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Bond Fund Performance During Periods of Rising Interest Rates

edited December 2012 in Fund Discussions

Current trend on MFO is discussion of negative impact to bond-heavy income and retirement portfolios, if and when rates rise.

In David's inaugural column on Amazon money and markets "Trees Do Not Grow To The Sky", he calls attention to: "If interest rates and inflation move quickly up, the market value of the bonds that you (or your bond fund manager) hold can drop like a rock." And there have been several recent related posts about an impending "Bond Bubble."

Here's look back at average intermediate term bond fund performance during the past 50 years:


Background uses same 10-year Treasury yield data that David highlights in his guest column. Also plotted is the downside return relative to cash or money-market, since while these funds have held up fairly well on absolute terms, on relative terms the potential for under-performance is quite clear.

More dramatic downside performance can be seen the higher yield (generally quality less than BB) bond funds, where relative and even absolute losses can be 25%:


Taking a closer look, the chart below compares performance of intermediate, high-yield, and equities when interest rates rise (note year, 10-year Treasury yield, and rate increase from previous year):


I included for comparison 2008 performance. Here declines were not driven by increasing rates, but by the financial crisis, of course. Presumably, such strong relative performance for intermediate bonds in 2008 is what has driven the recent flight to bonds. That said, several previous periods of increasing rates happened during bear markets, like 1974, making alternatives to bonds tough to find.

Over the (very) long run, equities out-perform bonds and cash, as is evident below, but may not be practical alternative to bonds for many investors, because of investment horizon, risk-tolerance, dependence on yield, or all the above.


What's so interesting about this look-back are the distinct periods of "ideal" investments, by which I mean an investment vehicle that both outperformed alternatives and did not incur a sharp decline, as summarized in table below:


In the three years from 1963-65, stocks were the choice. But in the 19 years from 1966-84, cash was king. Followed by the extraordinary 15-year bull run for stocks. Ending with the current period, if you will, where bonds have been king: first, intermediate term bonds from 2000-08, but most recently, alluring high yield bonds since 2009.

Despite its flat-line performance since 2009, cash is often mentioned as a viable alternative (eg, Scout Unconstrained Bond Fund SUBFX and Crescent Fund FPACX are now cash heavy). But until I saw its strong and long-lived performance from 1966-84, I had not seriously considered. Certainly, it has offered healthy growth, if not yield, during periods of rising interest rates.


  • ...So we should probably be investing where? tia
  • Thank you, very valuable information.

    How do you measure how a fund will hold value in a case of an interest rate increase, other than the average effective duration?
    Judging a financial matter only by looking at one measure seems too easy for me, and things are usually a lot more complicated.
  • edited December 2012
    Howdy Charles,

    First, thank you for your time and effort with the charting, lay-out and related. I know this is much work.
    "If interest rates and inflation move quickly up, the market value of the bonds that you (or your bond fund manager) hold can drop like a rock."
    This point can not be argued against. As with many sectors regarding any investment; is the what and when.

    Robin today, could likely comment to Batman; "Holy talking heads Batman, I do believe those on tv and many article writers are biased towards the equity camp; as this is where they have lived most of their investing lives; and perhaps have seldom been students of bonds, as this is not where the action has been." Perhaps some folks just do not find much value or interest with investing in bonds and really don't pay attention to this broad area of money.

    I do believe some of the current environment is also a matter of "getting one's head wrapped around and into the investing world and where it is residing today."

    We all know millions of words are written and spoken every week regarding the investment climate at any moment in time.

    I only know of our house and Hiyield007's bonds positions; and do not know the exposure amounts of others who visit and/or write here to the bond sectors. Needless to say though, that anyone invested in any area does not want to find a downward direction of the investment from any given event(s).

    To the "If interest rates and inflation move quickly up" statement; and the what(s).
    --- one would presume economic conditions have improved to the extent that the central bank finds enough growth and lower unemployment to remove their fear of "lack of growth" and/or "deflation"; causing a pull back in their stimulus program(s) of buying every bond in sight.
    --- some of this was recently noted and discussed; to the point that the equity sectors should have already reacted to this condition
    --- interest rates could be jerked around from bond traders; as may have been the case in some bond markets in Europe over the past 3 years. Such actions sometimes are used to push a country into monetary reforms. Today, I suspect this is much more a pure attempt to generate "profits". Whether there is enough cash to cause problems in this area for the U.S. is the large question; and would such a forced action to pushing interest rates up really be of benefit for those involved, towards a country that shapes much of the global economy. I don't think so. But, there are folks/firms with a lot of abilities to do things monetarily; and not all of these people are kind and/or nice; and have little else in mind, except large volumes of positive cash flows directed their way.

    What is going to cause interest rates and inflation to move upwards quickly; and what time frame is "quickly"?

    I am finished with thinking tonight...........time for the relax mode.

    Ya'll take care,

  • Here are some questions from a long-term investor's standpoint:

    If one is a long-term investor (20+ years until retirement) and if one truely believes that this bond bubble will bust within 5 years.... would it not be best to pull my 10% allocation to bond funds 100% out of the market, and wait it out in equities (or cash), with the plan to re-enter my 10% bond fund position (or by then, more than 10%) after that bust occurs?

    If the magnitude of this bubble popping wipes out several years of bond investments... from the perspective of long-term investor, it seems hard to find an argument to stay invested in bonds now.

    I'd love to hear any contrary opinions from folks who are in the camp of believing this bubble is going to burst. For that matter, I'd love to hear any predictions on what folks think the potential hit could be on a core bond fund (e.g. PTTRX), and how long it would take for a fund like that to recover from a burst, considering the mid/long-term macro economic climate of slow/no growth.
  • Reply to @MoneyGrubber: if you're comfortable with your market timing abilities, then of course. However, many people argued that the rates can go only up from here in 2009, 2010, 2011 and 2012. i saw people get clobbered investing in TBT. The sponsor had to do a 10 to 1 reverse split or the symbol would be very close to zero.

    First, define what kind of bonds you own. Read Catch's thoughts, above, and his weekly addresses. He outperformes tons of people with equities by investing in bonds only and with less volatility. So what do you mean by "10% bond fund position"? This would be similar to saying "10% equity fund position" i.e. not saying much. What kind of bond fund?

    Second point depends on your previous answer. If your bond fund is a credit fund, then it correlates with equities with some downside protection (which is in its yield). If your bond fund is a treasury fund, then it provides larger diversification (while, admittedly, no yield currently). In a day when market panics, this part of your portfolio will be a single line item that goes up, not down.

    You are most likely right that the yields will go up within the next 5 years. (if they don't, we are in Japan kind of situation and it is indeed scary.) But it is not a linear relationship. You will have a lot of jerking around with tons of sell-offs and volatility. Don't you want to stay diversified?
  • edited December 2012
    Howdy MoneyGrubber,

    Fundalarm provided excellent points for consideration, relative to what type of bond fund, some diversification away from 90% equity exposure with a bond fund and looking forward as to what will be driving forces in the future to cause changes with interest rates moving higher.

    You used PTTRX as a core bond fund example. I would expect this fund to continue to be able to manage interest rate swings; as well as many other broad based bond funds. Is this your core bond fund?

    This discussion thread, in part; was based around this statement, " "If interest rates and inflation move quickly up". Quickly is relative to folks in their own time frame, eh?

    Using the 10 year Treasury note as an example and that the current yield has been hanging out in the 1.6% range for many months; my view of quick for upward yield changes would currently be a .1% average weekly upward yield move for 6 to 8 weeks. If such upward yield moves, at a point in time in the future; could be maintained without some pull backs of consequence, I would have to assume a trend has begun. As noted previously, there should have already been other areas (upward equity prices for one) that would be showing strong positives, also which have suststained upward moves.

    It is easy, among all of the other investment areas, with numerous talking and written opinions (from any source) and one's own convictions and knowledge towards their own portfolios; to try to find and then determine what to watch for clues that may affect one's portfolio.

    As to watching, I do pay attention to the 10 year Treasury note yields. It is very easy to glance at this number at one of the tv business channels and be ho-hum about the yield number; but today this number is so small, that small changes are large percentage numbers that would not be ignored in the equity world. If one finds a sustained move from a current 1.6% to 1.7% yield in one week; the change is +6.25%. This number would be big talk in the equity world, eh? The following week finds a similar .1% upward yield move, with the 10 year now parked at 1.8%. The change is now at +12.5% in a two week period. After 8 weeks of similar moves, and now finding the 10 year yield at 2.3%; also finds the change equaling a 43.8% move reflected. Of course, bond prices would have moved downward during this same period. In theory, the downward pricing would have first been shown in plain jane Treasury issues, as well as etf's which follow these issues and closely related bonds. Likely, the best clues as to a fading bond market would be the actively managed bond funds; with pricing being reflected in the abilities and/or luck of management. IF broad based, active managed bond funds are able to manuver through the interest/yield rate increases with available adjustment tools, an investor being in the "right" bond fund should not suffer major losses. This does not mean that one should ignore their active managed bond fund for downward moves that are sustained. We all know a long list of active managed bond funds will always find funds at the bottom of the list; both during the good and bad times. Not unlike we individual investors, the professionals and highly trained/skilled will miss the boat from time to time.

    Another aspect of considering when to sell a fund is "when did I buy it?" None of us ever want to give up what we've already earned. But, if you happened to buy PTTRX 4 years ago and "the bond bubble" started this week, you would have an easier decision and a bit of "wiggle room" about selling the fund; versus if you bought the fund the week before. You may also be dollar cost averaging via a retirement plan for many years into a PTTRX; so your cost during the growth of this fund has smoothed your investment. Worse case with any investment area/fund is to sell down in 25% chunks, if you are no longer happy with the fund or market conditions.

    You noted a 20 year (long term) time frame prior to retirement, and assuming a traditional retirement age of 65. If you so desire, you have a 40 year long term horizon with your investments; assuming a 20 year post-retirement period. Although I am likely 20 years in front of you, our house hopefully, will continue to be long term investors, too; if I/we are able to average the longevity tables. Your advantage is that you should be able to continue to have cash flow into your house with employment, while we won't have this position and eventually will have cash flowing the other direction from our retirement accounts. Although employment provides for an ease of mind concerning investments, an investor of any age has to be mindful of preservation of investment capital in order to benefit from the greatest advantage an investor has; and this is the continued compounding of monies going forward, building upon what has been "retained" for compounding versus "I can make up a large investment loss with cash from employement". Yes, these are easy words to write; but less easy to deal with the reality.

    At this point in time, I would not be concerned about a 10% portfolio holding in a broad based bond fund causing any damage to your overall portfolio return from a possible, future bond bubble; and such a fund will provide a cushion against your equity portfolio. You may also hold more bonds than you are aware of via equity funds positioned in these areas, too.

    You may be assured that this house is watching for a "bond bubble" with this portfolio:

    ---High Yield/High Income Bond funds
    FAGIX Fid Capital & Income
    SPHIX Fid High Income
    FHIIX.LW Fed High Income
    DIHYX TransAmerica HY

    ---Total Bond funds
    FTBFX Fid Total
    PTTRX Pimco Total

    ---Investment Grade Bonds
    ACITX Amer. Cent. TIPS Bond
    DGCIX Delaware Corp. Bd
    FBNDX Fid Invest Grade
    FINPX Fidelity TIPS Bond
    OPBYX Oppenheimer Core Bond

    ---Global/Diversified Bonds
    FSICX Fid Strategic Income
    FNMIX Fid New Markets
    DPFFX Delaware Diversified
    LSBDX Loomis Sayles
    PONDX Pimco Income fund (steroid version)
    PLDDX Pimco Low Duration (domestic/foreign)

    All of these funds were positve on Dec. 10, Monday; with the exception of DPFFX, FBNDX and PLDDX, which were all "flat" for the day. The average gain was +.14%, ranging from .01% through .39%.
    Are our bond funds expensive today? Well, surely more so versus 1,2 or 3 years ago. Would we buy any bond funds today? We (our house) will have to wait until 2013 to review this whole area. One always has to ask the question, regardless of investment sector involved. I have to ask the question today, as I look at one corporate bond fund, FBNDX with a current 30 day SEC yield of about 1.6% and compare this to an equity/dividend fund at Fidelity with a yield of 2.5%. Hmmm, perhaps it is time to rotate the bond fund; as if pricing does not continue upward from this point, I may expect only the 1.6% yield. Nope that ain't gonna work, eh? These are the questions in place at this house, but will have to be on hold until the new year to find what, if many investment sectors, may receive a face slap, pending actions in Washington and our being away from trading capabilities the last week of this year. Argh !!!
    Prior to June, 2008; our house was also 90% equity. We will not likely find that positioning again, as we move into retirement; but do need to "find" the right mix going forward.
    Any and all of these decisions come in a time of "an artifical and perverted" world of monetary involvement from central banks and global economies in flux worrying and concerned about growth and deflation, with the resulting investing circumstances perhaps being this house's "once in a lifetime" investing road course.

    Lastly, your greatest investment asset; being you, is that you are thinking and considering the aspects of your house's investments. In my opinion, you are involved in, and part of an excellent community (MFO) from where you will obtain a wide range of opinons and thoughts from a vast group of thinkers, across a wide spectrum of topics, to help one another detail and rethink our investment portfolios, based in part; of where any of our house's are positioned related to one's investment risk and reward psychology. Heck, one may also obtain excellent guidance about the best wi-fi router for home use. A most excellent community, is this place.
    Don't become discouraged about the one's (investments) that got away, or the should've, would've, could've investments that may have been missed. Also do not forget to pat yourself upon your back for investment work well done; as many others will not be aware of the amount of effort put forth to properly grow your hard earned monies.

    Okay, I have blabbered enough to fill and fly a hot air ballon; and my chores list is staring at me, too.

    Take care,
  • Reply to @fundalarm:
    To answer your first question, let’s say that 10% of the portfolio has been invested in PTTRX via incremental/month purchases within a 401K plan for the last 3 years.

    I suppose this is where I feel conflicted – I do see the importance of taking a disciplined approach to sticking with an allocation plan of different asset classes in order to stay diversified… however, when pressed with what seems to be an overwhelming amount of information that points to an inevitable collapse of a bubble, my feeling is that those allocation plans can be altered for an interim period until there is some sign of the bubble popping. I think less extraordinary extremes of potential volatility would not have me react this way, but the magnitude of the down-side impact of rate hikes happening within the next 5 years may justify a strategy where one sets aside reserves to apply back to bonds once a significant drop is seen.

    To address your last question, I do intend to stay diversified, but see the implementation of the diversification plan being stretched out over the life span of the current bond bubble. My alternate plan may to be to stop new bond fund purchases and just keep my existing shares rather than sell off, hoping that those investments will recover after the bubble pops.

    I may well be full of puff too, and will just end up sticking with my current % allocation plan, and try to alleviate my anxiety by avoiding and turning off the TV for the next few years. Please consider that these rantings are coming from someone that doesn’t have a good head for bonds, thus my deference for letting Bill G. take care of all things “bond” for me.

    Still undecided…
  • Hi Catch, I just read your post just after replying to FundAlarm reply above. Thanks for the very descriptive, if not illustrative explanation of bond fund behavior. I think you nailed the head in in terms of addressing some of my anxieties about the "big picture" of investing in bond funds.

    Yes, my main bond vehicle at the moment is PTTRX and I'm considering moving into a minimal holding of DBLTX, just to get into the fund before it closes it's doors on new investors. I like what I see happening in other "steroid" bond funds as well (e.g. PONDX), but as you suggested, the cost as this point in time may be high (top of the bubble-ish) on some of these, so I am hesitant at venturing further into new bond fund territory at this time.

    Thanks for the feedback and words of wisdom. I hope there's an archive of these bond fund posts in 20 years so I can review your sage advice when I'm 90% bonds/10% equities!

  • If your with bond managers with a good record, let them manage, don't try and second guess unless you can do the managing. If your concerns are unbearable, go to lowest duration funds or to higher cash. Too much analyzing is bad for your health and wealth.
  • edited December 2012
    Reply to @ron:
    Thanks to all. Now I think I've been talked out of taking that drink : )
  • Reply to @MoneyGrubber: with PTTRX you get active management of a very sceptical mind. They will jump more to credit, short duration or EM debt if warranted. Do not worry, really. Also, if you are adding via your 401K allocation, you will be buying at different entry points and the lower price will buy you more shares. Stay the course, MG.
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