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Don’t bond fund holders lose money because of the sellers

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Posted by Rob Croll (Questions: 1, Responses: 1)
Posted on 08/22/2017 6:36 PM
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Question was cut off. When there are large redemptions during a rapid rise in interest rates, doesn’t this permanently affect those who stay in the bond fund? Bonds will be sold to cover redemptions, and losses taken, while the holder of an individual bond could hang on for better conditions, or until maturity. Later addition of new bonds to the fund could raise the interest rate, but would not improve the value for existing shareholders, would it?

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Posted by Rob Croll (Questions: 1, Responses: 1)
Answered on 08/22/2017 6:41 PM
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    Hi Rob,

    It really depends on the specifics. If you’re in an illiquid bond fund then yes, this could certainly happen. This is what happened to the 3rd Ave Focused Credit fund last year. But this is easily avoidable. You simply need to own highly diversified bond funds where redemptions (even large ones) will be spread out over so many bonds that it makes it hard to move the market much.

    If you read my latest post you’ll see some more specifics here. In my opinion the whole point of owning a “fund” is to own a diversified portfolio of assets that you could not otherwise purchase on your own. That means you should be buying broad aggregates and the types of funds that literally have thousands of holdings. These funds are far less likely to incur any permanent principal losses over time.

    In general I would argue that the fears over redemptions are vastly overstated. There’s definitely a risk there, but if you own the right types of funds and not silly concentrated bets on risky bonds, then the bond fund is very likely to be a superior overall holding to individual bonds.

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    Cullen Roche Posted by Cullen Roche (Questions: 10, Responses: 1749)
    Answered on 08/23/2017 12:06 AM
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      There are some additional risks with bond funds. The manager of the fund might change and might alter the mix or quality of the holdings. If, as you stated in your post footnotes that most large funds carry 10% cash, that’s 10% of my investment that is not earning much, reducing the return. There are management fees, even if small.

      I am in the individual bond picking camp. I get to pick the precise maturity of my ladder. I get to pick the precise quality of the bonds in my ladder. I get to decide whether I want any callable bonds. Once my purchases are made, there are no ongoing expenses. Everything is predictable, unless there is a default. But, I tend to pick high quality, boring bonds, leading to an entirely boring ladder cycle. Just the way I like it 🙂

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      Posted by Keith Winston (Questions: 1, Responses: 3)
      Answered on 08/23/2017 4:01 PM
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        Hi Keith,

        If you own ETFs which are mostly weighted to market cap weightings then the discretion of the manager doens’t play much of a role.

        The cash buffer problem is also resolved in ETFs.

        I think most of the “problems” people have with bond funds are vastly overstated. Kind of reminds me of technology aversion and Ludditism. That which is new seems to scare people….Maybe I am not as averse to these newer funds because my generation grew up with them as our normal investment options and not a “new” option….

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        Cullen Roche Posted by Cullen Roche (Questions: 10, Responses: 1749)
        Answered on 08/25/2017 2:43 AM
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          Cullen,

          Vanguard added bond ETFs that mirror their mutual funds when I wasn’t paying attention. I am guessing within the last few years. The expense ratio is almost zero, but most don’t match my quality comfort zone. The right mix of them probably would. I’ll think it over when the bottom of my ladder falls off.

          You kids with your fancy ETFs and hippie music, haha!

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          Posted by Keith Winston (Questions: 1, Responses: 3)
          Answered on 08/25/2017 2:04 PM
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