as the student loan company prepares to move cash-generating assets out of their reach and rely more heavily on secured funding as it seeks to split into two separate entities.

    ...


    Sallie Mae is separating its education loan business from its consumer lending operation, following legislation in 2010 that cut companies out of the government-guaranteed student loan market. The lender’s $17.9 billion of unsecured bonds will be serviced by the company housing Sallie Mae’s $118 billion portfolio of U.S.-backed loans that it’s winding down, while the earnings, cash flow and equity of the newly formed SLM Bank will be moved out of bondholders’ reach, according to Moody’s.

    “Anytime you split a company up like this and some portion of the cashflows that could have been available to support debt payments is no longer available, it is incrementally negative for bondholders,”

    ...

    “The company is going in the wrong direction in terms of building balance sheet strength with what we consider an over-emphasis on returning capital to shareholders,” Peter Thornton, a credit analyst at KDP Investment Advisors Inc., wrote in a research note yesterday. “Unfortunately for Sallie Mae creditors, all of the current unsecured debt will stay at” a newly formed entity that contains the government-guaranteed debt while the “more promising future businesses” are stripped.

    ...

    “What they are spinning off is the higher-risk profile business; what is staying behind is the steady cashflow business,” he said.
    (snip)

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    Default Re: Bonds/Bond Funds: Buy, Sell, or Hold ?

    and this as well ... from


    (snip)Junk Bonds Get Destroyed at the Close

    ---

    In the bond world, US Treasury yields continued their ascent, pushing bond prices down sharply. Junk bonds in particular took a major hit, and the sector's flagship ETF, the iShares High-Yield Bond Fund (NYSEARCA:JNK) is approaching new lows for the year following a steady rally into early May.

    There was notably heavy volume in JNK around the close, as you can see in this chart showing the last hour of trading:


    (snip)


    For the benefit of Dollar Den readers who may not be all that familiar with bonds ... or with bond funds ... I'll cautiously attempt to make an analogy with bank CD's

    If you invest say $10,000 in a 1-3-5 year 1% FDIC insured bank Certificate of Deposit, US taxpayers guarantee that the end of the 1-3-5 years you will receive your original $10,000 investment back. If you must 'cash out' the CD before it matures, with a typical 10% 'early withdrawl penalty' you're guaranteed to receive at least $9,000 of your original $10,000 back. In the meantime you will receive interest payments near 1% * $10k or $ 100 per year.

    If you invest the same $10k in a 5-10-20 year bond, unless that bond is specifically insured by a 3rd party ( in which case the interest rate will be lower to cover costs of said insurance ), as a bondholder you assume the risk that the corporation / gov't entity who issued the bond will in fact be able to pay you back your original $10,000 at the end of 5-10-20 years. While this happens in the vast majority of cases, there have been noteworthy exceptions ... which have ranged from complete loss of the original investment in highly risky corporate bonds backed by companies that completely folded, to GM bondholders receiving an arguable $1750 back on an original $10,000 investment, to Greek gov't bondholders receiving an arguable $5,000 back on an original $10,000 investment.

    If you must 'cash out' the bond before it matures, the market value of the bond will be directly related to the interest rate ( a.k.a. dividend payments ) the existing bond actually pays, versus the amount of initial investment required to buy a new bond that will provide the same interest earnings ( a.k.a. dividend payments ). To use a real world example, an already owned 10 year treasury bond providing 2% = 200 per year in interest earnings must now be compared to the ability of buying a new 10 year treasury bond providing 2.2% interest earnings. So to achieve $200 in annual interest earnings via the purchase of a new 10 year treasury bond paying 2.2% interest, the necessary investment is only ~$9,100. Therefore if the existing 2% bond must be 'cashed out', new buyers are only going to offer the same ~$9,100 to purchase the existing $10,000 2% bond.

    In the case of bond funds, the fund manager is constantly trading the bonds held in the fund's portfolio. Thus in essence bond fund assets are never held to maturity. As such, they are more exposed to potential principal losses in an environment of rising interest rates when compared to actual ownership of a bond ( which can be held to maturity ). The trade-off of course is that a bond fund holding bonds issued by many different companies or gov't agencies faces a much lower aggregate risk of bond issuer defaults, versus the default risk faced by the owner of a single bond issued by a single company / gov't agency.

    In terms of actual risk factors for bonds from different issuers, it is generally accepted that US Treasury Bonds are default proof. It WAS generally accepted that gov't sponsored entity bonds were also very safe re potential loss of principal ... however as the Sallie Mae student loan based bond chart above shows, this is becoming increasingly 'iffy'. And, arguably, bonds issued by various corporations, by various local gov'ts etc., are becoming increasingly subject to bankruptcy decisions which may or may not provide bondholders with 'first dibs' on remaining assets for repayment of bondholder principal.


    In regard to the OP's original question, I'll offer the following opinion from 'neutral' Reuters ...




    (snip)"May 31 (Reuters) - For investors who piled into bond funds this year, the past week has been an abject lesson of how to get bruised in short order.

    An uptick in yields smacked bond prices, which move inversely to yields. Funds investing in high-yield and long-maturity issues got hit the worst. Yields on 10-year Treasury notes hit a peak of 2.23 percent, the highest since April of last year, before dropping to 2.16 percent on Wednesday.

    The pre-June bond swoon is a harbinger of things to come. The U.S. economy is heating up after years of decline, which will trigger greater demand for credit and lower bond prices.

    The good news? There are a bevy of alternative vehicles to help you hedge bond price declines.

    But first, some things to consider: Bond yields have largely been watered down by the Federal Reserve's bond-buying program in an effort to grow employment and the economy since the 2008 market and credit meltdown. The U.S. economy grew 1.7 percent in 2011 and 2.2 percent last year.

    The U.S. is expected to grow nearly 2 percent this year and about 3 percent in 2014, according to a report released on Wednesday by the Organization for Economic Cooperation and Development (OECD), which added fuel to the credit market flare up. The organization said a Fed retreat from its easing program could lead to lower bond prices.

    Now traders fear the Fed will take its hands off the throttle of its stimulus engine to slow its bond purchases. That has led to the yips in the most volatile bond funds of late.

    "While I don't believe the Fed's bond buying program will imminently cease," said Jack Ablin, chief investment officer for BMO Private Bank in Chicago, "I do think that 'taper talk' will lead to high bond yields. We have been bond skeptics for a while; however, we have added bearish bond positions in income-oriented portfolios."


    MOST SKITTISH FUNDS

    In recent years, high-yield corporate or "junk" bond funds have been the darlings of income-oriented investors. These low-rated bonds have always had a high risk of default, but have paid healthy yields.

    Investors have been well compensated for the additional risk, which is closely linked to the stock market. Yet that risk can be biting. One of the largest junk-bond ETFs - the iShares iBoxx $ High Yield Corporate Bond fund - lost more than 1 percent in a week through May 29. It's up almost 3 percent year to date and yields 6 percent.

    The SPDR Barclays High Yield Bond Fund, has had similar troubles, losing 1 percent in a week. It's gained 3 percent year to date and yields 6 percent. Keep in mind that these funds will always be subject to amplified volatility, so they should only be small holdings in your income portfolios.

    Most bond investors, though, probably sample the broad section of the U.S. bond market through a giant index fund such as the Vanguard Total Bond Market Fund, which yields about 1.6 percent. It's also feeling the sting of lower prices, though, having lost 0.47 percent in the past week and 0.76 percent year to date."(snip)
    Last edited by Melonie; 06-01-2013 at 07:50 AM.

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