Bond funds question
Discussion
This is highly likely to be a silly question.
Why is it that some bond funds show a negative 5 year cumulative return?
E.g. Royal London UK Government Bond Fund.
I'm not picking on this one particularly as it seems a lot of bond funds have a negative 5 year cumulative annual return.
This one is all UK government bonds so why does it have a -4.58% annualised return over the last 5 years?
If I was guessing I'd say it was because the fund value at some point has been higher that the bonds held within it but if that is right I don't understand how that happens.
Why is it that some bond funds show a negative 5 year cumulative return?
E.g. Royal London UK Government Bond Fund.
I'm not picking on this one particularly as it seems a lot of bond funds have a negative 5 year cumulative annual return.
This one is all UK government bonds so why does it have a -4.58% annualised return over the last 5 years?
If I was guessing I'd say it was because the fund value at some point has been higher that the bonds held within it but if that is right I don't understand how that happens.
Not a silly question. It's because most bond funds aim to maintain a constant target maturity (or rather, weighted average maturity across their holdings).
In order to do that, they have to sell bonds as they fall out of the desired maturity profile, rather than holding them to maturity. If rates have risen over the time that the fund has owned those bonds, it will be selling them at a loss, and whatever bonds it's held onto throughout that time will be marked lower - both those things being to the detriment of the fund's overall NAV. But it will then be reinvesting the coupons earned from its holdings into new bonds at higher rates, so in the end it will catch up.
In order to do that, they have to sell bonds as they fall out of the desired maturity profile, rather than holding them to maturity. If rates have risen over the time that the fund has owned those bonds, it will be selling them at a loss, and whatever bonds it's held onto throughout that time will be marked lower - both those things being to the detriment of the fund's overall NAV. But it will then be reinvesting the coupons earned from its holdings into new bonds at higher rates, so in the end it will catch up.
Edited by NowWatchThisDrive on Monday 27th January 12:55
The longer the average duration the greater the 5yr loss will have been. You have to consider duration to suit the job you want it to do. A popular intermediate fund like VGVA is relatively sensitive to the 10yr yield whereas a MMF will be linked to the overnight rate - which is generally stable. Longer duration - the bigger the move and also based on expectations rather than just current interest rates like a short-term fund is. VGVA prior to 2022 would have been consolidating bonds/gilts on low yields so when interest rates rise, which they did (quickly), those bonds and the aggregate of them became very unattractive to new buyers. So the unit price of the fund (what you pay) corrected (down) to allow it to pay the higher (attractive) yield on offer of new bonds. Going forward this has made bond funds much more attractive to a diversified portfolio in two ways - a higher (real) yield and also downside protection to equities. You always need to consider duration though.
Phooey said:
The longer the average duration the greater the 5yr loss will have been. You have to consider duration to suit the job you want it to do. A popular intermediate fund like VGVA is relatively sensitive to the 10yr yield whereas a MMF will be linked to the overnight rate - which is generally stable. Longer duration - the bigger the move and also based on expectations rather than just current interest rates like a short-term fund is. VGVA prior to 2022 would have been consolidating bonds/gilts on low yields so when interest rates rise, which they did (quickly), those bonds and the aggregate of them became very unattractive to new buyers. So the unit price of the fund (what you pay) corrected (down) to allow it to pay the higher (attractive) yield on offer of new bonds. Going forward this has made bond funds much more attractive to a diversified portfolio in two ways - a higher (real) yield and also downside protection to equities. You always need to consider duration though.
I'm wondering if it's more than just duration. RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
Derek Chevalier said:
I'm wondering if it's more than just duration.
RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
Individual holdings? A quick Google says RL holds approx 40 whereas the Agg 10000. Country specific too - RL is UK. I can see they are both accumulating so interested in your thoughts? But generally the longer the duration the higher the volatility.RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
trickywoo said:
it seems a lot of bond funds have a negative 5 year cumulative annual return.
There's a very simple answer. Following the so called GFC (Global Financial Crisis) in 2008 there followed an unusual period of very low interest rates. Even negative interest rates in some cases - so customers had to pay banks to hold their money! Bizarrely this period of very low interest rates and negligible inflation went on much longer than I felt it should of done. Then, suddenly, things reverted to normal with inflation taking off (thank you Mr Putin) and interest rates rising rapidly.The effect of this was that the fixed interest from bonds suddenly looked horribly low and the price of bonds fell until the "yield" came down to a current market level. It's been a very rough ride for bond investors. Some overall returns may have been nominally positive at say +1% p.a. but once you adjust for inflation it's not a pretty picture at all.
Panamax said:
trickywoo said:
it seems a lot of bond funds have a negative 5 year cumulative annual return.
There's a very simple answer. Following the so called GFC (Global Financial Crisis) in 2008 there followed an unusual period of very low interest rates. Even negative interest rates in some cases - so customers had to pay banks to hold their money! Bizarrely this period of very low interest rates and negligible inflation went on much longer than I felt it should of done. Then, suddenly, things reverted to normal with inflation taking off (thank you Mr Putin) and interest rates rising rapidly.The effect of this was that the fixed interest from bonds suddenly looked horribly low and the price of bonds fell until the "yield" came down to a current market level. It's been a very rough ride for bond investors. Some overall returns may have been nominally positive at say +1% p.a. but once you adjust for inflation it's not a pretty picture at all.
Well explained.
The inverse relationship between bond value and yield is so obvious, when given enough thought about the arithmetic, but some who never bother thinking about it, just assume that bonds are safe, especially gilts issued by the government.
The surprisingly long period of historically low interest rates, meant that many retail bond holders were completely unaware of what would eventually happen.
Making money with long dated bonds, is easy on extremely rare occasions. You need a period of very high interest rates, which are expected to fall. When circumstances are the other way round, tears can be expected. During 2022 and 2023, PHers were asking, "What has gone wrong with bonds". It was too late then, to find out about the inverse relationship. I wondered whether their advisors had warned about the certainty that would eventually take place. The 0.1% Bank of England base rate stayed at that level for eighteen months. If anyone really believed that such a low interest rate had become the norm, then clearly they had not studied history.
Panamax said:
There's a very simple answer. Following the so called GFC (Global Financial Crisis) in 2008 there followed an unusual period of very low interest rates. Even negative interest rates in some cases - so customers had to pay banks to hold their money! Bizarrely this period of very low interest rates and negligible inflation went on much longer than I felt it should of done. Then, suddenly, things reverted to normal with inflation taking off (thank you Mr Putin) and interest rates rising rapidly.
The effect of this was that the fixed interest from bonds suddenly looked horribly low and the price of bonds fell until the "yield" came down to a current market level. It's been a very rough ride for bond investors. Some overall returns may have been nominally positive at say +1% p.a. but once you adjust for inflation it's not a pretty picture at all.
I think you mean the price of the bonds fell and hence the yields came up to the prevailing market level. The effect of this was that the fixed interest from bonds suddenly looked horribly low and the price of bonds fell until the "yield" came down to a current market level. It's been a very rough ride for bond investors. Some overall returns may have been nominally positive at say +1% p.a. but once you adjust for inflation it's not a pretty picture at all.
As described by the OP, in many cases returns have not been positive, that’s exactly the point. Of course the tightening of credit spreads will have added to corporate bond fund returns over the period, but obviously not relevant for the UK Government bond fund referred to by the OP.
Edited by Sport_Turismo_GTS on Thursday 30th January 12:55
Derek Chevalier said:
I'm wondering if it's more than just duration.
RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
It’ll be the convexity of their holdings. RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
Put very simply the lower the coupon of a bond the height the convexity….convexity is the sensitivity of a bonds price to a change in yield. Low coupon bonds have a higher convexity…so when yield rise it loses more value than a bond with a higher coupon.
A bond is a series of cash flows….you have coupon payments typically every six or twelve months and then the final repayment of principal at the when the bond matures. The lower those coupon payments are the greater % of the return is paid at final maturity….so higher convexity/exposure to interest rates.
In a market where fund managers expect rates to rise they will seek out low coupon bonds as it will be a positive for performance and look like they are out performing the market.. However, managing a bond fund is a bit like turning an oil tanker. So when rates start rising those same low coupon bonds will be their kryptonite.
Personally because I don’t care about mark to market I’m very happy holding high coupon bonds…I own some bonds in my pension that pay a 9.95% yield. Bought them in 2008 when they were issued and will almost certainly own them until they mature in 2038.
Jon39 said:
Making money with long dated bonds, is easy on extremely rare occasions. You need a period of very high interest rates, which are expected to fall.
Panamax said:
Sport_Turismo_GTS said:
I think you mean the price of the bonds fell and hence the yields came up to the prevailing market level.
Which everyone could see from the context, but thanks for taking the time to point it out. Sport_Turismo_GTS said:
Panamax said:
Sport_Turismo_GTS said:
I think you mean the price of the bonds fell and hence the yields came up to the prevailing market level.
Which everyone could see from the context, but thanks for taking the time to point it out. Happy to be corrected
Cheib said:
Derek Chevalier said:
I'm wondering if it's more than just duration.
RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
It’ll be the convexity of their holdings. RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
Put very simply the lower the coupon of a bond the height the convexity….convexity is the sensitivity of a bonds price to a change in yield. Low coupon bonds have a higher convexity…so when yield rise it loses more value than a bond with a higher coupon.
A bond is a series of cash flows….you have coupon payments typically every six or twelve months and then the final repayment of principal at the when the bond matures. The lower those coupon payments are the greater % of the return is paid at final maturity….so higher convexity/exposure to interest rates.
In a market where fund managers expect rates to rise they will seek out low coupon bonds as it will be a positive for performance and look like they are out performing the market.. However, managing a bond fund is a bit like turning an oil tanker. So when rates start rising those same low coupon bonds will be their kryptonite.
Personally because I don’t care about mark to market I’m very happy holding high coupon bonds…I own some bonds in my pension that pay a 9.95% yield. Bought them in 2008 when they were issued and will almost certainly own them until they mature in 2038.
Sport_Turismo_GTS said:
If the inverse relationship between bond prices and yields was readily apparent to the OP, then the thread probably wouldn’t exist in the first place.
Bonds themselves are easy enough to understand - it’s when they’re in funds that the fund’s performance can be difficult to understand.Bits of my main work pension were defaulted into two bond funds - one just bumbled along exactly as hoped, the other got battered.
People said it would recover but I don’t see how it can (at least in any reasonable time) - once the fund has had to sell bonds at beaten down prices and crystallised a loss it’s going to take a lot to make that back again.
Cheib said:
I own some bonds in my pension that pay a 9.95% yield. Bought them in 2008 when they were issued and will almost certainly own them until they mature in 2038.
They don't happen to be those GM bonds? when they were teetering on chapter 11? I remember you patiently helping me through that minefield around then (back when you had a different username!) and am still very grateful about how that turned out.Edited by mids on Thursday 30th January 20:06
Derek Chevalier said:
I'm wondering if it's more than just duration.
RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
There are probably a few different things going on here:RL has a duration of 8.52 and is down around 20% over the last five years
Global Agg (hedged to GBP) is 6.43 and down around 5%
1) The RL fund is a government bond. While this probably can hold a small amount of credit risk, its performance is primarily driven by interest rates. In contrast the Global Agg fund has, by definition, a substantial allocation to credit. The extra carry combined with the contraction in credit spreads over the period will be a significant driver of the better performance.
2) By definition, a global fund can take exposure to a broad range of government and corporate bond markets - the changes in interest rates (and credit spreads) that have impacted UK Gilts are not the same across all markets
3) as already highlighted, the funds have a different duration and hence different exposure to changes in the level of rates.
In contrast
mids said:
Cheib said:
I own some bonds in my pension that pay a 9.95% yield. Bought them in 2008 when they were issued and will almost certainly own them until they mature in 2038.
They don't happen to be those GM bonds? when they were teetering on chapter 21? I remember you patiently helping me through that minefield around then (back when you had a different username!) and am still very grateful about how that turned out.GM and Ford were in crisis back in 2005 !
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