Time to bail out of bonds?

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big easy
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Time to bail out of bonds?

Post by big easy »

With VAB (aggregate bond index) yielding 1.6% to maturity and VSC (corporate 1-5 year bond index) yielding 0.9% to maturity, I can do almost as well or better with a 1 year GIC and not face the prospect of a capital loss if interest rates go back up. Does anyone seriously consider that interest rates could go lower? Even high interest savings accounts yield 1% or more.
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Re: Time to bail out of bonds?

Post by Lazy Ninja »

big easy wrote:Does anyone seriously consider that interest rates could go lower?
TD seems to think so

I just checked and my fixed income component is about 58% GICs, 19% ZCM, 15% VAB and 8% ZRR. Total fixed income is currently about 29% versus my target of 31%, so I probably won't be changing anything too drastically for now. I've been trying to talk myself into adding to the small amount of ZRR I bought on Dec. 27, 2013 at $15.70 without much luck. Overall, I find it very frustrating, but plan to just stay the course for now.
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big easy
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Re: Time to bail out of bonds?

Post by big easy »

I'm about 13% GIC ladder, 12% RRBs and 25% short corporate bonds (VSC, ZCS). The next time I roll over a GIC it will be to buy a 5 year at 2%. It's all getting to be a bit much. Except for my RRB's, I feel like the proverbial guy in the poker game who doesn't know who the sucker is.
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Re: Time to bail out of bonds?

Post by westcoastfella »

I'm 100% in Canadian convertible debentures for my fixed income with an average YTM of nearly 5.5%, and FI only accounts for about 15% of my overall portfolio vs a target of 25%. Certainly riskier than blue-chip bonds, but they produce the yield that I desire for this class with a reasonable amount of safety, assuming I choose well. With so little of my portfolio tied up in them, its a risk I'm willing to take.

To the OP's point, I agree that there is simply not enough money in investment grade bonds to be worth it now - everything worthwhile seems to trade above par so you will incur a cap loss at maturity, yields are nothing special, and the potential upside of lower rates (and therefore higher values temporarily) is too small to make it worthwhile. I'd just as soon go to GIC's for the same (or better) yield and no capital loss if I were interested in this sector.

As long as we're not at zero, interest rates can always go lower :wink: . Its hard to fathom, but at the same time, who thought we'd be at rates this low for this long after 2008/09? If oil stays low for a long time, or if Europe actually does split up, I think you'd see another drop or two.
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Re: Time to bail out of bonds?

Post by Springbok »

I have no GICs, no bond etfs, no rrbs, no bond mutual funds and no FI yielding less than about 3.5%. Mostly investment quality corporate bonds and debentures in a 6yr ladder. Also, have some retractable pfds that are bond-like.

Nothing foreign, but thinking about it. Possibly with hedging.

Those ultra low rates in first post are for the risk averse! With a little added risk we can do a lot better. Can't see earning negative real returns.

Personally, I am working on basis that there will be no increase in interest rates for some time. And they may even drop a little.
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Re: Time to bail out of bonds?

Post by longinvest »

big easy wrote:With VAB (aggregate bond index) yielding 1.6% to maturity and VSC (corporate 1-5 year bond index) yielding 0.9% to maturity, I can do almost as well or better with a 1 year GIC and not face the prospect of a capital loss if interest rates go back up. Does anyone seriously consider that interest rates could go lower? Even high interest savings accounts yield 1% or more.
For one thing, I wouldn't compare the YTM of such a complex bond fund as VAB to a GIC rate. VAB's YTM is not a promise of future return. For another thing, I don't know what else I could use other than bonds as ballast for stocks in my portfolio.

So, as usual, I'll ignore the noise and stay the course.
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Re: Time to bail out of bonds?

Post by SoninlawofGus »

westcoastfella wrote: As long as we're not at zero, interest rates can always go lower :wink: .
Lower than that. Swiss 12-year bonds recently went below zero. Many of our bonds are already well below zero in real returns. I somehow doubt nominals will go negative, or if they do, only the very short stuff, but it's clearly possible.

FWIW, in Dec/Jan, I sold all of my long bonds, and most of my mid-term stuff, just before the rate drop -- so not the greatest timing, but I'll take it.
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Re: Time to bail out of bonds?

Post by OptsyEagle »

You could take a look at Aberdeen Asia Pacific Income Fund (Symbol FAP in Toronto). This is a fund that invests in fixed income securities of mostly Asian countries and other emerging markets like Brazil, etc. I think over 2/3rds of the fund are sovereign government bonds and the rest are mostly higher grade corporate bonds. They work hard trying to manage the currency exposure as well. Right now it yields around 9% and pays monthly. This closed end fund traded at a premium to it's NAV for years, but currently is trading at around a 7% discount.

I suspect as bond managers work devilishly hard trying to find higher yield, in todays bond market, these bonds will not stay overlooked for too long. I would expect a pretty good increase in the NAV as these bonds get snapped up. Our world is only so big and even if most bond fund managers allocated 1% of there mega billion dollar funds to emerging markets, the high yields on these bonds won't stay this high for too long. That is my thesis, anyways. As always, don't bet the farm.

Like any fixed income ETF or bond fund these days, one should expect the yield to reduce, over time, as the older bonds mature and new bonds at lower yields are purchased, but at a 9% yield, I suspect it will beat most bond ETFs for many, many years into the future.
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Re: Time to bail out of bonds?

Post by zinfit »

I have 2/3's of my RRSP in bonds and GICs. They laddered over an 8 year period and have a strong emphasize on corporates. According to my math it yields about 4% per year. My basic goal is to beat inflation and to preserve capital. When you getting close to 70 that's important. I am not sure that we aren't going to see deflation in the years ahead. If I am right their in room for some capital gains on these bonds. I am thinking of buying some corporate bond ETFs with a maturity date. They appear to offer competitive if not superior rates and reduce the risk of a default. Curious what thoughts people might have on the ETFs with maturity dates.
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Re: Time to bail out of bonds?

Post by Springbok »

Thanks for the FAP suggestion. I will have a look at it. Any other similar funds/etfs for comparison purposes?

What got me interested in foreign bonds, was reading a FP article about why low rates may be here to stay (I think the article is simplistic and does not take into account other factors). But it did include the ~Jan 2015 chart below that includes 10yr bond rates. Not sure I want to be in some of the higher yield countries!
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Re: Time to bail out of bonds?

Post by ockham »

To answer the question posed by this thread, I return to the basics: why hold any fixed income in the first place? what role is fixed income supposed to play in one's portfolio?

The answer (for me, in any event): the reason one holds fixed income and the role it plays is (i) to ensure (with a cushion) that short and medium term liabilities can be paid, and (ii) to guard against self-destructive behaviour when equity markets behave badly.

The low current rates of return on fixed income don't change those basics. Indeed, one might argue that the current low rates mean that, in order to meet objective (i) (paying short to medium term liabilities), one should increase one's fixed income holdings.

Me, I will continue to buy new rungs as old rungs mature.

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Re: Time to bail out of bonds?

Post by scomac »

ockham wrote:To answer the question posed by this thread, I return to the basics: why hold any fixed income in the first place? what role is fixed income supposed to play in one's portfolio?

The answer (for me, in any event): the reason one holds fixed income and the role it plays is (i) to ensure (with a cushion) that short and medium term liabilities can be paid, and (ii) to guard against self-destructive behaviour when equity markets behave badly.

The low current rates of return on fixed income don't change those basics. Indeed, one might argue that the current low rates mean that, in order to meet objective (i) (paying short to medium term liabilities), one should increase one's fixed income holdings.

Me, I will continue to buy new rungs as old rungs mature.
Excellent post ockham! :thumbsup:
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Re: Time to bail out of bonds?

Post by AltaRed »

scomac wrote:Excellent post ockham! :thumbsup:
Ditto for me. Precisely the reasons I hold the mix of FI that I do.
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Re: Time to bail out of bonds?

Post by ghariton »

AltaRed wrote:
scomac wrote:Excellent post ockham! :thumbsup:
Ditto for me. Precisely the reasons I hold the mix of FI that I do.
Tritto,

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Re: Time to bail out of bonds?

Post by zinfit »

I am starting to think we are following the long term pattern that Japan went through. With the debt levels that western countries have any significant interest rate increase will bring on a whole of problems. I don't think it's a realistic option. I also believe that over capacity will prevent any inflation problems. Look no further then oil.
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Re: Time to bail out of bonds?

Post by OptsyEagle »

Springbok wrote:
Not sure I want to be in some of the higher yield countries!


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As I said, I would not bet the farm, but on the other hand, what is the risk of buying Italian bonds and getting 1.69% return for your investment risk, or Spain at 1.53%. Do you really want to pay Switzerland 0.27% a year to hold onto your money?

The main point I am making is, if you are a bond fund manager charging 1.5% management fees, so that you can make a living and give a small fee to the advisor that is still finding you money, you have only about 3 choices to make, these days. Either buy bonds of developed countries, like Italian, Spanish, US, Canadian and let's say German yields. Let's say about 1.5% gross yield. So with the required fees, there is virtually nothing left for the investor. How long can that last. So your 2nd other choice is to lower your fee. Remember, from the 1% they keep, 0.20% is HST (13% of 1.5%), easily 0.25% will go to operating costs, so what's left; 0.55%. Even if you are willing to drop your management fee by 0.50% and drop your profits by 90%, you are still only providing a rate of return to the investor of 0.50% per year. A high interest savings account will beat that.

So now we come to option number 3. Increase your yield. This means ravaging through the corporate bond market and of course the emerging markets, and I would say the corporate bond market has already been pretty much ravaged through already.

I cannot say for sure, but I am betting more then a few of those bond managers are going to start buying those higher yielding countries that you are currently so concerned about. Compared to corporate bonds, I would bet most of them are a lot safer, especially if you hedge out the currency risk.

All this is just my opinion.
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Re: Time to bail out of bonds?

Post by AltaRed »

zinfit wrote:I am starting to think we are following the long term pattern that Japan went through. With the debt levels that western countries have any significant interest rate increase will bring on a whole of problems. I don't think it's a realistic option. I also believe that over capacity will prevent any inflation problems. Look no further then oil.
I am now more inclined to also believe we will have low interest rates (relative to the past) for a very long time, partly for the reason you suggest, but also partly because global GDP growth is not likely to return to historical levels. Demographics, environmental sustainability, planetary constraints on population growth, etc. will all conspire to reduce consumption on a per capita basis. IOW, being satisfied with less.

I also am beginning to believe BRIC type nations will not impact global GDP growth in the way we would normally predict. India and China especially will grow but I see that mostly as self-contained consumer growth, not overly dependent on imports beyond luxury goods. Russia, in my opinion, will always be dysfunctional, if nothing else, due to self-inflicted cultural behaviours and Brazil is just a higher form of a dysfunctional banana republic.
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Re: Time to bail out of bonds?

Post by ig17 »

OptsyEagle wrote:I cannot say for sure, but I am betting more then a few of those bond managers are going to start buying those higher yielding countries that you are currently so concerned about. Compared to corporate bonds, I would bet most of them are a lot safer, especially if you hedge out the currency risk.
You cannot hedge out the currency risk of the high yielding emerging markets. The cost of hedging is directly tied to the interest rate differential.
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Re: Time to bail out of bonds?

Post by SoninlawofGus »

OptsyEagle wrote: So now we come to option number 3. Increase your yield. This means ravaging through the corporate bond market and of course the emerging markets, and I would say the corporate bond market has already been pretty much ravaged through already.

I cannot say for sure, but I am betting more then a few of those bond managers are going to start buying those higher yielding countries that you are currently so concerned about. Compared to corporate bonds, I would bet most of them are a lot safer, especially if you hedge out the currency risk.
But there is that pesky historically high default risk in emerging markets. I would not even attempt quantify the risk, but as others have written, I hold FI primarily for stability.
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Re: Time to bail out of bonds?

Post by OptsyEagle »

You cannot hedge out the currency risk of the high yielding emerging markets. The cost of hedging is directly tied to the interest rate differential.
Agreed. I believe a lot of their hedging is done by buying bonds denominated in $US. They don't profess to hedge out all currency risk, probably due to the reason you stated.

As for the default risk, that is the reason for the high yield. If you get an 8% yield and 1% default, you are left with 7%. I doubt 6% to 7% of the bonds in this portfolio are going to default, each and every year, to the point where your yield is less then what you would get if you invested in those so called safe developed world bonds. By the way, I am not all that warm and fuzzy lending money to these over-indebted countries like Spain, Italy and even the United States of America, for that matter.

In any event, it might make a good piece of a diversified fixed income portfolio for some people. I am not planning on holding on to it for the long term. I expect it to rise over the next year or so as those bond fund managers scramble to find new ideas, in what has become a very limited idea pond, for bonds.

As always, I could be wrong.
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Re: Time to bail out of bonds?

Post by scomac »

When is a bond not a bond? There have been several suggestions how to eek out extra return on the fixed income side of the portfolio, but compared to some of these things, like EM debt, I'll take my chances with common equity traded on a NA market thank you very much.

Perhaps the better approach is to determine just how much withdrawal risk you need to defease; do that with the least possible risk and then look for returns elsewhere and don't lose sleep over the paltry yields on investment grade debt. You can go a long way to removing that risk with as little as 30% spread across a 5 yr. GIC ladder and a bit of a cash buffer for current year expenses as well as emergency funds.

That would make for a pretty aggressive portfolio by most measures and yet it seems intuitively safer to me that trading good quality blue chip stocks in for sketchy debt just to hit some predetermined asset allocation and performance targets. Yes, you have to have the stomach for a roller coaster ride, but the risk of having to cash out equities at the worst possible time to meet withdrawal needs has been pretty well covered off in all but the most serious of scenarios. Furthermore, when you go out on the credit quality yardstick looking for extra yield there's no guarantee that you won't end up having a bumpy ride anyway!
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Re: Time to bail out of bonds?

Post by SoninlawofGus »

OE, you could be right, of course. But consider that the distributions within ETFs or funds may not be equal. FAP, noted above, has 17% exposure to Indonesia and 16% to India. If either default, your losses would be a lot more than 1% -- not to mention the reverberations across the EM debt market.

Added: I would be remiss in not mentioning that I checked on the two countries above, and are rated BB+ and BBB- stable.
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Re: Time to bail out of bonds?

Post by gsp_ »

scomac wrote:When is a bond not a bond? There have been several suggestions how to eek out extra return on the fixed income side of the portfolio, but compared to some of these things, like EM debt, I'll take my chances with common equity traded on a NA market thank you very much.

Perhaps the better approach is to determine just how much withdrawal risk you need to defease; do that with the least possible risk and then look for returns elsewhere and don't lose sleep over the paltry yields on investment grade debt. You can go a long way to removing that risk with as little as 30% spread across a 5 yr. GIC ladder and a bit of a cash buffer for current year expenses as well as emergency funds.

That would make for a pretty aggressive portfolio by most measures and yet it seems intuitively safer to me that trading good quality blue chip stocks in for sketchy debt just to hit some predetermined asset allocation and performance targets. Yes, you have to have the stomach for a roller coaster ride, but the risk of having to cash out equities at the worst possible time to meet withdrawal needs has been pretty well covered off in all but the most serious of scenarios. Furthermore, when you go out on the credit quality yardstick looking for extra yield there's no guarantee that you won't end up having a bumpy ride anyway!
Well said. :thumbsup:
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Re: Time to bail out of bonds?

Post by big easy »

scomac wrote:
ockham wrote:To answer the question posed by this thread, I return to the basics: why hold any fixed income in the first place? what role is fixed income supposed to play in one's portfolio?

The answer (for me, in any event): the reason one holds fixed income and the role it plays is (i) to ensure (with a cushion) that short and medium term liabilities can be paid, and (ii) to guard against self-destructive behaviour when equity markets behave badly.

The low current rates of return on fixed income don't change those basics. Indeed, one might argue that the current low rates mean that, in order to meet objective (i) (paying short to medium term liabilities), one should increase one's fixed income holdings.

Me, I will continue to buy new rungs as old rungs mature.
Excellent post ockham! :thumbsup:
I agree that fixed income is to provide ballast to one's portfolio. However, I'm not sure traditional fixed income fits the bill anymore. Taking XBB or VAB as the widely accepted benchmark for fixed income with a ytm of 1.6% and duration of around 7, a 1% increase in rates will not be recovered through yield for 3 years (round numbers). So instead of providing ballast, FI may well serve as an anchor.

If you prefer to buy individual bonds, then you can fill your boots with negative real yielding bonds and hold them for the next five years thereby guaranteeing a loss of capital via inflation.

My suggestion was that ultra-short bonds, 1 year GICs or high interest savings could provide the same yield without the risk of negative returns for multiple years. The only justification to hold a universal bond fund at this point is to offset the risk of deflation. Even then, at some time we're going to return to normal.
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Re: Time to bail out of bonds?

Post by like_to_retire »

scomac wrote:When is a bond not a bond? There have been several suggestions how to eek out extra return on the fixed income side of the portfolio, but compared to some of these things, like EM debt, I'll take my chances with common equity traded on a NA market thank you very much.
Yeah, I have to say, that I would much rather bet on a stock like BCE in Canada with its tax advantaged and stable 4.65% yield and multiple years of dividend increases than a "fixed income" bond from Azmanistan at 7%.

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