Bond ETF Performance (Update)

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I last reported on bond ETF performance on

10/13.

Here is a year-to-date update.

Allocating the fixed income portion of invested assets has been a challenge for investors over the past few years and continues as rates refuse to rise in tandem with experts' expectations, corporate spreads widen, and international worries mount.  This was especially true since the last update, as investors piled into Treasury securities and sold high-yield and international bonds.

Not long ago, investors could put the bulk of fixed income assets in an index fund tracking the Barclay's Aggregate Index and then go to thinking about the stock portion of assets.  Not true in 2013, and still not true as we approach the end of 2014.  Most observers continue to believe that rates will head higher, especially once the Fed starts its expected increasing of the Federal Funds rate in mid-2015.

Important dynamics in today's market are the rising dollar and the lower yields globally.  For example, the yield on the 10-year German Bund is 0.56%, 166 basis points below the 2.22% yield on the 10-year U.S. Treasury!  From the perspective of a European investor looking globally, an extra 1.66% in a depreciating Euro market is mighty attractive!

As you can see, the returns vary widely among the different funds.  Since the last update, long duration Treasury notes and bonds have outperformed high yield instruments; and the yield curve has flattened. Note the -3.81% performance of the international high yield fund!  Note, also, the payoff for being in the 7 - 10 year part of the Treasury curve at 8.45% versus 2.70% for the 3 - 7 year sector!

Unfortunately, most 401(k)s do not offer a decent selection of bond funds - you are typically forced to select from a couple.  On the other hand, if you have an IRA, you  have the selection available below as well as many others - another reason in favor of rolling over 401(k)s.

In general, you want to limit, to the extent it makes sense, the bond exposure of your investable assets  in your taxable accounts--where they will get hit with your marginal tax rate as ordinary income--and invest your bond allocation in qualified accounts like 401(k)s, 403(b)s and Roths.

The bogey in the bond market is AGG, the Barclay's Aggregate Bond Index:  it is to the bond market what the S&P 500 is to stocks.  Thus, the overall market has achieved a return of 5.63% to date. Given that the Treasury portion of this index has increased in weighting over the past few years, it has been especially well positioned for a market where investors are piling into Treasury securities.

Disclosure:  this post is for educational purposes.  Individuals should do their own research or consult a professional before making financial transactions.

ETF	YTD RET.	DESCRIPTION
HYG	2.32	HIGH YIELD
AGG	5.63	TOTAL MARKET
SCHZ	5.80	TOTAL MARKET
MBB	6.16	MBS
CSJ	0.48	1-3 YR. CORP.
IEI	2.70	3-7 YR. TREAS.
IEF	8.45	7-10 YR. TREAS.
EMB	6.53	EMERGING MKT.
BKLN	0.17	BANK LOANS
IHY	-3.81	INT'L. HIGH YLD.
PFF	13.38	PREFERRED STK.
FLOT	0.16	FLOATING RATE
BSJF	0.48	2015 HIGH YLD.
LQD	7.84	INVEST GRADE CORP.
BAB	16.16	BUILD AMER.
BOND	6.27	PIMCO TOTAL RET.
HYS	0.44	0-5 YR. HIGH YLD.
VCIT	7.36	INTERM. CORP.

Bond ETF Fund Performance (Update)

A Different Kind of Bonding

I last reported on bond ETF performance on 5/23.  Here is a year-to-date update on the performance of funds I follow based on Morningstar net asset value performance data.

Allocating the fixed income portion of invested assets has been a challenge for investors over the past few years and continues as rates refuse to rise in tandem with experts' expectations.

 Not long ago, investors could put the bulk of fixed income assets in an index fund tracking the Barclay's Aggregate Index and then go to thinking about the stock portion of assets.  Not true in 2013, and still not true as we approach the end of 2014.

An important dynamic in today's market is the rising dollar and the lower yields globally.  For example, the yield on the 10-year German Bund is 0.85%, 143 basis points below the 2.28% yield on the 10-year U.S. Treasury!

As you can see, the returns vary widely among the different funds.  Since the last update, long duration Treasury notes and bonds have outperformed high yield instruments; and the yield curve has flattened. International bonds have not fared as well in recent markets.

Unfortunately, most 401(k)s do not offer a decent selection of bond funds - you are forced to select from a couple.  On the other hand, if you have an IRA, you typically have the selection available below as well as many others - another reason in favor of rolling over 401(k)s.

In general, you want to limit, to the extent it makes sense, the bond exposure of your investable assets  in your taxable accounts--where they will get hit with your marginal tax rate as ordinary income--and invest your bond allocation in qualified accounts like 401(k)s, 403(b)s and Roths.

The bogey in the bond market is AGG, the Barclay's Aggregate Bond Index - it is to the bond market what the S&P 500 is to stocks.  Thus, the overall market has achieved a return of 4.10% to date.

Disclosure:  this post is for educational purposes.  Individuals should do their own research or consult a professional before making financial transactions.

ETF	YTD RET.	DESCRIPTION
HYG	2.43	HIGH YIELD
AGG	4.10	TOTAL MARKET
SCHZ	4.14	TOTAL MARKET
MBB	4.27	MBS
CSJ	0.69	1-3 YR. CORP.
IEI	1.81	3-7 YR. TREAS.
IEF	5.64	7-10 YR. TREAS.
EMB	7.36	EMERGING MKT.
BKLN	1.18	BANK LOANS
IHY	0.79	INT'L. HIGH YLD.
PFF	11.20	PREFERRED STK.
FLOT	0.55	FLOATING RATE
BSJF	1.51	2015 HIGH YLD.
LQD	6.33	INVEST GRADE CORP.
BAB	11.58	BUILD AMER.
BOND	4.82	PIMCO TOTAL RET.
HYS	0.93	0-5 YR. HIGH YLD.
VCIT	5.93	INTERM. CORP.

Posted by Robert Wasilewski at 9:14 AM

Bond ETF Fund Performance (Update)

I last reported on bond ETF performance on 12/21.  Here is an update on the performance of funds I follow based on Morningstar performance data.

Allocating the fixed income portion of invested assets has been a challenge for investors over the past few years and continues as rates refuse to rise in tandem with experts' expectations.  Not long ago, investors could put the bulk of fixed income assets in an index fund tracking the Barclay's Aggregate Index and then go to thinking about the stock portion of assets.  Not true in 2013 and still not true as we approach mid-2014.

As you can see, the returns vary widely among the different funds.  Unfortunately, most 401(k)s do not offer a decent selection of bond funds - you are forced to select from a couple.  On the other hand, if you have an IRA, you have the selection available below as well as many others - another reason on the side of rolling over 401(k)s.

In general, you want to limit, to the extent it makes sense, the bond exposure of your investable assets  in your taxable accounts--where they will get hit with your marginal tax rate as ordinary income--and invest your bond allocation in qualified accounts like 401(k)s, 403(b)s and Roths.

The Table shows the longer duration or longer maturity funds performed best as would be expected in a declining yield environment.  Spreads tightened, as shown by the better performance of corporate bond funds, including high yield, compared to Treasury bond funds.  Note also the strong performance of emerging market bonds (EMB) and international in general.

The bogey in the bond market is AGG, the Barclay's Aggregate Bond Index - it is to the bond market what the S&P 500 is to stocks.  Thus, the overall market has achieved a return of 3.30% to date. FLOT and BKLN are essentially money market substitutes.  Their returns, therefore, although meager relative to the overall market, were quite good compared to anemic money yields.

Disclosure:  this post is for educational purposes.  Individuals should do their own research or consult a professional before making financial transactions.

ETF	YTD RET.	DESCRIPTION
HYG	3.94	HIGH YIELD
AGG	3.30	TOTAL MARKET
SCHZ	3.61	TOTAL MARKET
MBB	3.66	MBS
CSJ	0.55	1-3 YR. CORP.
IEI	1.90	3-7 YR. TREAS.
IEF	4.91	7-10 YR. TREAS.
EMB	7.27	EMERGING MKT.
BKLN	1.26	BANK LOANS
IHY	3.82	INT'L. HIGH YLD.
PFF	9.67	PREFERRED STK.
FLOT	0.59	FLOATING RATE
BSJF	1.97	2015 HIGH YLD.
LQD	5.27	INVEST GRADE CORP.
BAB	9.12	BUILD AMER.
BOND	3.53	PIMCO TOTAL RET.
HYS	1.89	0-5 YR. HIGH YLD.
VCIT	5.22	INTERM. CORP.

Beat the Bond Market (Part II)

In the last post, we looked at a portfolio of several exchange traded bond funds, as an example of a portfolio seeking to outperform the overall bond market.  I stressed then, and re-stress here, that trying to beat any market, in my opinion, is very difficult.  I do recognize, however, that markets tend to go to extremes on occasion (read: bubbles are created) and, in deference to the tactical asset allocation approach, do present opportunities for structuring assets accordingly. Many people believe that we are in that situation today in the fixed income markets.

In the investment approach I take, there are 3 steps.  Decide on an asset allocation, decide how to invest, and monitor your investments.  Here we have an asset allocation, and are investing in low-cost, well diversified funds.  The final step is to monitor, i.e., track so that you can see if you are in fact achieving your goal of outperforming the market.  In our specific, we are monitoring the percentage of assets allocated to fixed income.

The exercise here is merely instructive to show the process.  It has only been 3 weeks since the beginning of the year, at which point the portfolio was set up.  This exercise would, at most, be updated when changes are made or on a monthly or quarterly time schedule.  Again, here I'm just setting out the process.

Calculate Portfolio Price Return

Step 1 is to gather prices.  This can be done by going to Morningstar or Yahoo! Finance, for example.

	(P) 12/31	(P) 1/18
HYS	103.43	104.69	1.218	0.059
BKLN	24.98	25.17	0.761	0.012
SCHZ	52.34	52.3	-0.076	-0.004
VCIT	87.66	87.7	0.046	0.015
CSJ	105.48	105.72	0.228	0.062
MBB	107.99	108.05	0.056	0.007
FLOT	50.59	50.59	0.000	0.000
HYG	93.35	94.71	1.457	0.162
PORT.				0.313
AGG	111.08	110.93	-0.135

The 1st column on the left lists the ticker symbols of the ETFs comprising the portfolio set up in the last post.  In the 3rd column are the updated prices.  The 4th column shows the calculated price returns.  For example, HYS had a price return of 1.218% over the 3-week period.  Here's the formula as entered into Excel:  =((I2/H2)-1)*100, where I2 and H2 refer to particular cells on the spread sheet.

The final column shows the contribution to total return based on the weighting of each ETF in the portfolio.  Here's the formula:  =C2*J2.  For HYS,  C2 is .049 (meaning that it represents 4.9% of the portfolio).  Thus, .059, shown above, is just .049 * 1.218.

The bottom line is that, so far, the portfolio is ahead with a return of .313% versus -.135% for the overall bond market as represented by the Barclay's Aggregate Index.

A teaching moment:  the reason the price return on AGG is negative is because bond yields have risen since the beginning of the year!

For this short time period, the result doesn't have a whole lot of meaning - I would hold back on the high 5s!  Also, there is an income component that over longer periods you'll want to add in.  For example, after 6 months you'll add one-half of the yield to get an estimate of total return.

Knowing how to use the copy key in Excel and how to sum columns makes this an easy spreadsheet to set up  and can increase your understanding of how the fixed income portion of your portfolio is performing relative to the overall market.

Disclosure:  This post is for educational purposes.  Individuals should consult with an advisor or do their own research before making an investment decisions.  My clients and I own some of the ETFs mentioned above.

Beat the Bond Market

Beating any market is not easy.  Philosophically, I'm of the school that markets are basically efficient, meaning that at any point in time buyers and sellers offset themselves to the extent that the market fully reflects available information including expectations.  If they didn't, then shrewd traders would be able to exploit situations on a persistent basis.  I haven't seen convincing evidence that more than a very few investors may be able to do this with any consistency and more than enough evidence that many take a severe beating trying.

I see you are still here; so, with that off my chest, let's think about beating what many people would argue (and, by the way, have been arguing for some time) is the most mis-valued market today - the bond market.

Barclay's Aggregate Index

The first step is to define the market we're trying to beat and, for most fixed income investors, that would be the Barclay's Aggregate Index.  For those not familiar with the index, it is to the bond market what the S&P 500 is to the stock market.  Ask a large cap stock manager about performance, and he or she will typically give you a comparison versus the S&P 500.  Similarly, a professional bond manager will give you a comparison versus the Barclay's Aggregate.

The second step, then, is to understand the Barclay's Aggregate Index.  To grasp the importance here, let's recall that we are talking about a major portion of most investor's assets.  For example, a 40-year-old may have an allocation of 60% stocks/40% bonds and cash.  Thus, outperforming the bond market adds meaningfully to the bottom line.

The Aggregate Index is essentially the taxable investment grade U.S. bond market with a maturity greater than 1 year.

The two most important things to know about the index is its sector composition and its duration.  In terms of sector composition, consider U.S. Treasuries.  This is a sector that has been growing as the Federal Government finances its chronic deficits and now comprises more than 35% of the index.  U.S. Treasuries happen to be the safest and most liquid taxable fixed income instrument in the world.  As such, they have the lowest yields.  So right off the bat, a major change to a fixed income position would be to hold a larger or smaller position in Treasuries.  This would be balanced by holding an offsetting position in the other sectors.

Duration, the second important thing to know, measures the approximate price responsiveness for a given change in interest rates.  The duration of the Aggregate Index is approximately 4.4 years.  It tells you that, if yields rise 1%, then the price of the index will drop 4.4% and vice versa.  Thinking about this, you realize that prices will drop more if duration is higher and yields rise than otherwise.

Today, the consensus seems to be that yields will rise (after all, they are at historical lows and the Fed is aggressively expanding the monetary base); and, therefore, the aspiring bond market beater would want to have less duration than the Aggregate Index.

So here is the composition of the Index in terms of AGG, the exchange traded fund that tracks the Index:

Source: Blackrock

CLICK IMAGE TO ENLARGE Composition-wise then, any difference in the weightings will be a different portfolio and hence a different performance.  In other words, varying the sector composition is a way to express your bets.  An example of a way to do this would be to put 75% of the bond portion of your assets in the AGG exchange traded fund and then 25% in CSJ or LQD.  These are exchange traded funds comprised of corporate bonds.  CSJ has the shorter duration.

Investing Outside the Index

Another, more aggressive, approach investors use is to go outside the index.  There is a lot of this going on today.  An example would be to invest 10% of the bond allocation in JNK or EMB.  JNK is an exchange traded fund indexed to a high yield or "junk bond" index.  EMB is an exchange traded fund indexed to emerging markets bonds (i.e., China, India, etc.).  Both of these are outside the Barclay's Aggregate Index.  And both increase credit risk and, therefore, should be used judiciously.

As you can readily see, the possibilities are endless in terms of structuring your bets relative to the Barclay's Aggregate Index.

But what about duration?  The moves just mentioned will change duration, and they should be monitored.  An easier approach, if you want to stick with the sectors in the Aggregate Index but lower the duration (because, again, you think yields will rise), would be to increase cash.  This obviously will lower duration.

Monitor versus the Aggregate

Finally, you may want to monitor whether or not your market-beating attempt is playing out.  Here is a sample  portfolio:

		%	YLD.	DUR.	EXP.	(P) 12/31
HYS	15487	0.049	3.71	1.77	0.55	103.43
BKLN	4988	0.016	4.8	0	0.76	24.98
SCHZ	18587	0.058	1.3	4.47	0.05	52.34
VCIT	105672	0.331	2.54	6.31	0.12	87.66
CSJ	87531	0.275	0.72	1.84	0.2	105.48
MBB	41043	0.129	2.53	1.37	0.26	107.99
FLOT	10122	0.032	1.02	0.14	0.2	50.59
HYG	35378	0.111	5.31	4.01	0.5	93.35
	318808	1.000
PORT.			2.32	3.57
AGG			1.61	4.4	0.08	111.08

Note that the portfolio has a duration lower than the index at 3.57 years versus 4.4 years for the Index and has a bit higher of a yield.  To monitor, all I have to do is collect prices (from Morningstar or Yahoo! Finance) and weight using the weights under the "%" column.  I also put in the expenses of each fund because I like to keep them in front of me.

After 6 months or so, you'll be able to tell if you are a bond market guru.  To get a bit accurate, add in the yield differential.  In fact, you may want to compare to active bond mutual fund managers.

As an aside, if you are interested in the bond market but haven't explored it much, it would be a good exercise to check out the exchange traded funds listed, as they will give you an idea of what is out there.

Good luck!

Disclosure:  This post is for educational purposes only.  Individuals should do their own research or consult a professional before making investment decisions.  I and my clients own the exchange traded funds mentioned.