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Your Favorite Fixed Income Funds For a Rising Rate Environment
@Crash: 1. The duration is 4.4 years, meaning that for each 1% interest rate rise, the bonds will go down in value by 4.4%. Could be risky in a rising rate environment. 2. You mentioned you wish you owned it. What's holding you back?
But seriously, Note that the Fed can only raise short term interest rates. Long term interest rates will only rise if there is confidence that the economy is strong.
Rates won't go up in a straight line. At the first set of increases, the equities will tank with worries about the effect of rising rates. This drives cash to Treasuries which will bring the rates down. We might even see inverted yields if the Fed raises aggressively. The outlook improves as the economy absorbs the rate increase and the yield curve steepens. Meanwhile, there will be some economic and earnings shocks and that will push the rates down. Etc,... That gives plenty of time for good managers to manage duration and benefit from higher yields of new issues.
If you want to bet on which fund will do well, run a screen for the last 18mo or so when the 10yr went up some 100 basis points and went down and crept up again. That should show some nimble funds.
If you want to be passive in allocation, the best bet is to stay with exactly the same funds you think are good now with either good multi-sector funds or a well diversified fixed income allocation across interest rate and credit quality spectrum.
Trying to outsmart the rising rates will likely leave you with a severely underperforming portfolio during all the periods the rates are not rising.
@Crash: 1. The duration is 4.4 years, meaning that for each 1% interest rate rise, the bonds will go down in value by 4.4%. Could be risky in a rising rate environment. 2. You mentioned you wish you owned it. What's holding you back?
.....Well, I could. I'm holding enough different bond funds of different sorts already, though. Not a big piece of the portfolio anymore, anyhow. I'm overweight equities, given all the stuff we all know about in the news, the economy, the Fed, etc.
Anybody invested in FPNIX? (FPA New Income). A very risk averse manager. I think he would take action to prevent or minimize losses in a rising rate environment. FFRHX should do well in a rising rate environment, but not in a bear market for stocks.
A fairly new fund, USFIX, from a very good income fund family USAA (Voted #1 - Best Fixed Income - Large Fund Family by Lipper for 2014) USAA is available NTF through Vanguard brokerage.
Also, I just wanted to mention there are a number of Pimco Income funds ( I own PONDX), but I have noticed others here holding PIMIX, PDI, PONCX, PONAX.
That USFIX looks very interesting. The duration is only 1.66 years, so it won't get hit too badly as rates normalize. I'm going to look into that, thanks! Very good to know about them being voted #1, best fixed income. I'm going to try and find that article where they discuss the award and talk about them.
The Pimco Income fund has a duration of 4.78 years, so I'd be more concerned in a rising rate environment.....the price of the bonds would go down 4.78% for each 1% rise in corresponding interest rates.
Looking at effective duration for an actively managed multi sector bond fund is a deeply flawed fund selection strategy. There is very little correlation between reported duration and returns for such funds. To see this, check the performance of different funds between mid Apr and mid June of last year when the 10 year went up almost 1.25%. Or any period when your interest rate metric went up.
@cman, yes, certainly agreed, current duration is not in and of itself a good fund selection strategy for actively managed funds....... especially the more 'actively' they manage. They can have significant changes in the bond sectors they are invested in, as well as the maturities/duration and quality metrics of their investments. So at one point in time they may emphasize short term very high quality bonds, and at another, intermediate term junk bonds, if they like the credit spreads.
In your prior post: "That gives plenty of time for good managers to manage duration". I have doubts about the 'plenty of time' issue, and the whole issue of: will the fund take steps to manage duration, and to defend their portfolio.
I vividly recall the days when it was easy to get 10% interest on an FDIC insured certificate of deposit. And the days when inflation and rising rates must have devastated portfolios.
The reason I thought USFIX looked interesting is that they are already managing duration right now; already positioned for a rise in rates, so this is probably a fund manager that actively manages or at least is very conservative with respect to duration.
What I don't like about the fund is the 1.0% expense ratio, which I think puts any bond fund at a sig. disadvantage. And unfortunately, the unconstrained bond funds that I have found have high expense ratios too. Or sales loads, which I consider to be confiscation for those who don't use financial advisers.
I have a portfolio which is extremely overweight in equities, and need to find some fixed income funds that will serve the safety net/ballast portion of a portfolio, and not tank in case interest rates 'normalize'/rise, and not tank in a bear market for stocks.
You also mentioned, with respect to a passive allocation: "or a well diversified fixed income allocation across interest rate and credit quality spectrum".
I would seriously consider a passive allocation.
For my purposes, which of course you didn't know about when you made you comment, I don't think investing across the interest rate and credit quality spectrum is the way to go. Since my purpose is to use fixed income as a safety net, it should err on the side of caution, and therefore be invested 'as if' rates will normalize/rise. The purpose is to protect the portfolio for when equities do poorly. So I can't risk having the fixed income portion go down when equities go down. This calls for short duration fixed income investments, as I see it. It also calls for quality fixed income rather than across the credit quality spectrum, c.f. 2008 when junk bonds and low quality fixed income tanked right along with stocks.
Of course, the short term high quality fixed income investments yield almost nothing now. I don't need income from my fixed income investments, only downside protection, but investing in fixed income with almost no yield is not my idea of a good investment.
You are a highly knowledgeable investor, and you analysis/assessment, and specific suggestions are appreciated. Whatever detail you are willing to provide is appreciated, whether in a public post or a PM/private message. Thanks!
Focusing on managing duration is not the right thing to do for active funds. Managers focus on total return, not duration. Duration is just one factor and doesn't say much about what the total return will be.
On the other hand, just looking at duration can be misleading. For example USFIX gets its performance in its short life from overweighting short term junk bonds while having a small asset base. It has a short duration because of that allocation. However, this says nothing about how this fund will manage an increasing asset base when it cannot put everything into that asset class or when economy heads down and junk bonds start to default.
There are no guarantees with any fund and there isn't anything that will be inversely correlated with equities and not be rate sensitive except short term treasuries. But the yields will be small for a long time and the opportunity cost of being in such a fund can be large which is also a type of loss.
You are much better off with some of the multi sector funds mentioned here with low risk rating on M* and picking the one or two whose volatility is acceptable. All of their total return will be managed with a combination of duration, credit quality or allocation or even interest rate hedges. Buy a couple of them, if you want to diversify to reduce manager risk.
Since my purpose is to use fixed income as a safety net, it should err on the side of caution, and therefore be invested 'as if' rates will normalize/rise. The purpose is to protect the portfolio for when equities do poorly. So I can't risk having the fixed income portion go down when equities go down. This calls for short duration fixed income investments, as I see it.
Let me address the last sentence first. Last year (2013), the 10 year treasury rate went up from 1.78% (12/31/12) to 3.04% (12/31/13). Over that year, about 15% of intermediate bond funds did not lose money. Among these were several of the more popular funds on MFO, including D&C (DODIX), DoubleLine TR (DBLTX, though DLTNX was slightly negative), MetWest Int Term (MWIIX, MWIMX), MetWest TR (MWTIX, MWTRX), TCW TR (TGLMX, TGMNX), USAA Int Term (USIBX). (If one wants Dan Fuss/Loomis Sayles managing a basic intermediate term fund w/o a load, there's Managers Bond MGFIX, which was also positive for 2013.)
The point is that unless you expect yields to spike (exceed 4% this year or 5% next year), decently run funds will likely not lose much and can even make you a little money. Heck, the average intermediate bond fund last year lost "only" 1.4%, and with yields a percent higher this year (so the interest should boost the total return by about a percent over last year), even the typical intermediate bond fund will pretty much break even.
Sources: US Treasury (treasury yields), and Morningstar.
As to the first part of the quoted post, I've started questioning more and more seriously the value of the bond portion of a portfolio. If the purpose is a safety net - to ride out a market downturn until stocks recover - then one might set aside something like five years worth of money, and expect to draw that down to zero. That might not be enough for the market to fully recover, but I expect it should come close enough. The risk of losing a percent or so each year in a bond fund shouldn't affect the portfolio allocation significantly (thus the observations above regarding intermediate term funds). To the extent that this risk is deemed too large, a portion of that allocation can be kept in cash rather than bonds.
If the purpose is to sleep at night (i.e. it's not a question of living off investments), then I respectfully submit that restful sleep is overrated. If one doesn't need to use the investment money, that's just another way of saying that one can afford to trade short term volatility for longer term gains.
@cman: "For example USFIX gets its performance in its short life from overweighting short term junk bonds while having a small asset base. It has a short duration because of that allocation"
Not sure how you arrived at this. Morningstar.com says that 54.52% of their bonds have maturities over 30 years, and 11% in the 20-30 year maturities. And 16% of the bonds in the 7-10 year maturities. I only see 4.42% of their bonds as somewhat short term. My guess is that they have arrived at their 1.66 year duration by using derivatives rather than short term bonds.
I certainly agree that the opportunity cost can be large and is also a type of loss. But due to the very specific purpose for my fixed income allocation, probably the opportunity cost should not be weighted much.
One option I am seriously considering is FPNIX, because it has not had a negative calendar year return in 30 years, and they have as their stated purpose to not lose principal, and to be risk averse. But I would like at least 4 fixed income investments, with FPNIX probably being one of them. And since the purpose of my fixed income is to not lose principal, this is a top consideration. If I could find another 3-4 funds that do a great job with risk management and not losing principal, I would be set.
A great investment would be similar to the "stable value funds" that many 401ks have, which wrap fixed income investments in Guaranteed Investment Contracts, and manage to keep the NAV at $1.00 while still providing acceptable return. I'm not aware of these outside of retirement plans.
I also think that most fixed income managers hew pretty closely to a benchmark, and this limits them in managing risk and loss of principal. Bill Gross tends to use the Barclay's Aggregate Bond Index as the benchmark for his Total Return Fund, which limits his ability to keep the portfolio out of harm's way. And his unconstrained bond fund is very expensive, 1.30% plus a load for the A shares.
rjb112, the long maturity notes in USFIX are mostly floating rate notes with low credit quality. Their effective duration is low because the floating rate note interest rate resets regularly. In other words, equivalent to short term junk. Look at their Credit Quality table and allocation relative to category average for BBB or below. Average credit quality is BB for the fund like most high yield funds.
USFIX also has exposure to equities (about 20%) which will hurt this fund in market downturns.
Maybe ST muni funds similar to NEARX or USSTX. Hogan's fund, VWLUX, I believe is also a long term muni fund, Vanguard offers VWSTX. NEARX has had only one negative year over the last 23 years. Its ER is .45%. For USSTX...no negative returns over the last 30 years with an ER of .55%. VWSTX...36 years without a loss with an ER of .20%.
@bee: some great information, thanks. 1. Regarding the USFIX exposure to equities: that probably rules it out for me; I don't need more equities.
2. Where do you find the information on how many years a fund has gone without a negative calendar year return? "NEARX has had only one negative year over the last 23 years" "For USSTX...no negative returns over the last 30 years" "VWSTX...36 years without a loss"
That's very useful to me, and I'd like to be able to find that out for any fund I am looking into.
if one assumes that interest rates will normalize, as the OP suggested, then it woud mean that the economy continues to heal and grow. in this environment, corporations will do well and their bonds, especially those where exposure to credit overwhelms exposure to interest rates, such as high yield and senior loans, should do well.
for those who don't have a chrystal ball, such as myself, who is not sure when/if interest rates will normalize and what the new 'normal' level of rates is, it probably makes sense to stay diversifed in their fixed income allocation and include some, gasp, long-term investment grade bonds for safety (see friday's action), credit, and non-USD debt (europe, for example is still on the easing path).
one might want to look at the closed end funds (some were referenced above). the universe offers attractive yields and is still trading at reasonable discounts.
@bee: thanks, very useful stuff.....each calendar year annual return! I've been getting my calendar year return figures from Morningstar, but they only go back to 2009 for mutual funds.
Interesting that Morningstar and Yahoo don't concur on all their data. In the analyst report for FPNIX, Morningstar states "This fund hasn't lost money on a total-return basis in a single calendar year since 1984". The Yahoo Finance data shows a 16.43% return in 1984, and no negative returns except 1973 and 1974.
@fundalarm: I concur wholeheartedly that one does not have a crystal ball and does not know when/if interest rates will 'normalize' and what the new 'normal' will be. I'm not an interest rate forecaster........The way a person should invest in fixed income should be related to the purpose that the fixed income sleeve will serve in the portfolio. Some people invest in fixed income with total return being their priority. Some have the production of current spendable income as their priority.
If the dedicated purpose of the fixed income sleeve is for the equity heavy investor to have a sleeve of 'safe money' that will hold up well in a bear market for stocks, as well as in an inflationary environment, I don't think the high yield bonds or senior loans/bank loans, or long-term (long duration) investment grade bonds serve the purpose.
@bee: thanks, very useful stuff.....each calendar year annual return! I've been getting my calendar year return figures from Morningstar, but they only go back to 2009 for mutual funds.
Interesting that Morningstar and Yahoo don't concur on all their data. In the analyst report for FPNIX, Morningstar states "This fund hasn't lost money on a total-return basis in a single calendar year since 1984". The Yahoo Finance data shows a 16.43% return in 1984, and no negative returns except 1973 and 1974.
@fundalarm: I concur wholeheartedly that one does not have a crystal ball and does not know when/if interest rates will 'normalize' and what the new 'normal' will be. I'm not an interest rate forecaster........The way a person should invest in fixed income should be related to the purpose that the fixed income sleeve will serve in the portfolio. Some people invest in fixed income with total return being their priority. Some have the production of current spendable income as their priority.
If the dedicated purpose of the fixed income sleeve is for the equity heavy investor to have a sleeve of 'safe money' that will hold up well in a bear market for stocks, as well as in an inflationary environment, I don't think the high yield bonds or senior loans/bank loans, or long-term (long duration) investment grade bonds serve the purpose.
M* provides annual performance data going back to 2004. On the performance tab, e.g. for FPA New Income, look at the total returns graph, and click on the "Expanded View" tab. This shows that FPNIX had a total return of 2.60% in 2004.
Yahoo data is tertiary - Yahoo gets most of its data from M*, which in turn gets it from the funds. FPA's page (click on "Historical" tab) for New Income (IMHO rightly) goes back only to July 11, 1984. (Thus M* says the fund hasn't lost money in a single calendar year since [its modern inception in] 1984.)
FPA footnotes the fund's annual return data with: "* Inception for FPA Management was July 11, 1984. Return information for period July 1-July 10, 1984 reflects performance by a manager other than FPA. A benchmark comparison is not available based on the Fund’s inception date therefore a comparison using July 1, 1984 is used. " FPA provides no data for earlier years, when the fund was not FPA New Income.
As you note, there are different reasons why people invest in bonds. But I don't see "safe money" as an objective. It's a means to an end, not the end itself. The rule of thumb, which I alluded to above, is that money that is going to be spent within five years should be invested very conservatively regardless of market expectations. If one is not going to do anything with the investment for many years, what difference does it make how it behaves in the short term?
I'm a strong advocate of mark-to-market, so I'm not saying, e.g. that if one buys a security (e.g. a bond) one hasn't lost money until one sells. What I am saying is that if one is not going to do anything with that holding, the short term loss doesn't matter (i.e. it doesn't affect the purpose of making that investment).
@msf: thanks for that great information about accessing Morningstar's annual calendar year data back thru 2004.
"If one is not going to do anything with the investment for many years, what difference does it make how it behaves in the short term?"....... "if one is not going to do anything with that holding, the short term loss doesn't matter (i.e. it doesn't affect the purpose of making that investment)."
This year Warren Buffett discussed his Will, and how he wants the money he leaves to his wife to be invested for her: "But I’ve told the trustee to put 90% of it in an S&P 500 index fund and 10% in short-term governments. And the reason for the 10% in short-term governments is that if there’s a terrible period in the market and she’s withdrawing 3% or 4% a year you take it out of that instead of selling stocks at the wrong time"
What Buffett said gets to the reason to have fixed income investments in 'safe money', or at least in fixed income investments that will hold up in a bear market for stocks, and in an inflationary environment, which typically is very bad for bonds.
You said "if one is not going to do anything with the investment for many years....." But we have no idea when the next big bear market will come. When it does, assuming one has just retired and no longer has a paycheck from a job, living expenses should be funded with that fixed income investment rather than selling equity mutual funds in a bear market. So we can't say that it will be "many years" before there will be a need for that investment.
If one could depend on that 'many years' scenario, then I would wholeheartedly agree, we wouldn't care about short term volatility
That helps quite a bit. I believe many if not most people here felt Buffett was being too aggressive, though I posted approvingly of his suggestion.
IMHO, he's suggesting forsaking bonds, and keeping three years cash or near cash around (at a 3-4% draw down rate, a 10% stake would provide about 3 years of safety net). So long as the market doesn't dive, one can sell off the equities for cash flow. Should the market take a multi-year dip, one has that safety net. I now understand you to be thinking along those lines.
As I posted before, I would tweak his allocation in two ways: drop the equity portion to 85% (I'm not that comfortable with only three years of near-cash), and diversify beyond the S&P 500.
As to the near-cash portion - he's (IMHO rightly) saying that one need not seek a 100% guarantee that the value of this investment never drop. Even short term government bonds can drop a little. There's nothing magical about the number zero. A small loss (even a percent or two over that 3-5 year period) can be worth the risk.
On the other hand, a short term government fund is even worse than cash right now - higher risk (interest rate risk) and similar yield (about 0.9% for a 3 year note) than you can get in an insured bank account.
For a taxable account, I might consider Bee's suggestion of a short term muni fund. Unlike Bee and BobC, I'm not so comfortable with NEARX because of the risk it takes on (though I see it has dumped lots of its Illinois bonds since the last time I looked). In contrast, VMLUX (which is a short term muni fund also) takes on less risk (with correspondingly lower yield). Maybe consider NEARX as part of a portfolio (for the 4th and 5th years of the safety net I suggested above).
Ultimately, what one (or at least Buffett) seems to be looking for here is a near cash investment - not one that really "feels" like a bond allocation.
In a gradually-rising rate environment, I would likely avoid any fund that has limited ability to select issuers, sectors, and kinds of fixed income holdings. For us, best bets would be flexible mandate funds like OSTIX, TSIIX, GSZIX, BSIIX, LSBDX. And something like LASYX, with the ability to short fixed-income, could prove a good option. And LLDYX would probably be a fairly good option. For tax-exempt, I would tend to favor NEARX or LTMIX.
I agree with @bobc above as the right thing to do if one isn't actively managing their allocation. However, selecting the right allocation fund is not that easy or time efficient for individual investors depending on their needs.
As I have mentioned before this is one area where a good advisor can spend the large amount of time needed to understand a fund well enough as they can amortize this effort over multiple portfolios.
For example, if you are looking for regular income, a fund that emphasizes this with a stable NAV is better than a fund that optimizes total return. If you are in an accumulation phase, then it might be quite the opposite.
Then there is the question of tax efficiency and how volatile the fund can be being active. In addition, do the flexible funds really deliver from the flexibility especiallybqhen they have a huge asset base.
So, there is no flexible fund that fits all. You have to put in the effort to understand all of the above for a fund or find a good advisor which is not easier than finding a good fund or as my preference, create a diversified bond portfolio across multiple fixed income assets, durations and credit quality that satisfies your income needs and/or gains in the same way you create an equity portfolio and just stick to it.
The effect of a gradual rising rate is not as dire as predicted for most bond funds, especially if regular income is the goal than capital appreciation. Yes, you may have paper losses in NAV but part of the increasing dividends that is more than what you need can be reinvested.
Comments
1. The duration is 4.4 years, meaning that for each 1% interest rate rise, the bonds will go down in value by 4.4%. Could be risky in a rising rate environment.
2. You mentioned you wish you owned it. What's holding you back?
But seriously,
Note that the Fed can only raise short term interest rates. Long term interest rates will only rise if there is confidence that the economy is strong.
Rates won't go up in a straight line. At the first set of increases, the equities will tank with worries about the effect of rising rates. This drives cash to Treasuries which will bring the rates down. We might even see inverted yields if the Fed raises aggressively. The outlook improves as the economy absorbs the rate increase and the yield curve steepens. Meanwhile, there will be some economic and earnings shocks and that will push the rates down. Etc,... That gives plenty of time for good managers to manage duration and benefit from higher yields of new issues.
If you want to bet on which fund will do well, run a screen for the last 18mo or so when the 10yr went up some 100 basis points and went down and crept up again. That should show some nimble funds.
If you want to be passive in allocation, the best bet is to stay with exactly the same funds you think are good now with either good multi-sector funds or a well diversified fixed income allocation across interest rate and credit quality spectrum.
Trying to outsmart the rising rates will likely leave you with a severely underperforming portfolio during all the periods the rates are not rising.
Metropolitan West-, MWTRX, Osterweiss-OSTIX, Pimco-PIMIX
Derf
Also, I just wanted to mention there are a number of Pimco Income funds ( I own PONDX), but I have noticed others here holding PIMIX, PDI, PONCX, PONAX.
The Pimco Income fund has a duration of 4.78 years, so I'd be more concerned in a rising rate environment.....the price of the bonds would go down 4.78% for each 1% rise in corresponding interest rates.
In your prior post: "That gives plenty of time for good managers to manage duration".
I have doubts about the 'plenty of time' issue, and the whole issue of: will the fund take steps to manage duration, and to defend their portfolio.
I vividly recall the days when it was easy to get 10% interest on an FDIC insured certificate of deposit. And the days when inflation and rising rates must have devastated portfolios.
The reason I thought USFIX looked interesting is that they are already managing duration right now; already positioned for a rise in rates, so this is probably a fund manager that actively manages or at least is very conservative with respect to duration.
What I don't like about the fund is the 1.0% expense ratio, which I think puts any bond fund at a sig. disadvantage. And unfortunately, the unconstrained bond funds that I have found have high expense ratios too. Or sales loads, which I consider to be confiscation for those who don't use financial advisers.
I have a portfolio which is extremely overweight in equities, and need to find some fixed income funds that will serve the safety net/ballast portion of a portfolio, and not tank in case interest rates 'normalize'/rise, and not tank in a bear market for stocks.
You also mentioned, with respect to a passive allocation: "or a well diversified fixed income allocation across interest rate and credit quality spectrum".
I would seriously consider a passive allocation.
For my purposes, which of course you didn't know about when you made you comment, I don't think investing across the interest rate and credit quality spectrum is the way to go. Since my purpose is to use fixed income as a safety net, it should err on the side of caution, and therefore be invested 'as if' rates will normalize/rise. The purpose is to protect the portfolio for when equities do poorly. So I can't risk having the fixed income portion go down when equities go down. This calls for short duration fixed income investments, as I see it. It also calls for quality fixed income rather than across the credit quality spectrum, c.f. 2008 when junk bonds and low quality fixed income tanked right along with stocks.
Of course, the short term high quality fixed income investments yield almost nothing now. I don't need income from my fixed income investments, only downside protection, but investing in fixed income with almost no yield is not my idea of a good investment.
You are a highly knowledgeable investor, and you analysis/assessment, and specific suggestions are appreciated. Whatever detail you are willing to provide is appreciated, whether in a public post or a PM/private message. Thanks!
On the other hand, just looking at duration can be misleading. For example USFIX gets its performance in its short life from overweighting short term junk bonds while having a small asset base. It has a short duration because of that allocation. However, this says nothing about how this fund will manage an increasing asset base when it cannot put everything into that asset class or when economy heads down and junk bonds start to default.
There are no guarantees with any fund and there isn't anything that will be inversely correlated with equities and not be rate sensitive except short term treasuries. But the yields will be small for a long time and the opportunity cost of being in such a fund can be large which is also a type of loss.
You are much better off with some of the multi sector funds mentioned here with low risk rating on M* and picking the one or two whose volatility is acceptable. All of their total return will be managed with a combination of duration, credit quality or allocation or even interest rate hedges. Buy a couple of them, if you want to diversify to reduce manager risk.
The point is that unless you expect yields to spike (exceed 4% this year or 5% next year), decently run funds will likely not lose much and can even make you a little money. Heck, the average intermediate bond fund last year lost "only" 1.4%, and with yields a percent higher this year (so the interest should boost the total return by about a percent over last year), even the typical intermediate bond fund will pretty much break even.
Sources: US Treasury (treasury yields), and Morningstar.
As to the first part of the quoted post, I've started questioning more and more seriously the value of the bond portion of a portfolio. If the purpose is a safety net - to ride out a market downturn until stocks recover - then one might set aside something like five years worth of money, and expect to draw that down to zero. That might not be enough for the market to fully recover, but I expect it should come close enough. The risk of losing a percent or so each year in a bond fund shouldn't affect the portfolio allocation significantly (thus the observations above regarding intermediate term funds). To the extent that this risk is deemed too large, a portion of that allocation can be kept in cash rather than bonds.
If the purpose is to sleep at night (i.e. it's not a question of living off investments), then I respectfully submit that restful sleep is overrated. If one doesn't need to use the investment money, that's just another way of saying that one can afford to trade short term volatility for longer term gains.
Not sure how you arrived at this. Morningstar.com says that 54.52% of their bonds have maturities over 30 years, and 11% in the 20-30 year maturities. And 16% of the bonds in the 7-10 year maturities. I only see 4.42% of their bonds as somewhat short term. My guess is that they have arrived at their 1.66 year duration by using derivatives rather than short term bonds.
I certainly agree that the opportunity cost can be large and is also a type of loss. But due to the very specific purpose for my fixed income allocation, probably the opportunity cost should not be weighted much.
One option I am seriously considering is FPNIX, because it has not had a negative calendar year return in 30 years, and they have as their stated purpose to not lose principal, and to be risk averse. But I would like at least 4 fixed income investments, with FPNIX probably being one of them. And since the purpose of my fixed income is to not lose principal, this is a top consideration. If I could find another 3-4 funds that do a great job with risk management and not losing principal, I would be set.
A great investment would be similar to the "stable value funds" that many 401ks have, which wrap fixed income investments in Guaranteed Investment Contracts, and manage to keep the NAV at $1.00 while still providing acceptable return. I'm not aware of these outside of retirement plans.
I also think that most fixed income managers hew pretty closely to a benchmark, and this limits them in managing risk and loss of principal. Bill Gross tends to use the Barclay's Aggregate Bond Index as the benchmark for his Total Return Fund, which limits his ability to keep the portfolio out of harm's way. And his unconstrained bond fund is very expensive, 1.30% plus a load for the A shares.
Maybe ST muni funds similar to NEARX or USSTX. Hogan's fund, VWLUX, I believe is also a long term muni fund, Vanguard offers VWSTX. NEARX has had only one negative year over the last 23 years. Its ER is .45%. For USSTX...no negative returns over the last 30 years with an ER of .55%. VWSTX...36 years without a loss with an ER of .20%.
Here's a 3 year chart of the three:
1. Regarding the USFIX exposure to equities: that probably rules it out for me; I don't need more equities.
2. Where do you find the information on how many years a fund has gone without a negative calendar year return?
"NEARX has had only one negative year over the last 23 years"
"For USSTX...no negative returns over the last 30 years"
"VWSTX...36 years without a loss"
That's very useful to me, and I'd like to be able to find that out for any fund I am looking into.
Here's link USSTX and a snapshot
finance.yahoo.com/q/pm?s=USSTX+Performance
Here's a snap shot of USSTX:
for those who don't have a chrystal ball, such as myself, who is not sure when/if interest rates will normalize and what the new 'normal' level of rates is, it probably makes sense to stay diversifed in their fixed income allocation and include some, gasp, long-term investment grade bonds for safety (see friday's action), credit, and non-USD debt (europe, for example is still on the easing path).
one might want to look at the closed end funds (some were referenced above). the universe offers attractive yields and is still trading at reasonable discounts.
Interesting that Morningstar and Yahoo don't concur on all their data. In the analyst report for FPNIX, Morningstar states "This fund hasn't lost money on a total-return basis in a single calendar year since 1984". The Yahoo Finance data shows a 16.43% return in 1984, and no negative returns except 1973 and 1974.
@fundalarm: I concur wholeheartedly that one does not have a crystal ball and does not know when/if interest rates will 'normalize' and what the new 'normal' will be. I'm not an interest rate forecaster........The way a person should invest in fixed income should be related to the purpose that the fixed income sleeve will serve in the portfolio. Some people invest in fixed income with total return being their priority. Some have the production of current spendable income as their priority.
If the dedicated purpose of the fixed income sleeve is for the equity heavy investor to have a sleeve of 'safe money' that will hold up well in a bear market for stocks, as well as in an inflationary environment, I don't think the high yield bonds or senior loans/bank loans, or long-term (long duration) investment grade bonds serve the purpose.
Yahoo data is tertiary - Yahoo gets most of its data from M*, which in turn gets it from the funds. FPA's page (click on "Historical" tab) for New Income (IMHO rightly) goes back only to July 11, 1984. (Thus M* says the fund hasn't lost money in a single calendar year since [its modern inception in] 1984.)
FPA footnotes the fund's annual return data with: "* Inception for FPA Management was July 11, 1984. Return information for period July 1-July 10, 1984 reflects performance by a manager other than FPA. A benchmark comparison is not available based on the Fund’s inception date therefore a comparison using July 1, 1984 is used. " FPA provides no data for earlier years, when the fund was not FPA New Income.
As you note, there are different reasons why people invest in bonds. But I don't see "safe money" as an objective. It's a means to an end, not the end itself. The rule of thumb, which I alluded to above, is that money that is going to be spent within five years should be invested very conservatively regardless of market expectations. If one is not going to do anything with the investment for many years, what difference does it make how it behaves in the short term?
I'm a strong advocate of mark-to-market, so I'm not saying, e.g. that if one buys a security (e.g. a bond) one hasn't lost money until one sells. What I am saying is that if one is not going to do anything with that holding, the short term loss doesn't matter (i.e. it doesn't affect the purpose of making that investment).
"If one is not going to do anything with the investment for many years, what difference does it make how it behaves in the short term?"....... "if one is not going to do anything with that holding, the short term loss doesn't matter (i.e. it doesn't affect the purpose of making that investment)."
This year Warren Buffett discussed his Will, and how he wants the money he leaves to his wife to be invested for her:
"But I’ve told the trustee to put 90% of it in an S&P 500 index fund and 10% in short-term governments. And the reason for the 10% in short-term governments is that if there’s a terrible period in the market and she’s withdrawing 3% or 4% a year you take it out of that instead of selling stocks at the wrong time"
What Buffett said gets to the reason to have fixed income investments in 'safe money', or at least in fixed income investments that will hold up in a bear market for stocks, and in an inflationary environment, which typically is very bad for bonds.
You said "if one is not going to do anything with the investment for many years....."
But we have no idea when the next big bear market will come. When it does, assuming one has just retired and no longer has a paycheck from a job, living expenses should be funded with that fixed income investment rather than selling equity mutual funds in a bear market. So we can't say that it will be "many years" before there will be a need for that investment.
If one could depend on that 'many years' scenario, then I would wholeheartedly agree, we wouldn't care about short term volatility
IMHO, he's suggesting forsaking bonds, and keeping three years cash or near cash around (at a 3-4% draw down rate, a 10% stake would provide about 3 years of safety net). So long as the market doesn't dive, one can sell off the equities for cash flow. Should the market take a multi-year dip, one has that safety net. I now understand you to be thinking along those lines.
As I posted before, I would tweak his allocation in two ways: drop the equity portion to 85% (I'm not that comfortable with only three years of near-cash), and diversify beyond the S&P 500.
As to the near-cash portion - he's (IMHO rightly) saying that one need not seek a 100% guarantee that the value of this investment never drop. Even short term government bonds can drop a little. There's nothing magical about the number zero. A small loss (even a percent or two over that 3-5 year period) can be worth the risk.
On the other hand, a short term government fund is even worse than cash right now - higher risk (interest rate risk) and similar yield (about 0.9% for a 3 year note) than you can get in an insured bank account.
For a taxable account, I might consider Bee's suggestion of a short term muni fund. Unlike Bee and BobC, I'm not so comfortable with NEARX because of the risk it takes on (though I see it has dumped lots of its Illinois bonds since the last time I looked). In contrast, VMLUX (which is a short term muni fund also) takes on less risk (with correspondingly lower yield). Maybe consider NEARX as part of a portfolio (for the 4th and 5th years of the safety net I suggested above).
Ultimately, what one (or at least Buffett) seems to be looking for here is a near cash investment - not one that really "feels" like a bond allocation.
"I now understand you to be thinking along those lines."
Yes, you've got it.
As I have mentioned before this is one area where a good advisor can spend the large amount of time needed to understand a fund well enough as they can amortize this effort over multiple portfolios.
For example, if you are looking for regular income, a fund that emphasizes this with a stable NAV is better than a fund that optimizes total return. If you are in an accumulation phase, then it might be quite the opposite.
Then there is the question of tax efficiency and how volatile the fund can be being active. In addition, do the flexible funds really deliver from the flexibility especiallybqhen they have a huge asset base.
So, there is no flexible fund that fits all. You have to put in the effort to understand all of the above for a fund or find a good advisor which is not easier than finding a good fund or as my preference, create a diversified bond portfolio across multiple fixed income assets, durations and credit quality that satisfies your income needs and/or gains in the same way you create an equity portfolio and just stick to it.
The effect of a gradual rising rate is not as dire as predicted for most bond funds, especially if regular income is the goal than capital appreciation. Yes, you may have paper losses in NAV but part of the increasing dividends that is more than what you need can be reinvested.
@cman: Thanks for your comments.