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Are Bond Funds Unusually Risky Right Now?

If there’s one thing that’s clear from reader emails, it’s that many people are concerned — or even scared — about the riskiness of their bond holdings right now. The questions I keep getting over and over are whether intermediate-term bond funds (e.g., Vanguard’s Total Bond Market Index Fund or Fidelity’s Spartan U.S. Bond Index Fund) are unusually risky right now and whether moving to shorter-term bonds would make a portfolio less risky.

The answer to those questions depends on what you mean by risk.

Risk = Likelihood of Low Returns?

For people who think of risk as the probability of earning negative inflation-adjusted returns, yes, an intermediate-term total bond market fund is unusually risky right now, given how low interest rates are. But from that perspective, a short-term bond fund is even riskier given its lower yield and lower expected return.

Risk = Volatility?

On the other hand, if it’s price volatility (due to changes in interest rates) that makes a bond fund risky to you, then yes an intermediate-term fund is riskier than a short-term fund. But it’s important to understand that from that perspective, a longer-term fund is always riskier than a shorter-term fund. It’s got nothing to do with low interest rates.

In addition, from a price volatility standpoint, I’m not convinced that an intermediate-term bond fund is any riskier than it normally is.

“Autocorrelation” refers to a variable’s correlation to itself from one period to another. For example, a series of data points in which upward movements tend to be followed by more upward movements and in which downward movements tend to be followed by more downward movements is said to have high autocorrelation.

According to the data I’ve seen, interest rates (for both short-term bonds and long-term bonds) have strong positive autocorrelation over short-term periods. For example, according to Yale economist Rober Shiller’s data (and my Excel calculations), from 1871-2011, 1-year interest rates have an 83.6% autocorrelation from year to year. There’s even a 55.5% autocorrelation when you look at the 1-year rate in a given year as opposed to the rate 5 years later. And the autocorrelation for rates on 10-year Treasury bonds is even higher.

In other words, the fact that bond yields have been moving downward over the last few years and now sit well below historical averages does tell us that we should expect low returns from bonds going forward, but it does not tell us that we should assume rates will necessarily rise in the near future. If anything, it would suggest that an extended period of low rates is likely.

May 22, 2013

Looking Up a Fund’s Holdings

A reader writes in, asking:

“Is it possible to find out exactly what is in a mutual fund? I’m looking for something more complete than the “largest holdings” lists which I can see on Vanguard’s website.”

Mutual funds are required by the SEC to disclose a complete list of their holdings on a quarterly basis. SEC Form N-Q is used to disclose holdings as of the end of the first and third quarters of the fiscal year, and Form N-CSR is used for the end of the second and fourth quarters.

You can look up either of these forms in the SEC EDGAR database. For example, here’s the Form N-CSR for Vanguard’s Total Stock Market Index Fund (as well as several other Vanguard funds) as of December 31, 2012.

Because these disclosures are only done on a quarterly basis — and because the funds have a 60-day window during which they can make the filing — the information provided in these disclosures is not especially timely. As a result, these disclosures will be of little use for certain purposes (e.g., trying to mimic the strategy of an actively managed fund). But they would be useful, for instance, to somebody who is trying to figure out whether a given index fund holds shares a particular company (or group of companies) to which they have ethical or religious objections.

Finding a Fund’s Form N-CSR or Form N-Q

While it only takes a few seconds to look up a fund’s N-CSR or N-Q once you know where you’re going, getting there for the first time isn’t exactly intuitive — at least it wasn’t for me. So let’s quickly walk through it step by step.

  1. Go to the SEC EDGAR homepage.
  2. Click the link for “search for filings.”
  3. Click the link to search by ticker symbol or fund name, and on the next page enter the ticker of the fund in question and click “find companies.”
  4. On the next page, scroll until you find the most recent thing in the “filings” column labeled either “N-CSR” or “N-Q.” Click the “documents” button next to that listing.
  5. On the next page, find “N-CSR” or “N-Q” in the “type” column and click the red link in the corresponding row. (The link itself could be named anything.) Here’s a screenshot of what you’re looking for (click to enlarge):

ScreenShotscaled

Naturally, most funds — especially broadly diversified index funds — have a heck of a lot of holdings, so browsing the list in search of a specific stock or bond will take an exceedingly long time. A much faster approach is to use “control + F” to search the page for a specific word or phrase.

May 20, 2013

Investing Blog Roundup: Vanguard Emerging Market Bond Fund Now Available

As of this week, Vanguard’s new Emerging Market Government Bond Index Fund is open to new investors. Because the fund is still raising cash, the fund’s description page doesn’t have much information just yet.

Given the information currently available, I don’t have much to say about the new fund (and international bonds in general) other than what I wrote in my reply to the original announcement and the followup piece earlier this year.

Investing Articles

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Thanks for reading!

May 17, 2013

How to Assess a Fund without a Ticker

A reader writes in, asking:

“My 401-k at work has several funds with no ticker symbols, so I cannot find information about them online, not even at Morningstar. The booklet about the plan that I got at my orientation does describe the funds though. What should I look for? And why don’t they have tickers?”

Most likely, these investment options without ticker symbols are actually “collective investment trusts” or “separate accounts.” In other words, these investment options are probably not mutual funds at all, though the basic idea is the same (i.e., a professionally managed pool of money from many investors).

Because these products are not offered directly to retail investors, they have no ticker symbols and different regulatory guidelines. Still, you want to know the same basic pieces of information that you would want to know about a mutual fund. That is, you want to know:

  • What index the product tracks (if any),
  • What the costs are for the product, and
  • What is in the product’s portfolio (i.e., its asset allocation).

This information should be available in your plan documents. (If it isn’t, get in touch with your HR department.)

Because these types of investment options have a lesser degree of transparency than plain-old mutual funds, I’d also make a point of checking the published performance figures to make sure they’re what they should be. That is, if the investment option is designed to track a specific index, I would try to find the performance data for that index (or for another fund that tracks that index) and then compare that performance to the performance figures for this investment option that are disclosed in your plan documents. You don’t want any surprises down the road from finding out that the trust or account isn’t actually doing a good job of tracking what you thought it was tracking.

May 15, 2013

Portfolio Management vs. Financial Planning

I often hear from investors who are in the market for a financial advisor, but who, despite interviewing several, are struggling to find one who meets their needs. One of the most frequent causes of this difficulty is a failure to understand the difference between advisors who provide portfolio management services and advisors who provide financial planning services.

Portfolio management involves doing the actual portfolio maintenance: setting up the portfolio, rebalancing when necessary, tax loss harvesting, etc. (Just to be clear, portfolio manager is not a technical term, so these people might refer to themselves as wealth managers, money managers, investment managers, or something else entirely.)

In contrast, financial planning is about answering questions: Can you afford to retire? How much can you spend per year in retirement? Is your asset allocation appropriate? When should you claim Social Security? How can you reduce your taxes? Do you need to buy long-term care insurance? Things like that.

What confuses many people is that:

  • From a regulatory perspective, both portfolio managers and financial planners are probably registered investment advisers (RIAs) or representatives thereof, and
  • Either of them can have the Certified Financial Planner (CFP) designation (but neither is required to have it).

Some firms do financial planning. (Examples would include members of the Garrett Planning Network, or Allan Roth’s firm Wealth Logic.) Some firms do primarily — or exclusively — portfolio management. (Examples would include Rick Ferri’s firm Portfolio Solutions or Bill Schultheis’s firm Soundmark Wealth Management.) Many firms do both.

The story I hear over and over from readers is that, having been in the market for financial planning services, they contacted a local CFP and set up a meeting. But, once they arrived at the meeting, it became clear that the CFP was not really interested in providing one-time financial planning services. Rather, the CFP’s goal was to get the investor to sign up for ongoing portfolio management services — something in which the investor has no interest.

The key is to know ahead of time who you’re contacting — what type of business does this advisor usually do? If their website speaks a great deal about their wealth management services and doesn’t say anything about hourly consultations, that should be a good clue. If the advisor’s website doesn’t make it clear, you can check their Form ADV II. (When researching an RIA, checking this document is a good idea anyway.) Or, you can always call the advisor, telling them very explicitly what services you are and are not interested in, and asking if they would be a good fit.

May 13, 2013

Investing Blog Roundup: Friends and Enemies

As an individual investor, it’s difficult to know who is on your side. It can be hard to distinguish one financial services firm from another or one industry group from another.

That’s why I was interested to see Daniel Solin’s new series for US News in which he categorizes various industry parties as “friend” or “enemy” — no room in between. (In reality, I think there is a bit of a gray zone. But quick categorizations can still be helpful for investors trying to work their way through the morass that is the investment industry.)

Investing Articles

Thanks for reading!

May 10, 2013
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