Monday, 10 December 2012

Bond Market Year To Date - Vanguard ETF

Last post I went over the year to date performance of Vanguard's ETF, specifically calling out the difference in small vs mid vs large caps.  Another interesting class of assets is the bond market, with it being split among corporate, government bonds and different maturity rates.  As most people are aware, interest rates are incredibly low in the US and that shows with dramatic drops in bond yields.  So for those who like bonds, how does the yearly results look?

As you can see below, short term govt bonds are absolutely poor, a YTD result of 0.38%...You can find almost better value in a savings account!  While overall short term bonds are ok, its driven almost entirely by the corporate bonds which ended up 5.65%.  While bonds, especially corporate bonds are not as "risk-free" as govt bonds (I put in quotes because I believe default risk is not the only kind of risk you have to be aware of), if you are interested in returns at all, short term govt bonds are useless (as intended by the Fed).

Short-Term Bond

as of 12/07/2012
YTD Returns
as of
Average Annual Total Returns
as of 11/30/2012
PriceChangeSEC Yield1 Year5 Year10 YearSince Inception
Short-Term Bond ETFBSV$81.27–$0.03–0.04%0.51%A2.05%2.39%3.85%4.35%04/03/2007
Short-Term Corp Bond ETFVCSH$80.19–$0.03–0.04%1.24%A5.65%6.41%4.61%11/19/2009
Short-Term Govmt Bond ETFVGSH$60.96$0.000.00%0.16%A0.38%0.44%1.15%11/19/2009

For the intermediate term, again corporate bonds triumph with a strong 11.5% gain, much higher than govt bond at 3% and the total bond market at 4.3%.  However, these numbers are somewhat misleading because they combine price gains with dividend yields.  If you look at the yield, you'll see most of the gains have been due to price appreciation which happened as interest rates dropped due to Operation Twist and QE3.

Above, you can see the LIBOR chart for 2012 (not exactly the same interest rate I was mentioning but you get the idea).   The relatively large drop since the beginning of 2012 is responsible for the price gain which has overshadowed the yield.  For example, govt bond yield is only ~0.7% even with a 3% overall gain, and corporate bond has a 2.5% yield vs a 11.5% gain.  Once you strip out that gain they're not nearly as attractive.  In my opinion, you have to strip that effect because you can't count on itto happen again and there's a good chance it can come back to bite you later.  True, the Fed has promised rates to stay low till 2014 but you should never invest based on promises made of the future.  

Long term bond results continue the trend of short and mid term.  While corporate bonds hit an astounding 12.8% gain and govt bonds were acceptable at 5.5%, again, its again only due to the price gain from the drop in interest rates.  Though corporate bond gained 12.8%, it only yields 4.2%.  As I said above, you absolutely can not count on that happening again so moving forward, you have to factor in 3 risks:

  • The normal bond default risks (which the market places a premium of 1.8% for corp bonds over govt bonds)
  • Yield changes due to interest rates
  • Price drops also due to interest rates.  Current prices are right now very sensitive to interest rate changes and while its unlikely to change too much in the short term, eventual increase in interest rates will drop the bond price and eat into your returns from the dividend yield.

While generally most people advise holding some bonds, I have a hard time really being convinced to put too much into it today (different story if you bought already) as the interest rate sensitivity ongoing risk is too high for me considering the extremely low yields I can expect.  Better options if you want safe income options?  I haven't figured that out myself as even generally good yielding stocks such as Utilities also have issues of their own.  As an example, XLU, the utilities ETF below  has a good yield at 4% but also has shown more volatility than is typical for a safe investment.

My personal plays lately has been Preferred Shares ETF (PFF) and Intel (INTC) as they show good yields, 5.8% and 4.5% respectively, although not without risks of their own.  I'll go into that more in later posts.

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