Why Investors Should Avoid Longer Dated Bond Funds and Today’s Other Top Stories

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Volatility is bad news for most private investors. Why? Yesterday’s post by A Wealth of Common Sense shows how wide swings in price, increases the temptation for many investors to make changes and short-term moves simply overwhelms an investor’s time horizon.

“Everyone gets the feeling that they can guess which way things will go next when there is the possibility for big moves.”

So how does that affect bond investors? AWoCS says that the longer the maturity, the higher the volatility. Therefore, long-term bonds have the highest volatility (along with the highest interest rates). Which generally means, investors are willing to take on higher risk with the expectation of higher returns.

AWoCS “My theory is that the more stable, shorter-term bonds don’t get nearly as much action from investors that try to time the movements of interest rates (and thus bond prices — remember, bonds and rates have an inverse relationship) because there isn’t nearly as much bang for your buck in those maturities.”

In retrospect this behaviour is easy to understand. The textbook rules for interest rate movements are fairly straight forward. Unfortunately, theory doesn’t always translate so neatly into practice in the financial markets.

AWoCS: “There will always be a seemingly no-brainer move for interest rates. Rarely does the market cooperate and do what everyone thinks should happen. Yes, rates will eventually rise.  But chances are you don’t have the ability to nail the timing and magnitude of that move by shifting in and out of different maturity bonds.”

Armed with this knowledge, the solution is simple. Steer clear of longer dated bond funds. This is more important now than it was in the past since there will be higher volatility in long-term bonds at lower interest rates because there isn’t the yield cushion there once was.

AWoCS: “Try not to confuse your tolerance for volatility. Most investors should be content to take their volatility in stocks and keep bonds at intermediate-term or less.  That way you avoid unnecessary fluctuations in the part of your portfolio that’s supposed to be used for stability (for both risk management and psychological purposes) and income.”

Hopefully that will help close the behavior gap as well.


Todays Other Top Stories

Municipal Bonds

BondBuyer: – Puerto Rico bank near default on muni bonds: Agencies. – Puerto Rico-based Doral Financial Corp. is likely to default on more than $150 million in municipal notes and bonds after regulators ruled that receivables from the commonwealth government can’t be included in Tier 1 capital, ratings agencies said.

BondBuyer: – Market Post: Reinvestment will start ‘food fight’ for munis, investors say. – Demand for municipal bonds will remain high through May and June, investors predict. “There’s going to be a food fight for any issuance that is coming,” a trader in Virginia said.

Bloomberg: – Dulles airport operator sells bonds for new metro line. – Travelers arriving at Dulles International Airport in northern Virginia will have a new option to get to downtown Washington — a direct transit line, partly financed by municipal bonds this week.

ETF Trends: – Long and short of it: Munis outshine in 2014 as demand holds. – Demand for munis continues to outpace supply and the result is the muni market is reflecting strength from the five year maturity range on out.

PBN.com: – R.I. bonds would be dropped to ‘junk’ status on 38 Studios moral obligation default. –  An assessment of the 38 Studios LLC moral obligation bond debt service conducted by SJ Advisors concluded that failure to repay the bonds would probably result in a downgrade of Rhode Island’s bond rating to “junk bond” status.


Treasury Bonds

Business Recorder: – Long bond drops after 30-year bond auction. – Thirty-year Treasuries sat out a modest US bond market rally and dropped on Thursday after the government sold $16 billion of new long bonds at unexpectedly high yields. The 30-year auction, the last of three this week by the Treasury Department selling $69 billion of new debt, came with a high yield of 3.440 percent, or over two basis points more than the market level signalled just before the auction.

Minyanville Pro: – Long-term Treasuries caught the haven bid. – If Russian money flowed back into Treasuries or if flight capital from elsewhere flowed into Treasuries, it seemed to be going into the long end of the yield curve, the last refuge of positive real returns.

Businessweek: – Treasuries fall for second day before economic reports this week. – Treasury 10-year notes fell for a second day before reports this week economists said will show retail sales rose and housing starts increased at the fastest pace this year, damping demand for fixed-income securities.


High Yield Bonds

Business Recorder: – Junk bond fund yields trounce peers as managers buy stocks to boost returns. – If you’re looking for top performing US junk bond funds, pick one that’s maxed out in stocks.

FT: – Some signs of dash-for-trash caution. – Ultra-loose monetary policy coupled with disinflationary pressures are keeping benchmark bond yields near recent and – in the case of Bunds – historic lows.

Morningstar: – Don’t chase high yields. – Investors should be wary about simply looking for the highest yields on offer. History shows that dividends from the highest yielding stocks can often be unsustainable.


Emerging Markets

FT: – Unholy EM trinity tempt investors with double-digit returns. – Argentina, Venezuela and Ukraine are the unholy trinity of emerging market debt, their double-digit returns tempting investors to ignore fears about civil war, crippling inflation and legal battles.


Investment Strategy

LearnBonds: – Bond market bears should bear this in mind. – Much to the embarrassment of countless bond market strategists, 2014 has been quite a good year for intermediate- to long-term Treasuries. After closing 2013 above 3% on the 10-year Treasury and near 4% on the 30-year Treasury, yields have dropped roughly 40 to 55 basis points respectively. Similarly, 2014 has been a positive experience for corporate bond investors.

David Schawel: – Why fixed income investors are once again turning to leverage. – Investors and strategists aren’t in love with high yield—nor are they counting on price appreciation—but they seem to reckon they can collect coupons since a turn in the credit cycle doesn’t appear imminent. They reason that with current annual default rates under 2% the actual loss adjusted yields are reasonably attractive.

Think Advisor: – Forget bonds; Your portfolio needs ‘James Bond’. – Jeffrey Kleintop of LPL Financial says: “There are no opportunities” in the bond market, he said, and “there’s no ‘high’ in high yield.” Instead, he recommended that advisors put some “James Bond” in clients’ portfolios, by which he meant not “cool gadgets” as seen in the Bond movies, but alternatives like REITs, business development companies (BDCs) and MLPs.

WSJ: – Bill Gross cut mortgage-backed bond holdings in Pimco bond fund in April. – Bill Gross kept U.S. government-related holdings steady while cutting mortgage-backed securities in the Pimco Total Return Fund in April as U.S. fixed-income markets strengthened broadly in April.

FT Advisor: – Should investors go short or long? – Markets may have surprised last year but since the end of 2013 the global economy has gone rather quiet in places. Ian Winship, manager of the BlackRock Absolute Return Bond fund, insists it is an “interesting time” for the macro economic environment. He cites the news on April 30 which revealed US growth slowed to just 0.1 per cent in the first quarter of 2014. This suggests the severe winter in the country was far more of a headwind than predicted.

FT Advisor: – Bonds are under the spotlight again. – With concerns about rising interest rates and the great rotation into equities, many investors are questioning whether bonds can deliver the stable, solid returns we have become used to.


Bond Funds

US News: – 3 Things to know about bond funds. –  You get virtually nothing on your savings or certificates of deposit, interest rates on home mortgages are low, as are interest rates on bonds. Investing in bond mutual funds is a challenge for investors. Here are three things to know about your bond funds.

NASDAQ: – Vanguard total bond market ETF experiences big inflow. – Looking today at week-over-week shares outstanding changes among the universe of ETFs covered at ETF Channel , one standout is the Vanguard Total Bond Market ETF (Symbol: BND) where we have detected an approximate $57.2 million dollar inflow.

WSJ: – Bond Funds: The new frontier. – Investors in pursuit of higher yields have poured billions of dollars into so-called nontraditional bond funds. But they may not be aware of the added risks the funds could pose, financial advisers say.

BondBuyer: – Bond Ratings: Two sides to transparency. –  Increased transparency in the bond rating agencies has been a positive for both investors and issuers, even though it can potentially create a false sense of analysis being an exact science, experts told fellow municipal analysts on Thursday.

CNBC: – Is a bond selloff looming? – With the era of zero interest rates nearing its close in the U.S., some analysts are beginning to worry that bonds on the short end of the yield curve may face a selloff.

Reuters: – DoubleLine says hires 2nd Pimco employee for mutual fund operations. – DoubleLine Capital, the bond management firm run by Jeffrey Gundlach, on Monday said it had hired its second employee from rival Pimco as the Los Angeles-based company continues to build out into new lines of business.




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