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Real world measurements of risk. What was the funds loss in 2022? Using Portfolio Visualizer you can also get maximum drawdown and worst year since 2016. Also SD. And tons of stuff I don’t understand.
If you own a home in an area that is at risk for 100 year floods, it is not safe simply because you haven't had a flood in the past couple of decades that you've owned your home. Likewise, risk to your home does not increase if you're flooded out and have to rebuild.
A quiescent period leads people to underestimate risk. (So intrinsically risky funds like SEMMX come to be regarded as cash alternatives.) Likewise, an isolated instance of bad luck can lead people to overestimate risk.
Risk as represented by M*'s risk score is long term risk. If you're concerned about worst case, pretty much any metric will underestimate that. A meteor might crash into your home tomorrow and do much more damage than a flood. The odds are ridiculously low, but the amount of damage a meteor would inflict is pretty close to worst case, if that's what keeps you up at night.
OTOH, long term conditions (as opposed to recent events) might gradually change. Weather is becoming more unstable and disruptive events are becoming more severe. This sort of change affects long term risk.
Excellent perspective above from @msf. I think we all tend to think in very short time frames and assume things will always be the same. A kind of deceptive ”time-warp” if you will. So I’ve tried to generate a list of key dates for thought. No doubt AI could have done it much better and faster..
Years Since …
Since our planet’s creation 4.5 billion years
Since the North American continent was created 200 million years
Since the mass extinction of the dinosaurs 66 million years
Since the Grand Canyon was created 6 million years
Since the first Homo sapiens walked the earth 300,000 years
Since Rome ruled the known world (Pax Romana) 2100 years
Since the signing of the Magna Carta810 years
Since the Dutch Tulip bulb mania 389 years
Since The United States became a nation 249 years
Since the opening of a U.S. Stock Market 233 years
Since completion of the first transcontinental railroad 156 years
Since the advent of powered flight 123 years
Since the U.S, Federal Reserve was created 112 years
Since the first U.S. commercial radio broadcast 105 years
Since the beginning of The Great Depression96 years
Since the end of WWII 80 years
Since Fidelity Investments was founded 79 years
Since John Templeton opened his first mutual fund 71 years
Since the first nationwide color TV broadcast 71 years
Since Hawaii became the 50th state 66 years
Since money market funds yielded over 15% 55 years
Since John Bogle founded Vanguard 51 years
Since introduction of the first mass marketed home computer (VIC 20) 45 years
Since Junk Bond King Michael Milken was indicted on corruption charges 37 years
Since CNBC began broadcasting 36 years
Since the first ETF was created 32 years
Since Dow first reached 10,000 26 years
Since the NYC Trade Center Attacks 24 years
Since the first IPhone was introduced 18 years
Since the end of The Great Recession16 years
Since Donald Trump nominated Jerome Powell to be Federal Reserve Chair 8 years
Since the last Presidential Impeachment 4.5 years
Since the U.S. 10-year treasury bond last yielded under 2% 3 years
Food for thought. Apologies if this seems trite. Thanks to @equaizer for the correction
The site works, but it doesn't find this document. I've tried searching the site for Morningstar Methodology, MPRS, and various other terms but haven't come up with a relevant document. Just lots of COVID stuff and lots of M* reports on individual securities.
@WABAC I never know what will work, and why I only own funds that are doing well currently. Never in my life have I owned CLO, but I held this category for about 20 months. In 2025 it was the first time that I held a big % in international bonds; not anymore.
Any bond fund that I have owned and went down 0.6-0.8%, I sold immediately. I'm coming up now on about 15 years of investing in bonds, and I've always found funds that don't lose money, unless risk is so high and I'm out.
When evaluating bond oefs, I have often avoided funds with high percentages of derivatives in that fund's portfolio. The Investopedia definition of derivatives is as follows:
"What Is a Derivative? The term “derivative” refers to a type of financial contract whose value is dependent on an underlying asset, a group of assets, or a benchmark. Derivatives are agreements set between two or more parties that can be traded on an exchange or over the counter (OTC).
These contracts can be used to trade any number of assets and come with their own risks. Prices for derivatives derive from fluctuations in the prices of underlying assets. These financial securities are commonly used to access certain markets and may be traded to hedge against risk. Derivatives can be used to either mitigate risk (hedging) or assume risk with the expectation of commensurate reward (speculation). Derivatives can move risk levels (and the accompanying rewards) from the risk-averse to the risk seekers."
Some of the funds recently mentioned have significant portfolio positions in derivatives, including SCFZX 33%, NRDCX 42%, CBLDX 10%. Other mentioned funds have 0% in derivatives including HOSIX, DHEAX , DBLSX.
I am curious if any other posters are concerned about the % of derivatives held by a given fund?
Some of the funds recently mentioned have significant portfolio positions in derivatives, including SCFZX 33%, NRDCX 42%, CBLDX 10%. Other mentioned funds have 0% in derivatives including HOSIX, DHEAX , DBLSX.
I am curious if any other posters are concerned about the % of derivatives held by a given fund?
I certainly pay attention to them the way I pay attention to securitized debts and CLO's.
In the case of CBLDX, which I own, I can look up EUR/USD FWD 20250715 and discover that there is an active currency market. Ten per cent doesn't seem too large for me to worry about. It finished 2022 in the black; I have no idea how it will perform in a recession. I also see it is 15% cash, which suits my confirmation bias. I'm not holding it in the expectation that is anything like a CD or money-market fund.
DBLSX is 52% securitised. I can look up BATTALION CLO XI LTD too. I still don't know what it is, or how liquid it is.
DHEAX is 87% securitised. How liquid is FIRSTKEY HOMES TRUST or RESEARCH-DRIVEN PAGAYA MOTOR ASSET TRUST ?
HOSIX is 89% securitised. How liquid is BXHPP LTD or Sound Point Clo Xvi Limited?
The Fund’s investments in derivative instruments, specifically options, swap agreements and forward currency contracts (collectively, “Derivatives”) are generally used to reduce exposure to, or “hedge” against, market volatilities and other risks.
More generally, derivatives can be used to increase exposure to something or reduce exposure. So they can be used to leverage a fund in lieu traditional leveraging - borrowing to buy more of an asset. And they can be used in a variety of other ways including hedging against currency fluctuations.
There's a whole category of funds that does this: "global bonds (hedged)". 41% of VTABX is in derivatives. Vanguard is not a company that comes to mind when thinking "high risk".
Securitized securities often carry another form of derivative risk, though it is hidden.
A mortgage borrower can usually prepay the mortgage, whether that's to refinance at a lower rate or because the borrower is selling the underlying property to move. That's a form of embedded option. One of the risks it creates is called, not surprisingly, prepayment risk. The risk of a high yielding bond being paid off early.
This embedded option also creates extension risk. Homeowners may be less inclined to pay off their mortgages if rates are going up and they've locked in a lower rate for years.
Investors typically look at duration - the first derivative, or slope, of the bond price vs. market interest rate curve. When looking at bonds with embedded options it can be important to look at the convexity or second derivative of that curve. Prepayment risk and extension risk affect the convexity to the detriment of the lender (bond holder).
Securitization is a well-defined process that isn't considered among derivatives, but some may do so. Risks of securitization come from tranches of various credit ratings. As the underlying portfolio typically has mid-quality, the traches have ratings of investment-grade, junk and equity. There are assumptions and some artificiality involved. If the underlying portfolio collapses for any reason, all tranches suffer. List keeps growing - MBS, ABS, CDO, CLOs, PO, IO, STRIPS, etc.
Derivatives are futures, options, swaps, etc. Several are traded on exchanges, but many are customized OTC derivatives. Their risks are from underlying securities as well as from 3rd party derivative dealers - if your derivative dealer goes under or disappears, you derivatives are gone too.
Morningstar classifies derivatives and securitized separately.
I was surprised about VTABX. Its prospectus mentions currency-hedging and that the global index that it benchmarks to has derivative and securitized products within.
I agree that securitization per se does not create derivatives, at least the way many (me included) think of them. While securitization can create (or diminish) risk via structuring (e.g. tranches), risk in securitized assets also comes from the underlying assets themselves.
Securitized assets can contain derivatives not because of the securitization process (with or without tranches) but because the underlying assets that are being securitized themselves contain options. Such as the embedded call options (aka embedded derivatives) I referenced above.
While a securitization process may create tranches, it doesn't have to. To simplify things consider single class GNMAs.
These are bundles of mortgages that just pass through interest and principal payments to the GNMA owners. (See GNMA I and GNMA II). Nothing complex, little structuring, no tranches. Still, in merely passing through cash flows of the underlying mortgages, they also pass through the derivative risk embedded in those cash flows.
There are some rate-hedged bond etfs that might meet some people’s needs if they’re worried about significantly higher interest rates down the road. IGHG (investment grade bonds) AZGD (higher quality bonds)
I’ve been comparing IGHG out to 10 years against various income-oriented OEFs. It has yielded similar returns to BAMBX with just a bit more volatility. That’s probably deceptive because IGHB was saddled with extremely low prevailing rates over most that time. As one concerned about the longer term rate picture I would lean towards either of these over an unhedged fund.
Yield-curve control is something central banks to, not funds.
Most intermediate-term bond funds manage their yield-curve exposure by following strategies such as barbell approaches (i.e. loading up on ST and LT binds but skipping the belly, when appropriate), rolling-down-the-yield-curve (as years go by, maturity shortens, and if yield-curve is normal, the decline in yield will provide temporary gains - those gains will disappear at maturity), duration control (with futures; PIMCO does this a lot), etc.
If you're convinced everything's going to hell, that's what you want to own. But the monthly fees almost buried Scion Capital before it paid off. Burry was way too smart, and rather early in figuring out the fact that the Housing Market would crash.
And then there's the human cost, in a severe situation like the GFC. In the film, Brad Pitt's character (Ben Rickert) was something of a mentor for Geller and Shipley. "We just made the best deal of our lives," they said to him, gesticulating and dancing. "Just don't DANCE," he pushed back at them.
What if there was securitization at the grocery store? A bag of unknown food items at the mini mart at the Shell Station ? Pass! A bag of stuff at Whole Foods ? Maybe. But it seems hard to know how you can accurately rate a bond funds quality if 50% of the holdings are securitized. Back in the day the funds held government, corporate and cash. My only fund without securitization is PRPFX.
am also open to the fact that trump may not care re:long rates, given its non-factor on his family grifting, but this goes against his initial trade taco move, as well as the truss experience in the UK.
I have experienced several market crash periods, in which several funds with low volatility for years, had dramatic losses during a market correction. In post-crash analysis, derivatives that were using leveraging and speculation, were blamed for the "surprisingly" large losses. When I see relatively new funds, which has large percentage investments in derivatives, I wonder how those derivatives are being used. It is hard to be sure, but often "suspect" leveraging and speculation, but hard to be sure. I tend to avoid them. Below is an AI article that explains that in more detail:
"Derivatives can both increase and decrease market volatility, though the overall impact is complex and depends on factors like market maturity, regulation, and how the instruments are used. While they can enhance stability through risk management and price discovery, high leverage and speculation can lead to amplified price swings and increased volatility. However, derivatives also increase information flow and liquidity, which, in mature markets, can lead to more efficient price discovery and reduced long-term volatility.
Factors contributing to increased volatility
Leverage and speculation: Derivatives amplify exposure, meaning small price movements in the underlying asset can lead to large gains or losses, contributing to volatility. Speculative trading: When derivatives are used for speculation rather than hedging, they can attract destabilizing speculative activity, particularly in less mature markets. High short-term reactions: Derivatives can cause prices to react more sharply to new information, increasing short-term volatility.
Factors contributing to decreased volatility
Price discovery: Derivatives markets facilitate faster price discovery as they incorporate new information, leading to more efficient markets. Risk management: By allowing participants to hedge against price fluctuations, derivatives can reduce overall market risk and contribute to stability. Increased information flow: The increased information flow from derivatives markets to the spot markets can accelerate this information absorption and reduce volatility. Market maturity: In more mature and efficient markets, derivatives are used more for risk management, and their price discovery role leads to more stable prices.
Conclusion The relationship between derivatives and volatility is not a simple cause-and-effect. Derivatives can act as a double-edged sword: they offer valuable tools for managing risk and improving market efficiency but can also be used in ways that amplify volatility through speculation and leverage. The overall impact depends heavily on the specific market conditions and the regulatory environment."
Comments
https://pdfhost.io/v/E..d~yHtX_MStar_MPRS_102024
https://pdfhost.io/v/E..d~yHtX_MStar_MPRS_102024
Excellent perspective above from @msf. I think we all tend to think in very short time frames and assume things will always be the same. A kind of deceptive ”time-warp” if you will. So I’ve tried to generate a list of key dates for thought. No doubt AI could have done it much better and faster..
Years Since …
Since our planet’s creation 4.5 billion years
Since the North American continent was created 200 million years
Since the mass extinction of the dinosaurs 66 million years
Since the Grand Canyon was created 6 million years
Since the first Homo sapiens walked the earth 300,000 years
Since Rome ruled the known world (Pax Romana) 2100 years
Since the signing of the Magna Carta 810 years
Since the Dutch Tulip bulb mania 389 years
Since The United States became a nation 249 years
Since the opening of a U.S. Stock Market 233 years
Since completion of the first transcontinental railroad 156 years
Since the advent of powered flight 123 years
Since the U.S, Federal Reserve was created 112 years
Since the first U.S. commercial radio broadcast 105 years
Since the beginning of The Great Depression 96 years
Since the end of WWII 80 years
Since Fidelity Investments was founded 79 years
Since John Templeton opened his first mutual fund 71 years
Since the first nationwide color TV broadcast 71 years
Since Hawaii became the 50th state 66 years
Since money market funds yielded over 15% 55 years
Since John Bogle founded Vanguard 51 years
Since introduction of the first mass marketed home computer (VIC 20) 45 years
Since Junk Bond King Michael Milken was indicted on corruption charges 37 years
Since CNBC began broadcasting 36 years
Since the first ETF was created 32 years
Since Dow first reached 10,000 26 years
Since the NYC Trade Center Attacks 24 years
Since the first IPhone was introduced 18 years
Since the end of The Great Recession 16 years
Since Donald Trump nominated Jerome Powell to be Federal Reserve Chair 8 years
Since the last Presidential Impeachment 4.5 years
Since the U.S. 10-year treasury bond last yielded under 2% 3 years
Food for thought. Apologies if this seems trite. Thanks to @equaizer for the correction
The current M* MPRS methodology is available on the M* website at:
https://marketing.morningstar.com/api-corporate/axiom/ama/v1/research/download/1177471?timestamp=17565052800000500&token=eyJhbGciOiJIUzI1NiIsInR5cCI6IkpXVCJ9.eyJkYXRhIjp7ImRvY3VtZW50SWQiOjExNzc0NzF9LCJpYXQiOjE3NTc0NDkyNDV9.9aQf_8CVDlGMFVBc0-43UPZsty9g7XuBNSCAnGOWJ-c
If that doesn't work (it has an embedded timestamp), look for Risk Score on this page:
https://www.morningstar.com/business/insights/research/methodology-documents
I'll read at leisure (31 pages). Too occupied by class readings now that the academic semester has begun.
I never know what will work, and why I only own funds that are doing well currently.
Never in my life have I owned CLO, but I held this category for about 20 months.
In 2025 it was the first time that I held a big % in international bonds; not anymore.
Any bond fund that I have owned and went down 0.6-0.8%, I sold immediately.
I'm coming up now on about 15 years of investing in bonds, and I've always found funds that don't lose money, unless risk is so high and I'm out.
"What Is a Derivative?
The term “derivative” refers to a type of financial contract whose value is dependent on an underlying asset, a group of assets, or a benchmark. Derivatives are agreements set between two or more parties that can be traded on an exchange or over the counter (OTC).
These contracts can be used to trade any number of assets and come with their own risks. Prices for derivatives derive from fluctuations in the prices of underlying assets. These financial securities are commonly used to access certain markets and may be traded to hedge against risk. Derivatives can be used to either mitigate risk (hedging) or assume risk with the expectation of commensurate reward (speculation). Derivatives can move risk levels (and the accompanying rewards) from the risk-averse to the risk seekers."
Some of the funds recently mentioned have significant portfolio positions in derivatives, including SCFZX 33%, NRDCX 42%, CBLDX 10%. Other mentioned funds have 0% in derivatives including HOSIX, DHEAX , DBLSX.
I am curious if any other posters are concerned about the % of derivatives held by a given fund?
In the case of CBLDX, which I own, I can look up EUR/USD FWD 20250715 and discover that there is an active currency market. Ten per cent doesn't seem too large for me to worry about. It finished 2022 in the black; I have no idea how it will perform in a recession. I also see it is 15% cash, which suits my confirmation bias. I'm not holding it in the expectation that is anything like a CD or money-market fund.
DBLSX is 52% securitised. I can look up BATTALION CLO XI LTD too. I still don't know what it is, or how liquid it is.
DHEAX is 87% securitised. How liquid is FIRSTKEY HOMES TRUST or RESEARCH-DRIVEN PAGAYA MOTOR ASSET TRUST ?
HOSIX is 89% securitised. How liquid is BXHPP LTD or Sound Point Clo Xvi Limited?
More generally, derivatives can be used to increase exposure to something or reduce exposure. So they can be used to leverage a fund in lieu traditional leveraging - borrowing to buy more of an asset. And they can be used in a variety of other ways including hedging against currency fluctuations.
There's a whole category of funds that does this: "global bonds (hedged)". 41% of VTABX is in derivatives. Vanguard is not a company that comes to mind when thinking "high risk".
A mortgage borrower can usually prepay the mortgage, whether that's to refinance at a lower rate or because the borrower is selling the underlying property to move. That's a form of embedded option. One of the risks it creates is called, not surprisingly, prepayment risk. The risk of a high yielding bond being paid off early.
This embedded option also creates extension risk. Homeowners may be less inclined to pay off their mortgages if rates are going up and they've locked in a lower rate for years.
Investors typically look at duration - the first derivative, or slope, of the bond price vs. market interest rate curve. When looking at bonds with embedded options it can be important to look at the convexity or second derivative of that curve. Prepayment risk and extension risk affect the convexity to the detriment of the lender (bond holder).
Derivatives are futures, options, swaps, etc. Several are traded on exchanges, but many are customized OTC derivatives. Their risks are from underlying securities as well as from 3rd party derivative dealers - if your derivative dealer goes under or disappears, you derivatives are gone too.
Morningstar classifies derivatives and securitized separately.
I was surprised about VTABX. Its prospectus mentions currency-hedging and that the global index that it benchmarks to has derivative and securitized products within.
Securitized assets can contain derivatives not because of the securitization process (with or without tranches) but because the underlying assets that are being securitized themselves contain options. Such as the embedded call options (aka embedded derivatives) I referenced above.
While a securitization process may create tranches, it doesn't have to. To simplify things consider single class GNMAs.
These are bundles of mortgages that just pass through interest and principal payments to the GNMA owners. (See GNMA I and GNMA II). Nothing complex, little structuring, no tranches. Still, in merely passing through cash flows of the underlying mortgages, they also pass through the derivative risk embedded in those cash flows.
I’ve been comparing IGHG out to 10 years against various income-oriented OEFs. It has yielded similar returns to BAMBX with just a bit more volatility. That’s probably deceptive because IGHB was saddled with extremely low prevailing rates over most that time. As one concerned about the longer term rate picture I would lean towards either of these over an unhedged fund.
anyone know of bond fund\mgr prioritizing and implementing a ycc (yield curve control) strategy above all?
Most intermediate-term bond funds manage their yield-curve exposure by following strategies such as barbell approaches (i.e. loading up on ST and LT binds but skipping the belly, when appropriate), rolling-down-the-yield-curve (as years go by, maturity shortens, and if yield-curve is normal, the decline in yield will provide temporary gains - those gains will disappear at maturity), duration control (with futures; PIMCO does this a lot), etc.
https://www.investopedia.com/terms/c/creditdefaultswap.asp
Think about Michael Burry, Charlie Geller, Jamie Shipley.
https://www.imdb.com/title/tt1596363/?ref_=nv_sr_srsg_0_tt_8_nm_0_in_0_q_big%20short
If you're convinced everything's going to hell, that's what you want to own. But the monthly fees almost buried Scion Capital before it paid off. Burry was way too smart, and rather early in figuring out the fact that the Housing Market would crash.
And then there's the human cost, in a severe situation like the GFC. In the film, Brad Pitt's character (Ben Rickert) was something of a mentor for Geller and Shipley. "We just made the best deal of our lives," they said to him, gesticulating and dancing. "Just don't DANCE," he pushed back at them.
of course. fund managers have interest rate strategies, no one would claim they set interest rates.
but i am searching for bond fund managers who have considered a minor fed rate cut will have trivial impact , and trump's most likely (only?) move to kick the can and avoid pain is suppressing long rates via ycc. so very specific to that.
several good recent posts exist :
https://www.reuters.com/markets/europe-could-escape-bond-doom-loop-us-not-so-much-2025-09-09/
am also open to the fact that trump may not care re:long rates, given its non-factor on his family grifting, but this goes against his initial trade taco move, as well as the truss experience in the UK.
Milken case was 36 years ago, not 66.
"Derivatives can both increase and decrease market volatility, though the overall impact is complex and depends on factors like market maturity, regulation, and how the instruments are used. While they can enhance stability through risk management and price discovery, high leverage and speculation can lead to amplified price swings and increased volatility. However, derivatives also increase information flow and liquidity, which, in mature markets, can lead to more efficient price discovery and reduced long-term volatility.
Factors contributing to increased volatility
Leverage and speculation:
Derivatives amplify exposure, meaning small price movements in the underlying asset can lead to large gains or losses, contributing to volatility.
Speculative trading:
When derivatives are used for speculation rather than hedging, they can attract destabilizing speculative activity, particularly in less mature markets.
High short-term reactions:
Derivatives can cause prices to react more sharply to new information, increasing short-term volatility.
Factors contributing to decreased volatility
Price discovery:
Derivatives markets facilitate faster price discovery as they incorporate new information, leading to more efficient markets.
Risk management:
By allowing participants to hedge against price fluctuations, derivatives can reduce overall market risk and contribute to stability.
Increased information flow:
The increased information flow from derivatives markets to the spot markets can accelerate this information absorption and reduce volatility.
Market maturity:
In more mature and efficient markets, derivatives are used more for risk management, and their price discovery role leads to more stable prices.
Conclusion
The relationship between derivatives and volatility is not a simple cause-and-effect. Derivatives can act as a double-edged sword: they offer valuable tools for managing risk and improving market efficiency but can also be used in ways that amplify volatility through speculation and leverage. The overall impact depends heavily on the specific market conditions and the regulatory environment."
The only sure way to control volatility is to sell early.