They aren't comfortable with the inverse relationship between prices and yields; they aren't familiar with different sectors of the fixed income market; they aren't familiar with the difference between brokers and dealers, and the different yield calculations are a puzzle. Throw into the mix the fact that yields have been at historical lows, and it is easy to see that many investors mismanage this part of their portfolio.
And bonds aren't easy to learn about. If there was an all time list of boring books, undoubtedly bond investing books would rank high on the top of the list - maybe along with this post. Rumors are that doctors sometimes recommend them for sleep-challenged patients.
But they are important to understand for the DIYer.
My work around, when asked how to learn about bonds, is the simple suggestion of tracking bond prices. My preferred way to do this is by tracking bond ETFs. I do this on an ad-hoc basis - meaning, when I feel like it. Here's my table from Excel where I keep prices and where it is easy to calculate relative returns:
The data shown is price data for various sectors:
HYG: high yield, i.e., junk bonds. These are below investment grade. This sector is a top performer over long periods of time; but, when the first whiff of a downturn comes, their spreads can widen out dramatically and result in significant underperformance.
AGG: indexed to Barclay's Aggregate Bond Index - the investment grade bond market. Everything with more than 12 months to maturity. This is the bond market benchmark equivalent to the S&P 500 in the stock market, i.e., it is the most widely used benchmark professional bond managers seek to outperform.
SCHZ: Schwab's version of AGG. Commission-free to Schwab customers.
MBB: Mortgage -backed securities. Offer really attractive yields, but subject to negative convexity. This just means they have great performance in stable yield environments but can underperform otherwise. For example, if mortgage rates drop sharply, homeowners refinance leaving the bond holders significant principle to reinvest at lower rates.
CSJ: indexed to 1- to 3-year credit bond index. Has been a good holding in the low-yield environment.
IEI: indexed to 3- to 7-year section of Treasury yield curve.
IEF: indexed to 7- to 10-year section of Treasury yield curve.
EMB: indexed to emerging markets bonds.
BKLN: indexed to senior loan leveraged index.
Under normal circumstances, i.e., 10-year Treasuries yield 5% or higher, it would be perfectly fine to use AGG for the entire bond portion of assets. It would be similar to using S&P 500 for the large cap stock portion of the asset allocation.
But, because yields are abnormally low and face the risk of a push up in yields, I typically put about half the bond portion in AGG or SCHZ and then spread the rest among some of the other sectors like CSJ, HYG, EMB, and MBB. I have not used BKLN. I am still tracking it to get a feel on how it trades.
IEI and IEF are used as yield curve trades whereby you take a position based on whether you believe the yield curve will steepen or flatten.
I also collect data on the yields of the ETFs, although, admittedly, I'm not sure how the yields are calculated. They are not yields-to-maturity corresponding to bond yields - which makes sense, given that they don't have a fixed coupon payment. Here's that table for what it is worth:
As you can see, there is quite a pickup in going from AGG to junk bonds represented by HYG. Also, look at the spread between the longer maturity IEF and the shorter maturity IEI. This represents the reward for taking the longer duration risk - i.e., when rates move higher the prices of longer duration bonds will fall more!
CSJ is worth considering for those parked in money funds or low rate CDs.
It is easy to get detailed information on any of these ETFs. Just google the ticker symbol and get the providers link as well as alternative links. As a rule, aside from AGG and SCHZ, I never put more than 5% of total assets into any of the other concentrated ETFs.
Disclosure: This post is purely for educational purposes. Individuals should do their own research or consult a professional before making investment decisions.
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