What is "Flight-to-Quality" ?

Source: Capital Pixel

Last week I wrote a post on the important role of bonds in a portfolio when the market gets scared--as in a 15% or greater sell-off.  The post showed that the four times the S&P 500 had negative returns over the past 20 years the Barclay's Bond Index produced positive returns.  When the S&P 500 returned -37% in 2008, the bond index returned greater than 5%.

Thus, bonds are a hedge or a type of insurance in the event of a significant sell-off in stocks.  This shift of assets into bonds is "flight-to-quality" and typically is concentrated in Treasury notes and bonds.  Again, it takes place when the market is scared.

A good way to put on this hedge is simply to use AGG or a similar Barclay's Aggregate Index exchange traded fund for the fixed income portion of assets.  Note three metrics:  .08% expense ratio, 5.3 duration, and 31.29% Treasury issues.  The duration of 5.3 tells you that, if yields rise 1% from 2.3% to 3.3% over the next 12 months, then AGG will fall in price by approximately 5.3%.  Add in 1.8% approximately from interest payments and total return would approximate -3.5%.  There's no free lunch here!

Those looking for a really good "flight-to-quality" hedge might consider TLO - the long Treasury etf. Note that it has a duration of 16.6 years so is a lot more volatile than AGG.  Also note that it was up over 23% in 2008!

Disclaimer:  This post is for educational purposes.  Investors need to do their own research or consult a professional before making investment decisions.  Exchange traded funds mentioned are held by me and by my clients.

The Most Important Thing About Bonds That Most Investors Don't Know

Not a bad hedge!

I've recently read a couple of books about bonds along with an article about how to protect a portfolio from a stock market correction.  The article was one of those Yahoo! type articles touting something like 10 ways to protect your portfolio.  It listed a number of esoteric ideas including puts, stop loss orders, etc. Nothing about bonds.  Maybe bonds wouldn't be your first thought either.

Maybe they should be.

Let's cut to the chase and take a look at the four times out of the past 20 years that the large cap core index, essentially the S&P 500, has produced a negative annual return along with the return on the Barclay's Aggregate Bond Index:

	2000	2001	2002	2008
Large Cap Core Stock Index	-1.1%	-4.8%	-9.8%	-22.8%
Barclay’s Aggregate Bond Index	+11.6%	+8.4%	+10.3%	+5.2%

 Source:  BlackRock Asset Class Returns

Hopefully something jumps out at you.  The fact is that bonds, as the table clearly shows, offer a pretty decent hedge, i.e. insurance, to dampen the impact of stock market downturns.

People many times want to get wrapped up in the mathematics and look at correlations which, essentially, are fancy averages; but there is more to it than this.  I say this because most correlations disappointed investors in 2008.  Asset classes that were supposed to provide a cushion in the event of a downturn didn't.

Bonds, on the other hand, especially Treasury notes and bonds which comprise most of the Barclay's Bond Index, are the go-to asset when investors get scared!  This is called "flight-to-quality."

Understanding a bit of history can lead to a pretty good idea of how bonds will act in various scenarios. Is it possible for both bonds and stocks to have a negative return?  Surely, especially when inflation picks up.  Most likely, in this situation, if stocks drop (which is not a given), it won't be by much.  On the other hand, if there is a major downturn, 15% or more say, it is probably because  the market is scared and bonds could be expected to do well.

One point worth emphasizing is that fixed income encompasses money markets, certificates-of-deposit, and savings accounts.  Sometimes people treat these as bond like instruments.  They are not.  Their price won't rise in a "flight-to-quality" instance.

What About Levels?

Most of the bond market has fixated over the past few years on the historically low rates and the need to position portfolios for a rise in rates.  After all, the thinking has been there is nowhere to go but up. Well, time has proven that this isn't exactly the case.  But beyond that, where should bond investors be today?

Well, if they load up on short duration bonds and corporate bonds offering higher yields, they could be severely disappointed in a crisis.  For example, if the market became convinced that we were locked into a serious Japanese-type deflation episode, the meager 2.35% 10-year Treasury yield could look robust.

The bottom line is that investors need to recognize that hedging like, insurance like, properties of bonds when managing their portfolios.  When is more the question rather than if when expecting a stock market correction?  When it comes, investors will appreciate their bonds (pun intended).

The Impact of Rising Interest Rates on Portfolios

Here are the numbers from an Edward Jones study interviewing 1,008 people as reported by Barron's (8/26/2013, p. 16).

63% said they don't know how rising rates affect their investment portfolios.

24% say they're completely in the dark about potential effects.

33% of respondents between 18 and 34 admit they don't know the impact of rates.

19% of men said they don't understand the specific impact.

First off, to understand rate movements and bond returns, investors need to understand that bond prices and interest rates move in opposite directions.  When rates rise, bond prices drop and vice versa. Secondly, in addition to the change in price, bond returns are impacted by accrued interest.  Thus, holding a bond with a yield of 3% will contribute that yield to the total return over the course of the year and will add to the impact of the unrealized capital gain or loss.  Over a 6-month period, it will contribute half of that, or 1.5% and so on.

The trick, then, is to get a handle on what will happen to bond prices as yields change.  For this purpose, the investor needs the duration of the bond portfolio or the individual bonds.  Let's back up a moment and think about this.  At first cut, a little thought will reveal that a bond with a longer maturity will have a price volatility greater than that of a bond with a shorter maturity.  But, this isn't enough. Consider two bonds with 5-year maturities, but the first bond pays a coupon of 5% and the second bond pays a coupon of 2%.  These are clearly two different animals with very different cash flows.  In fact, the bond with the 2% coupon has a more volatile price because its cash flows come in slower.

This difference is handled by a metric known as duration.  Duration is the key to estimating the impact on bond prices from a change in yields.  Let's consider a simple example.

Go to Morningstar, an excellent source for finding bond fund durations, and put AGG into the quote box.  AGG is the ETF which tracks the Barclay's Aggregate bond index.  It is used by many investors as the main investment for their bond or fixed income assets.  Hitting the quote button brings you to a page from which you need two pieces of information:  the yield and duration.

Source: Morningstar

As shown, yield on AGG is 2.40%.  On the same page, scroll down and find the duration on the right hand side.

With this information at hand, calculating the approximate impact of a change in yields is straightforward once you understand that duration tells you the change in price per 1% change in yields.  For example, assume that AGG comprises 40% of our portfolio and assume that yields rise 1% over the next 12 months (for example, the yield on the 10-year Treasury note rises from 2.9% to 3.9%).  Then the impact on portfolio return would be approximately .4*(-5.08+2.4%) = -1.07%.  If yields rise 2%, the impact would be approximately .4*(-10.16+2.4) = -3.90%.

If you play around with this, you can see the impact of time (getting 2.4% yield over 12 months as a cushion), portfolio weighting (the .4), etc.

It is a fairly simple step to bring in other bond funds or even individual bonds once you have their durations and yields.  Hopefully, you can see here how the recent sharp rise in yields over a short period of time, as well as the possibility of a longer-term increase, has unnerved investors.  And, hopefully, this short explanation reduces the percentages of people who don't understand the impact of bond yields on their portfolio  ;)

Bond ETF Performance

Fed Tapering?

Here are the year-to-date returns through Friday as reported by Morningstar on the ETFs that I follow.  As you can see, the returns vary widely and the funds are quite different.  For what it's worth, you'll find that 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 the bond exposure in your brokerage account because of taxes.

Generally, as you can see in the table, the shorter duration or maturity funds did best as would be expected in a rising yield environment.  This impact can be seen by comparing IEI (-2.57%) versus IEF (-5.75%).  The table also shows the poor performance of emerging markets 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. 

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	-0.7	HIGH YIELD
AGG	-3.61	TOTAL MARKET
SCHZ	-3.46	TOTAL MARKET
MBB	-3.43	MBS
CSJ	-0.3	1-3 YR. CORP.
IEI	-2.57	3-7 YR. TREAS.
IEF	-5.75	7-10 YR. TREAS.
EMB	-10.85	EMERGING MKT.
BKLN	1.4	BANK LOANS
IHY	-3.43	INT'L. HIGH YLD.
PFF	-0.52	PREFERRED STK.
FLOT	0.19	FLOATING RATE
BSJF	0.73	2015 HIGH YLD.
LQD	-5.56	INVEST GRADE CORP.
BAB	-6.21	BUILD AMER.
BOND	-3.38	PIMCO TOTAL RET.
HYS	1.74	0-5 YR. HIGH YLD.
VCIT	-5.12	INTERM. CORP.

Thoughts on Bonds

A video worth watching, 3 Ways to Maximize Bond Returns is an interview by Jeff Macke of Larry Swedroe, author of Wise Investing Made Simple and numerous other investment books.  Swedroe is a successful investor who does an excellent job of explaining complex investment topics.

Increase the Yield on Your Investment Assets

I see people all the time with six figures in money market funds and low-yield savings accounts - some barely above zero percent.  Some are befuddled by asset allocation models that recommend 40%, say, in fixed income and have no idea where to go from there.  If this sounds like you, or even if you just want to share what you are doing in the fixed income part of the portfolio and are in the area, join us at the Miller branch of the Howard County Library.

At this presentation, I'll present a sample portfolio that carefully monitors risk and still produces a yield exceeding the rate of inflation.  I'll assess other ways to approach this asset sector - after all, there is more than one way to skin a cat.

My bottom line goal is to provide profitable take-away ideas for attendees, both novices and experienced investors.

Teach Your Kids About Stocks -Dividends (Con't.)

When people talk about bonds today, more often than not the conversation will get into dividend paying stocks.  This reflects the favorable comparison for dividend-paying stocks relative to bonds. For example, Johnson & Johnson (TKR = JNJ) has a dividend yield of 3.60% (go to Yahoo! Finance and put in the ticker symbol to find the yield) compared to the yield on the 10-year U.S. Treasury note of 1.98%.

How to find 10-year Treasury yield:

• www.bloomberg.com
• click "Markets"
• find "Government Bonds" in drop-down list
• find yield indicated in the graphic

 CLICK TO ENLARGE  In making the comparison, the point is made that dividends frequently are increased over time, whereas the holder of the 10-year Treasury note will get the same payment over the 10-year period.  To truly convince yourself, go to Yahoo! Finance and check out the dividend paying record of JNJ!

To see the difference, note that, if we invest $5,000 in the Treasury, we will get $100 in interest/year (5000*.02).  On the other hand, if we buy $5,000 of JNJ, we will get $180/year (5000 * .036) based on the current yield.

Even the well-diversified iShares Dow Jones Select Dividend Index (ticker symbol DVY) yields considerably higher at 3.37% compared to the sub 2% yield on the 10-year Treasury.

Looking at the numbers,it is easy to see the compelling case for dividend-paying stocks.  It is easy to understand why people argue that the low interest rate policy of the Federal Reserve is pushing investors, especially those who need high income,  into riskier assets.  In this regard, it is useful to reflect on the essential difference between bonds and stocks.  Very simply, we know the price of the bond at a future date.  For example, the 10-year Treasury note will have a price of $100 on 2/15/2022 - its maturity date. In contrast, the price of JNJ, or DVY for that matter, is unknown going forward.

Which do you prefer - the 10-year Treasury, JNJ, or DVY?

Disclosure:  My clients and I own some of the securities mentioned  in this post.  It is intended solely for educational purposes.  Individuals should do their own research and/or consult a professional advisor before making investment decisions.

Bonds versus Stocks: Buffett versus Gross

The media is playing up the differing views of Buffett and Gross on stocks and bonds.  Buffett recently previewed his much-anticipated shareholder letter and called bonds "dangerous investments."  At the other end of the spectrum, Bill Gross, manager of the world's largest bond fund, at PIMCO, has recently increased exposure to Treasury issues.

Five years from now, we will look back and see that one of these icons of the investment world will be right and the other probably very wrong.  With the yield on the 10-year Treasury below 2%, the Fed and other world central banks on an inflation mission, and the yield on the S&P 500, for the first time in decades, yielding more than the 10-year Treasury, I have to side with Buffett - up to a point.

Some, in fact, like Laurence Fink, CEO of BlackRock Inc. (the world's largest investor), are pounding the table and arguing that investors should be 100% in equities.



I have to say that I believe Buffett is right but wouldn't go 100% into stocks.  I could sketch out a scenario where 10 years from now the S&P 500 is 10% lower than today (think Medicare, U.S. dysfunctional  government, Southern Europe, nutcase in Iran, etc., etc.) and the 10-year Treasury note is at 1.50%, say, where, in fact, Buffett followers would not have done well.  It is why my clients are diversified.

One comment that Fink made got a chuckle out of me.  He said he was sitting with Buffett one time and the market was falling off a cliff.  He said Buffett got up 3 times and bought stock.  This impressed him. It doesn't me.  Buffett is a multi-billionaire.  He has, for all practical purposes, unlimited capacity to take risk.  If the market fell 50% tomorrow, it would not make one bit of difference to Buffett's economic well-being.

I would suggest that  Fink sit with a couple who are 3 years into retirement, have a "nest egg" of $600,000, and are trying to generate an income from the nest egg and social security that will last.  See how often they are jumping up and down to buy stocks in a market that's falling sharply!

To me, the disagreement on the most important investment decision of all--asset allocation--by these extremely bright, successful long-term investors is the strongest argument for diversification.  Although I agree that long-term Treasuries should be avoided today, bonds in general should not.

Disclosure:  This post is for educational purposes only.  Individuals should do their own research or consult an investment professional before making investment decisions.

Trading Bonds (Part II)

Source: Capital Pixel

Yesterday we looked at the idea of bond trading on the basis of yield spreads.  Underlying this idea is that there is so-called "reversion to the mean" when it comes to yield spreads.

We looked at a set of data showing that, on average, selling IEF (a 7 - 10 Treasury ETF) and buying HYG ( a high yield ETF) resulted in a take out of $10.42.

Today HYG is $87.26 and IEF is $104.43 for a take out of $17.17! In other words, HYG is much cheaper relative to IEF than it has been on average.

This can also be expressed in terms of yield.  At $87.26, HYG is yielding 7.97%; and, at $104.43, IEF is yielding 2.69%.  The pickup in yield by moving IEF to HYG is, therefore, 5.28% (7.97 - 2.69).

Hopefully, this gives some insights into how bond traders shift among sectors of the bond market.  My plan is to revisit this trade in a couple of months to see how it works out!

Disclosure:  The information here is for educational purposes.  I hold HYG and IEF in client accounts.

Trading Bonds

Source: Capital Pixel

This post is for the active DIY investor who would like an approach  for  the fixed income portion of the portfolio.  It is presented solely as an idea to get the creative juices flowing.  In fact, in the end, the best approach for most DIY investors is to just buy the market, via AGG or BND which tracks the Barclay's Aggregate Index, i.e. the overall bond market, and forget it.

There are others who take investing as a challenge.  They like to try to "beat the  market" - at least for a portion of their assets.  They have a lot of time to study the market.  They spend considerable time researching stocks but are stymied when it comes to the bond portion of their assets.

Should I Try to Predict Interest Rates?
 
Serious investors understand that bond yields and bond prices move in opposite directions.  This, then, suggests that predicting interest rates is the natural way to outperform the bond market.

Sadly, as most professional bond managers will tell you, predicting interest rates is like predicting stock prices - it is a losers game.  2011 has been an excellent example of this.  When yields had been considerably higher than where they are today, most pros predicted yet higher rates.  Instead they dropped sharply; and, as a result, some of the most high-profile bond managers underperformed the bond market significantly.  So much for predicting rates.

Trade the Spread
 
Instead, many pros will tell you it is considerably easier dealing with spreads.  This is what I want to look at here.

A simple under-appreciated fact, IMHO, is that bonds are fundamentally different from stocks in that we know the future price of a bond.  For example, if we buy a 5-year Verizon bond, we know that at the maturity date the price of the bond will be $100 (for $100 in principal).  Obviously, if we buy Verizon stock, we have no idea where the price will be 5 years from now.

This gives special meaning to the much discussed "reversion to the mean" concept.  Think about it like this:  the price of a Verizon bond, for example, can wander all over the place depending on how investors feel about risk; but, in the end, it has to track closer to Treasury yields as it gets closer to maturity.  This is true in spades when a portfolio of bonds is considered.

I find it interesting that professionals spend a lot of time studying and trading on the basis of yield spreads and yet, despite all of the investment information on line, yield graphs are not easy to find!  In fact, I had to create my own data for this simple exercise to illustrate this idea of investing on the basis of yield spreads.

In thinking about what we are trying to do, first consider two bonds:  a corporate bond and a government bond.  Assume the Treasury bond yields 5% and the corporate bond yields 7%, i.e. the spread is 2%. Then, if the spread goes to 1.5%, it means that the price of the corporate bond has risen (or decreased less) relative to the price of the government bond - remember:  bond prices rise when bond yields drop. The idea then boils down to this:  buy corporate bonds when yield spreads are wide and you are getting paid to take on risk, and sell and go into Treasuries when the reward-to-risk is not so appealing. Professional bond traders spend a lot of time doing exactly this - studying yield spread graphs in their search for value.

Data Analysis
 
So, to begin I first found some historical yields.

I collected monthly yields on Moody's Baa rated bonds (Baa is actually the bottom of the investment grade category) and the 5-year constant maturity Treasury note going back to November 2005.  I then took the difference in the monthly yields and calculated the average.  At the end of November, the Baa yield was 5.14%, the Treasury note yield was 0.91%, and so the spread was 4.23%.  The average over the whole period for this spread was 3.58%.  So, as a first cut, a bond trader would say the Baa corporate "has value."

On the other hand, if the spread was less than the average of 3.58%, bond traders would typically prefer the Treasury.  In other words, they would say an investor is not getting paid enough to take on the risk of the corporate issue.

2011-04	6.02	2.17	3.85
2011-05	5.78	1.84	3.94
2011-06	5.75	1.58	4.17
2011-07	5.76	1.54	4.22
2011-08	5.36	1.02	4.34
2011-09	5.27	0.9	4.37
2011-10	5.37	1.06	4.31
2011-11	5.14	0.91	4.23
		AVG.	3.58

 Again, the above is a partial listing of the data.  The column headed by 6.02 is the Baa yield, the next column is the Treasury note yield, and the final column is the "spread," i.e. the difference.  The average is for the whole period going back to the of 2005.

Hopefully you get the idea at this point - the adept trader who sold corporates on 4/2011 at a spread of 3.95% could buy them back considerably cheaper on 11/2011 at a spread of 4.23%.

Let's go a step further and think about the best way for a DIY investor to exploit spreads.  For this purpose, I collected price data, back to 4/2007,  on HYG (high yield bond ETF) and IEF (7 - 10-year Treasury note ETF).  A significant positive here is that these are low-cost, highly-diversified investment instruments appropriate for the DIY investor.  HYG is a good choice for up to 5% of a portfolio for the fixed income portion of most DIY portfolios.  The question is when is a good time to buy?

Below is a partial listing of my data.  The difference here is that we are looking at prices.  The prices of the funds go up when bond prices rise, i.e. yields fall.  If yields on high yield corporates fall more than yields on Treasury notes, then HYG will rise more than IEF will and vice versa.  The spread reflects confidence in the economic recovery, etc.  When the spread is large (on an absolute basis), it means you have to pay a lot (example:  10/2010 at -12.52) for the safety of Treasuries - this is the time to buy HYG! As you can see, by early 2011, HYG had appreciated in price (from 83.04 to 86.93) and IEF had actually declined!  If you go to the earlier chart and collect the yield data, you'll find that the spread over the same period dropped from 4.59% to 3.92%! 

Hopefully this gives you a bit of an idea how spread information can help position the fixed portion of the portfolio.  There are, of course, other areas of the market, including mortgage-backeds, single-A corporates, etc., where this approach can be used profitably.  Keep in mind that the yield advantage of sectors relative to Treasuries brings time into the process.  This post is intended for educational purposes. Individuals should consult with a professional and do their own research.  I hold ETFs mentioned above.

	HYG	IEF	SPREAD
2010-10	83.04	95.56	-12.52
2010-11	81.99	94.7	-12.71
2010-12	84.26	91.45	-7.19
2011-01	85.67	91.43	-5.76
2011-02	86.9	91.24	-4.34
2011-03	86.93	91.1	-4.17
2011-04	88.32	92.78	-4.46
2011-05	88.44	95.1	-6.66
2011-06	87.93	94.62	-6.69
2011-07	88.25	97.62	-9.37
2011-08	85.84	102.16	-16.32
2011-09	81.29	104.45	-23.16
2011-10	88.19	103.1	-14.91
2011-11	86.05	103.7	-17.65
		AVERAGE	-10.42

Bonds (Part 4)

As commenters to my previous posts have pointed out, today a much easier way to participate in the bond market is via exchange traded funds (ETFs).  When you do an asset allocation and determine that a certain percentage of your assets, 30% say, should be allocated to bonds or fixed income, think exchange traded funds.  You immediately get diversification and avoid the pricing problem with odd lots of individual bonds.  You have available at your fingertips mounds of research data detailing portfolio composition, yield, duration, etc.

A natural choice, right off the bat, would be a fund indexed to the Barclay's Aggregate Bond Index.  This index is to the bond market what the S&P 500 is to the stock market.  It is the #1 benchmark active managers try to beat   (most are unsuccessful by the way).

A really good source of bond ETF data is Morningstar.  Put the ETF symbol in the quote box, and then putter around and check out the data under the various tabs.  For example, for AGG, you'll find under the" Portfolio" tab on the right hand side, after scrolling down, the fund duration is 4.50 years.  This is the number of years it takes to receive the presented weighted cash flows of the bonds in the portfolio. Duration is also the approximate change in the price of the fund's bonds for a 100 basis point (1%) move in yields.  If the yield on the 10-year Treasury note, for example, rises from approximately 2% now to 3% 12 months from now, then AGG could be expected to drop in price by roughly 4.5%.  Because the yield on AGG is approximately 3.2%, the total 12-month return would be around 1.3%.

You should be able to do the math and figure out the impact of a sharp rise of 2 -3% in rates.  For comparison purposes, the  ETF with symbol TLT indexes the longer maturity portion (20+ years) of the Treasury market and has a duration of 15.4 years.  For a period where yields change a lot,  this ETF will either hit the ball in the upper deck or strike out big time!

There are, of course, all kinds of bond ETFs available.  Most of my clients are with Schwab, and I rebalance frequently so I use Schwab's commission-free funds (SCHZ is Schwab's counterpart to AGG) which also have low expense ratios.  Some ETFs are devoted entirely to corporates; some index the international market.  There are low duration and high duration funds.  There are ETFs indexed to the mortgage-backed market.  All of these can be used to tailor the fixed income portion of a portfolio to fit a given interest rate outlook.  Here is a good source of bond ETFs:  Bond ETF List.

There are also many leveraged bond ETFs that can be used to magnify the impact of  increases and decreases in yields.  I would stay away from these unless you view yourself as a highly-seasoned trader and are positioned to take on the risk of these instruments.

Disclosure:  The information here is solely for educational purposes.  Individuals should do their own research or consult a professional advisor before making investment decisions.  I own some of the ETFs mentioned  here.

What is Negative Convexity?

Investors today are scrambling for yield, and one place they are looking is at funds of mortgage-backed securities. An example is MBB, a popular exchange traded fund, which is comprised of GNMA and FNMA mortgage-backed securities whose principal and interest payments are guaranteed by the U.S. Treasury.

Do-it-yourself investors know to consider the yield-to-maturity of funds along with the duration. These reveal the interest rate risk of a particular fund, and the key question is whether the yield compensates for the underlying risk.

This process is a bit trickier in the case of mortgage-backed securities because of negative convexity. Although ominous sounding, it is easy to understand.

Let's begin with the very first concept learned about bonds:  that yields and prices move in opposite directions. How much prices move when rates drop is determined by duration. The greater the duration, the greater the price volatility for given swings in yield. All of this depends on the coupon interest payment and the maturity of the bonds in the fund. But here's the kicker:  mortgage-backed securities don't have a maturity - they have an average life. And the average life changes as yields change. This is the callability feature of bonds in spades!

You may not have thought about this before, but you very likely have contributed to negative convexity by refinancing your mortgage. Because homeowners refinance when mortgage rates fall and hold on to mortgages longer when mortgage rates rise, the average life varies inversely with yields. In essence, you are buying bonds and not knowing their maturities! As a result, mortgages are considered to have an average life of 12 years.

The bottom line of all of this is that a fund of mortgage-backed securities will be paid off quickly as mortgage rates fall (in other words you have a portfolio of shorter term mortgages than you bargained for) and will extend in average life when interest rates rise. As a result, mortgage-backed securities tend to do well when yields stay within a given band (in other words, prepayment surprises are minimal) and under-perform when there are significant changes in rates.

Should you buy mortgage-backed security funds? It depends on whether you think mortgage rates will stay fairly stable or if you think they will go off on a trend upwards or downwards. It is very likely that many investors will be surprised if interest rates trend meaningfully higher over the next few years, as many observers think likely.

For the math geeks - duration is the first derivative of price change related to yield changes, and negative convexity is the second derivative.

How to Find the Most Actively Traded Bonds

One of the most comprehensive online free data sources available to DIY investors is at the Wall Street Journal site. For those who invest in individual bonds, it can be an excellent source to follow that market.

Click the drop down arrow at the "Markets" tab.

Source: WSJ

Source:Wall Street Journal

Click "Market Data Center" and you come to a number of tabs containing data on various market sectors.  I recommend puttering around on the "Calendars & Economy"  and "Earnings" sections when you have the time.

Next click the "Bonds, Rates, & Credit Markets" tab.

Source: Wall Street Journal

 CLICK TO ENLARGE Again, notice the data at your finger tips!

Click as indicated and we get the list of most actively traded corporate bonds. You'll notice a "print button" at the top of the page making it very convenient to print weekly or so to follow the bond market over time. The table can be used to get a good idea of yields on particular maturity and ratings for bonds. CLICK TO ENLARGE

Source: FINRA TRACE data. Reference information from Reuters DataScope Data. Credit ratings from Moody's®, Standard & Poor's, and Fitch Ratings.