So I am still catching up with some of the more interesting reads from while I was away, and this THIS damned cover made me fall off my chair:

 


Source: Barron’s

 

A few words about this: The classic magazine cover contrary indicator is a non-business press issue. This is because by the time a specific financial issue reaches the cover of a mainstream media, the entire world has already made the trade. Its late, and all that’s left are the suckers coming in to top tick the trade.

Regardless, there is something terrible disconcerting about a cover story on bond funds AFTER a 30 year bull run in fixed income instruments.

My point of view on bonds as investments or income sources is simple. Here are 5 points to know:

1. Ladder:  Owning individual bonds in a ladder (no longer than 7 years) is much preferred to bond funds. If and when rates go up, you get to replace the specific holdings with higher yielding issues (note that if this happens, inflation is likely higher)

2. Independent Credit Risk Analysis: Work with Bond managers who do their own due diligence and have a deep research division. DO NOT WORK WITH ANY MANAGER THAT RELIES ON Moodys or S&P for credit ratings. These firms are worthless money-losers who sold out inmvestorsd to iBanks the last crisis. They should have been put down like rabid dogs. If you invest based on their “analysis” you will deservedly lose money.

3. Bond ETFs/Indexes: If you cannot afford a ladder, consider bond ETFs that are more like indices. I like shorter term Treasuries, high quality Corporates, and (non-bank) emerging markets bonds.

4. Income/Yield: You can create a yield/income portfolio, but only if you understand there is more risk involved and are willing to accept the loss of principle. (See this).

5. Bond Funds Have Different Risks than Bonds If you buy a quality bond, and hold it to maturity, you will get your money back. Sure, a treasury can move up and down but held to maturity it will pay back its investment. Not so with all bond funds. If markets go topsy turvy and a bond fund faces redemptions, they sell what they can, sometimes at a loss.  Hence, its another risk factor versus bonds or bond ETFs.

That is my short bond lecture. Now go enjoy your Summer Friday!

Category: Contrary Indicators, Fixed Income/Interest Rates

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

26 Responses to “Uh Oh: Barron’s Cover — Best Bond Funds”

  1. machinehead says:

    Barron’s hyping bond funds on the cover? Oh, my! As yields go negative, frayed-collar journos suddenly fall in love with bonds, as zombie banks buy them hand over fist.

    What is wrong with this picture?

    To BR’s five-point bond lecture, let’s add a sixth, which partially contradicts no. 3. Quoting from David Swensen’s highly-recommended Pioneering Portfolio Management, page 6:

    Most asset classes contain investment vehicles exhibiting some degree of agency risk, with corporate bonds representing an extreme case.

    Structural issues render corporate bonds hopelessly flawed as a portfolio alternative.

    Shareholder interests, with which company management generally identifies, diverge so dramatically from the goals of bondholders that lenders to companies must expect to end up on the wrong side of nearly every conflict.

    To paraphrase the buttoned-down Swensen:

    ‘We don’t need no stinkin’ corporates!’

  2. eclane says:

    I like bond funds myself, especially the simple to understand investment grade corporate bond fund index ETF, LQD. It outdoes nearly all of Barron’s picks. With its own internal turnover, I believe interest rate risk is less than meets the eye, especially nowadays.

  3. dead hobo says:

    BR observed:

    Regardless, there is something terrible disconcerting about a cover story on bond funds AFTER a 30 year bull run in fixed income instruments.

    reply:
    ———-
    True, but who could have guessed the 30 year at about 2.6% was not something to panic about? Normally, most people would agree with you on your observation. But today you still have Europe trying to save itself from too much borrowing by more lending to countries who will never pay anything back … unless those amounts are borrowed first. Greece appears to even need to borrow the interest to pay on their debt. Come on … let’s see a show of hands … Would You Lend Your Own Money to Greece (Not OPM as an asset manager but you’re own retirement savings)? How about Spain or Italy long term?

    You have the southern half of the continent wanting cash from the northern half of the continent, and nobody want to take a loss for some bad prior decision making. There’s also a sense of entitlement wafting about in the southern regions. Then there’s the French … God only knows what they’ll do next year. But you know they will be real pissy about it.

    Then you have Finland, who is ready to tell the entire EU to go screw itself. Good for them. Who’s next? Germany via popular outcry or their court system?

    There is still a slight possibility the ECB will print a couple trillion euros and leverage the ESF or some new caricature of a banky kind of ‘mechanism’ (ha ha, great word .. mechanism in that context. Europeans are funny.)

    Then the China growth engine is turning out to be only normal expansion and not SuperCountry waiting to fly into battle against economic deterioration. Wall Street appears to expect Chinese corruption to prevail and print more money in unlimited quantities so more empty malls and population-free cities can be built. It’s a good day to buy stocks with that kind of algo programming running the S&P.

    Actually, I think the 30 year might still have room to move a little so bond pries rise some more. Maybe even after Twist ends.

  4. Mike in Nola says:

    Agree with 5 and think it’s the most important. Since ZIRP, treasuries are pretty worthless for income unless you bought individual bonds with a good rate and can hold onto them for the interest. Those 8% zero coupons we got in the 80′s paid through thick and thin.

    Over the past few years have been doing bonds for the capital gains, not interest which is pitiful. Following A. Gary Shilling on that one. He recently said he couldn’t care less about the interest.

    Most bond funds trade too much and suck up gains in management fees. They generally have no fixed maturity, so you can’t hold them to maturity if rates rise, even if the funds average maturity is only a few years. If rates drop, they trade the winners off immediately, so you don’t get to keep the higher income you might have bought.

    I found a couple of funds we were more or less forced to buy in my wife’s PCRA because they don’t let you buy individual securities. I suppose they wouldn’t get the kickbacks if you could. Anyway, I found a couple that have done about as well as expected, BTTRX and BTTTX, both are zero coupon funds with fixed maturity and about .5% fees. If you were shooting for interest, the funds would be foolish, but for capital gains they work nicely, one being up about 30% in the last year and another 20%. If the worst happens you can always hold them to maturity but plan to trade them off when I figure the run is done.

    Not trying to sell anyone on these as we may be near the the end, you have to be convinced yield is going a lot lower to be willing to be in them.

  5. sureseam says:

    Am old enough to remember the 1980s and, back then, it seemed impossible that interest rates would fall back down towards long term averages. But the unthinkable happened and they kept dropping.

    Now it seems impossible that interest rates will rise towards long term averages. But I think they will.

    Oh sure, there is lots of conventional wisdom and rationales that project low interest rates out into the distant future. Among educated folks you can find a logic to match whatever you want to believe, or whatever the politicians want you to believe.

    So yes I regard that magazine cover as a contrary indicator … writ large.

  6. Mike in Nola says:

    Deadhobo: You are certainly a cynic.

    I do expect rates to drop more DESPITE twist. If you compare the charts with the dates of twist, you find that twist had little overall positive effect on rates. The rates were already heading down when twist started. In fact, rates increased after twist got swinging, since (my theory) it encouraged risk on behavior. The real movement in bonds has been caused by fear and, as you point out, there is a lot more of that to come.

  7. Mike in Nola says:

    @sureseam: you are, no doubt, right in the long run. But, as Keynes said….

    Rates will eventually go up, but that is not immediate with no recovery and more bad things in the offing.

  8. Petey Wheatstraw says:

    I’m surprised they could get Kevin Costner to do the cover.

    Mike in Nola:

    No matter how gingerly we keep tiptoeing around it, eventually, the gorilla will wake up.

  9. Gridlock says:

    Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data, ability to repeat discredited memes, and lack of respect for scientific knowledge. Also, be sure to create straw men and argue against things I have neither said nor even implied. Any irrelevancies you can mention will also be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

    Best Comments Section intro ever…

  10. dead hobo says:

    Mike in Nola Says:
    July 13th, 2012 at 9:41 am

    Deadhobo: You are certainly a cynic.

    reply:
    ———
    Less than you might think. Please provide a scenario where Europe actually recovers without soaking the north to subsidize the south. Please include evidence of a desire for beggar nations to change their ways.

    Also, agree somewhat about Twist. It has only assisted in keeping down 30 year rates. It might have made a little difference. But without positive growth not accompanied by economic drag, rates will remain low a while longer. Also, just because the news cycle has chosen to ignore Europe for a few weeks and Europe has put on a Happy Face by creating and/ or promising to plan to create mechanisms and other whatchamacallits, they still are only running on hopes and ponzi borrowings.

    Look, I really want the 30 year to go back to about 4.5%. I can use the riskless cash. As long as commodity prices remain low due to no new Fed printing or Chinese capitulation to Wall Street types around the would, the US will continue to improve. I have Pollyannaish hopes about China. Europe is toast until they get real about cleaning up their financial mess.

    How much would you loan to Greece from your wife’s retirement fund?

  11. dead hobo says:

    Mike in Nola,

    PS, I kind of misread your reply a little. Please reduce the tone of my reply by 2/3.

  12. as BR begins to illuminate, w/..

    5. Bond Funds Have Different Risks than Bonds If you buy a quality bond, and hold it to maturity, you will get your money back. Sure, a treasury can move up and down but held to maturity it will pay back its investment. Not so with all bond funds. If markets go topsy turvy and a bond fund faces redemptions, they sell what they can, sometimes at a loss. Hence, its another risk factor versus bonds or bond ETFs.

    LSS: (Open Ended) Bond Funds are for Fools.

    http://www.knowyourphrase.com/phrase-meanings/fool-and-his-money-are-soon-parted.html

    http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus-ns-aaf&v%3Aproject=clusty&query=Barnum+A+Fool+and+His+Money+T.+Tusser

    “Diversify. Leave it to The Professionals.”

    Simple Ideas, grafted to the wrong root, have generated multi-Billions for the propagators (of them..)

    and, Obviously, have left Less, Financially and Economically, for those that did, in fact, provide the feedstock, in the first place..

  13. lonr505 says:

    Given the “financial-ization” of many companies, lots of retail investors already are heavily invested in bonds, probably without them knowing it.

    ex, if you own GE, you vicariously hold a big portfolio of debt via GE Capital.

  14. sureseam says:

    BR: a quick question.

    In point 3 you mention ETFs based on short dated Treasuries, but not ETFs based on index linked Treasuries. Is there a reason for this? Or any wisdom to share on this point?

  15. machinehead says:

    sureseam — I’ve simulated the performance of TIPS back to 1941. When interest rates are falling, conventional long Treasuries are the place to be. But when they’re rising, TIPS can be a good defensive bond holding.

  16. philipat says:

    That’s good advice Barry. Bond Funds seem to be about the only thing left that use mark to market accounting, so in times of turmoil or stress, redemptions can indeed lead to substantial losses. I learned this the hard way before I really understood it. The lesson I took away from that was never to invest in something that you don’t fully understand.

  17. Bridget says:

    Yields on quality short to intermediate term bonds are so low these days that fund manager’s fees would eat up all the returns were it not for the fact that they are loading up on dreck.

  18. kaleberg says:

    “willing to accept the loss of principle”

    I’m guessing you meant “principal”, but I like this version better. (Sort of along the lines of “Save your principal. Lose your principles.)

  19. katland says:

    I don’t understand the stock market and have always viewed it as a manipulated game. Like they say, if you don’t know who the sucker is at the table, you are the sucker. My investments have been primarily in Muni bonds, commercial and residential rental units, and private lending secured by adequate collateral. Transparency in Muni Bond spreads used to be very opaque but websites like “investinginbonds.com” have somewhat leveled the playing field for amateurs like myself. You still need a good broker with access to good inventory and who will call you first when a good deal comes up. To get the best prices it is best to buy in increments of at least 100k. I only bought 30 year, new issue, high volume, high quality bonds with a proven revenue stream. Ie, Manhatten Water Utility etc. The earliest call date was to be no earlier than ten years and the coupon had to be at least 5% but 6% was possible. For the past few years I have not bought any MUNIS because the low yields are not worth the risk. Muni risks include default and inflation. I plan to hold the bonds until they are called or mature. In my tax bracket a 5% muni has a tax equivalent yield of just under 9%. Several years ago I did a seven figure self-directed Roth IRA conversion and do a lot of my private lending through that vehicle with yields averaging in the 10 to 20 percent range tax free. Sometimes I do a blended loan where there are two different pieces, one from my ROTH for 20% and one from a personal account for 1% which nets out to 10.5%. The loans have to be set up correctly and have different start dates and terms. The low interest rate one must also exceed the AFR rate. When I got this idea I first cleared it with the IRS and then my CPA who could not find anything in the code to prohibit it.

  20. Mike in Nola says:

    @deadhobo: Don’t know if you are still around, but I seem to be retarded about using the sarcasm on and off signals. We think a lot more alike than not, although I think China is just dragging out the inevitable. Even the much dreaded Chinese Command Economy is not bigger than market forces, as we have learned from the once-feared Ben’s beating his head against a wall.

    China is the US in the 1930′s, except one without a Mellon in a high position to make the collapse quick.

    Interesting recent interview with Chanos on his philosophy and methods. Thought the most interesting thing there was how they stumbled onto the China play.

    http://www.youtube.com/watch?v=G1ykiUWXGRw&feature=player_embedded

  21. dead hobo says:

    Mike in Nola Says:
    July 14th, 2012 at 7:47 am

    @deadhobo: Don’t know if you are still around, but I seem to be retarded about using the sarcasm on and off signals.

    reply:
    ——–
    I have learned that written sarcasm needs to be way over the top to make it clear of your meaning. The rest is just fun.

    Just wait. Mellon will be imitated by Bernanke, who will someday blow up the world economy by taking it out with QE3. All assets will rise in value, including the wonderful asset classes known as commodities. Pundits will rejoice at the recovery by claiming the high commodity prices are evidence of high demand caused by economic expansion, as opposed to high demand for commodity prices by long only investors in ETF funds who hope to sell to a greater fool at even higher prices. Consumers will disagree and start a recession in reply due to high prices for everything caused by high oil prices. Discretionary purchased will disappear. Employment will fall, starting a vicious cycle … all caused by QE3 and FOMC incompetence. Remember, asset inflation and assyt bubbles are still a myth unsupported by evidence to the FOMC. Thus, since asset bubbles do not exist, they are not responsible.

  22. dead hobo says:

    Mike in Nola Says:
    July 14th, 2012 at 7:47 am

    @deadhobo: Don’t know if you are still around, but I seem to be retarded about using the sarcasm on and off signals.

    reply:
    ——–
    I have learned that written sarcasm needs to be way over the top to make it clear of your meaning. The rest is just fun.

    Just wait. Mellon will be imitated by Bernanke, who will someday blow up the world economy by taking it out with QE3. All assets will rise in value, including the wonderful asset classes known as commodities. Pundits will rejoice at the recovery by claiming the high commodity prices are evidence of high demand caused by economic expansion, as opposed to high demand for commodity prices by long only investors in ETF funds who hope to sell to a greater fool at even higher prices. Consumers will disagree and start a recession in reply due to high prices for everything caused by high oil prices. Discretionary purchased will disappear. Employment will fall, starting a vicious cycle … all caused by QE3 and FOMC incompetence. Remember, asset inflation and asset bubbles are still a myth unsupported by evidence to the FOMC. Thus, since asset bubbles do not exist, they are not responsible.

  23. Mike in Nola says:

    @deadhobo: While I hope you are wrong and we have just plain old deflation to get to the bottom and start up, I can’t say that you are wrong. It is plausible.

  24. philipat says:

    “BR: Funny, i just saw this:
    http://noahpinionblog.blogspot.com/2012/07/how-zero-hedge-makes-your-money-vanish.html

    Agreed that some of their more conspiratorial stuff but they are often ahead of the MSM with breaking news and some of their stuff is spot on. Including the piece on Treasuries which subscribed to your view that it’s a tad late.

  25. philipat says:

    And if anyone would make investment decisions basesd on any ONE financial blog, including ZH, or indeed any number of financial blogs without taking professional advice OR at least considering multiple opinions AND doing individual research, then good luck. I’m totally out of the financial casinos anyway other than some GLD so I guess I shouldn’t really comment. My funds are are all RE in Singapore and Indonesia and doing very nicely thanks.