Bond investors should rethink strategy as interest rates rise
I kept record of VAB's YTM at the time. This allows me to compare the YTM of VAB, on January 31, 2014, to VAB's annualized return over the two-year period spanning until January 31, 2016.George Young wrote:One of the more vexing questions facing investors in 2014 is what to do with the fixed-income portion of their portfolios. After enjoying decades of stable and consistent returns, the traditional fixed-income landscape no longer offers many attractive opportunities. Despite the strong rally in bonds to start this year, there is real concern that 2014 may produce negative returns, echoing last year’s. For bond investors, it is a case of fool me once, shame on you, but fool me twice – shame on me.
VAB's YTM on January 31, 2014: 2.43%
VAB's 1-year return on January 31, 2015: 11.09%
VAB's 1-year return on January 31, 2016: -0.89%
=> VAB's 2-year return on January 31, 2016: ((1 + 11.09%) X (1 + -0.89%))^(1/2) - 1 = 4.93%
Past returns are not indicative of future returns.
I simply don't understand why many investors continue to believe that they can predict a bond ETF's future return using such a simplistic metric as the average YTM of bonds in the ETF. In the short term, reaction to yield movements across all maturities dominates returns (e.g. 11.09% in 1 year, above). In the long term (2 X duration), the initial YTM of new bonds bought with reinvested principal dominates returns. In between, both factors impact returns.
The thing is that no one can predict future yields. So, no one can predict short-term returns (would need to predict yield movements across all maturities), nor long-term returns (would need to predict the initial YTM of bonds bought in the future), nor anything in between (would need to predict both) for an aggregate bond index ETF.
So, which is best, today: investing in VAB at an average YTM of 1.90% or in a 5-year Oaken GIC at 2.50%? Or, maybe it's time to rebalance into stocks?
* Vanguard Canada's Canadian Aggregate Bond Index ETF.