I agree MG, it’s important not to think of bonds as one aggregate asset class — there’s too much difference, and resulting opportunities, that would be (is) missed looking at it that way.
(as an aside, I also feel the generalization of hedge funds on this site suffers from the same.. there’s much opportunity missed when you group the 75% bad funds, and 20% only “good” funds, in with the 5% of outstanding funds, that are worth the fees)
Anyhow, back to bonds, while folks can talk all day about the “risk” and “worst scenario” for bonds, my favorite fund vehicle for long interest rate duration, TMF, is +36% so far this year. Preferred Equity and Sub Debt – my favorite spot in the capital structure currently – has offered nice opportunities for some time to book 6-10%+ annual yield, bought at discounts to par with upside in both lower rates and higher rates (!) — this bc if we see higher rates, it should be predicated on an improvement in economic conditions, increasing the creditworthiness of the issuer, and thereby the security’s price; and in lower rates the price increases bc the security’s fixed rate is worth more, relatively speaking… Munis also offer a ton of value in individual securities… especially longer, down in credit and/or 0%cpn bonds.
Floating coupons are not much discussed when “talking bonds”, and those can be used to pull back overall price risk (duration) in a portfolio, allowing to take on more said risk in other securities.
For example, building a portfolio of floating (low *interest rate* risk) bond of lower credit quality (higher *credit* risk) trading at a discount (like a State Street Bank trust preferred trading at $85, offering +2% over LIBOR), along with high quality (low *credit* risk) longer maturity (high *interest rate* risk) non-call bonds (like 15yr hi-grade munis at 4-5% taxable equivalent) I might suggest. If rates go up, your floaters reprice to higher interest cashflows, if rates go down, your longer bonds see capital gains… in the meantime, you’re clipping a nice cashflow.
Remember the other side of the coin from “interest rate risk” is “price appreciation potential”… no one really talks about that when they talk about duration — duration loses you money, but also can make you money… like in the last 30+ years… and I think for the next several years.
lastly, Cullen I’m not sure you mean ‘convexity’ when you are talking about the cumulative returns over time of a constant duration fund…. Convexity is the 2nd derivative of the Price and Yield relationship… the first derivative, duration, is how much the price changes per unit of yield change… the second derivative, convexity, is how much the price/yield relationship changes per unit of yield change. It is generally used to describe optionality of a bond – like with callable bonds, or pre-paying mortgage securities, where the option is held by the ‘issuer’, and – generally speaking – will always work against the bond investor. A bond exhibiting ‘negative convexity’ generally means that the investor is holding a bond with a call option to the issuer, and that the bond will be called away when the investor would rather be holding the bond’s cashflow (ie rates have declined), or not called when the investor would rather have his principal back to re-invest (ie rates have increased).