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The Ticking Time Bomb in Bond Funds

Here’s that theme again – investors are increasingly concerned about the crowded trade in bonds primarily thanks to the Federal Reserve’s herding of investors into such assets.   And it’s not just readers of Forbes who are coming to this realization.  It’s important names in credit like Howard Marks.

I should be clear though.  All bond funds are not created equally.  And I will emphasize again that I don’t think there is a bubble in government bonds.  Corporate credit, however, is beginning to look like a different story.

More via Forbes:

“We are at an all-time high in terms of duration risk,” says Rick Reider, who is the chief investment officer of fundamental fixed income at BlackRock. “Even a drift higher in interest rates could be painful for investors with the duration of bond funds where it is today.”

The general rule of thumb is that for every 1 percentage point increase in rates, a bond will lose the equivalent of its duration in price. So a 5-year bond would lose 5%. For a bond that comes due in 2055, it’s more like 40%. But that’s just the rule of thumb. The real concern, though, is that when investors in what they thought were risk-free bond funds see 10% losses, or more, they may stampede for the exits, creating even bigger losses.

The main reason bond fund managers are plunging into potentially more dangerous debt is low-interest rates. The longer a bond, the more interest it pays. Many bond funds market themselves on yield.

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