Best of the Week
Most Popular
1.UK House Prices BrExit Crash NOT Likely Despite London Property Market Weakness - Nadeem_Walayat
2.BrExit Morning - New Dawn for Britain, Independence Day! - Nadeem_Walayat
3.LEAVE Wins EU Referendum - Sterling and FTSE Hit Hard, Pollsters, Bookies and Markets All WRONG! - Nadeem_Walayat
4.BrExit Implications for UK Stock Market, Sterling GBP, House Prices and UK Politics... - Nadeem_Walayat
5.Trading BrExit - Stocks, Bonds, Sterling, Opinion Polls, Bookmaker Odds and My Forecast - Nadeem_Walayat
6.FTSE and Sterling Brexit Trading, Deconstruction of the EU Referendum Result - Nadeem_Walayat
7.UK Interest Rate Cut to 0.25% Imminent and More QE Money Printing - Nadeem_Walayat
8.Trading BrExit - British Pound Plunges, FTSE Stock Futures Slump on LEAVE Shock Referendum Win - Nadeem_Walayat
9.The Stock Market is Reading it Wrong! - Chris_Vermeulen
10.Breakouts Galore in Gold and Silver - Jordan_Roy_Byrne
Free Silver
Last 7 days
Soybean Commodity Price to Soar Again - 23rd July 16
SPX Stock Market Uptrend Continues - 23rd July 16
Gold And Silver – Debt Addiction Will Carry Precious Metals Higher, Guaranteed - 23rd July 16
Pokemon Go - How to Play, First Use, Balls, Stops, Catching Pokemon's... Great Excercise! - 23rd July 16
7 Signs That the Gold Market Remains Resilient - 23rd July 16
Basic Income in The Time of Crisis - 23rd July 16
Silver Bull Faces Correction - 22nd July 16
The Serious Warning No One’s Talking About - 22nd July 16
Stock Market Insight from Greed, Volatility, and Put/Call Ratio - 22nd July 16
What Will Happen To the Stock Market When Interest Rates Rise? - 22nd July 16
How to Escape the World’s Biggest Ponzi Scheme - 22nd July 16
Addicted to Debt - We Can’t Borrow from the Future Anymore - 21st July 16
Not Everything Is Bullish for Gold - 21st July 16
Don’t Get Sucked Back Into the Stock Market - The Big Picture Hasn’t Changed - 21st July 16
Silver – Caught Inside - 21st July 16
Forex: "The Markets Are Getting Exciting!" - 20th July 16
China Economic Troubles - Is Kyle Bass Finally Getting His Revenge? - 20th July 16
Why Lithium Will See Another Price Spike This Fall - 20th July 16
The Peak Oil Paradox Revisited - 19th July 16
SPX Challenges the Upper Trendline - 19th July 16
Missing ’28 Pages’ of the 9/11 Report Released into Blitzkrieg of World Events - 19th July 16
Likelihood of Organized Disruption at GOP Convention - 19th July 16
More on the ‘Breadth Thrust’ and Stock Market Internals - 19th July 16
FX Traders: Get a Free Week of Forecasts (Details inside) - 19th July 16
Ups and Downs in Gold and Crude Oil Price - 19th July 16
Keep an Eye on ‘Bitcoin’ as the Next ‘Financial Crisis’ Starts! - 18th July 16
Erdogan Might Have Known about the Coup but Didn’t Prevent It on Purpose - 18th July 16
More Deflation Ahead: Silver, Gold And Their Mining Stocks A Must-Have - 18th July 16
Stock Market Minor Top? - 18th July 16
5 Best Gold and Silver Junior Mining Stocks in 2016 - 17th July 16
Gold And Silver – NWO-Created Tragedies Will Never End, Seek Truth - 16th July 16
How Long Can Buybacks Continue To Support A Market Which Is Standing On A Fundamentally Flawed Premise? - 16th July 16
Will They Come For Your IRA? - 15th July 16
Gold’s Record Selling Overhang - 15th July 16
Capitalism Has Entered a New Era—and Historic Stock Market Investing Returns Are Gone Forever - 15th July 16
Gold Price Could Hit $5,000 or Even $10,000 in a Few Years - 15th July 16
Junior Gold and Silver Mining Funds or Individual Gold and Silver Mining Stocks - 15th July 16
The Soaring Risk of Flying in Bernanke's Helicopter - 15th July 16
The Broad Stock Market, Helicopters and Gold - 15th July 16
The Curious Case of Vanishing Lady Liberty; Only Gold and Silver Remember Her - 15th July 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Forex Forecasts

U.S. Bond Market Trouble Ahead

Interest-Rates / US Bonds Apr 19, 2013 - 08:40 PM GMT

By: Investment_U

Interest-Rates

Alexander Green writes: Warren Buffett recently opined that bonds should come with a warning label these days.

That is doubly true of most bond funds. Many investors are about to get steamrolled. But if you act now, you can avoid getting hurt.


Let me explain…

Historically, the best-performing bond funds have had one thing in common: low expenses.

For example, Vanguard’s fixed-income funds are routinely found in the top quartile of annual bond fund performance. Why?

Because, unlike stocks – where security selection is the key to outperformance – it’s tough to increase returns by picking individual bonds.

I’ll concede, however, that it is possible.

More than 30 years ago, Bill Gross and his colleagues at PIMCO pioneered a new approach to bond investing. Until then, a lender handed his money over to the borrower and then collected interest until the borrower repaid the loan.

The notion that anyone might routinely trade these instruments by selling them to others prior to maturity did not exist.

Gross recognized that opportunities exist to trade in and out of various sectors of the bond market – as well as individual issues – and moved to capitalize on this reality.

As a result of his expertise, the PIMCO Total Return Fund has outperformed through all market cycles over the long term. But Gross is often called “The Babe Ruth of Bonds” precisely because this is so darn hard to do.

Historically, the vast majority of fixed-income managers underperformed their unmanaged benchmark, like the J.P. Morgan Global Government Bond Index or the Barclays Capital Aggregate Bond Index.

But – surprising many analysts – this hasn’t been the case lately.

Hitting the Mark
Last year, for instance, 79% of intermediate-term bond funds – which hold a mix of government and corporate bonds maturing in five to 10 years – beat their benchmark. And over the past year, investment-research firm Morningstar estimates that long-term government bond funds beat their benchmarks by 2.5 points.

Wow.

Predictably, money is now cascading into actively managed bond funds as investors chase performance the ways dogs chase cars. (And with the same general results.)

Industry figures show that three-quarters of new fixed-income investments are going to bond pickers, not passively managed index funds.

Big mistake.

The hot bond funds are hot precisely because they are taking significantly more risk than the index funds.

Consider “duration,” a measure of a fund’s sensitivity to interest-rate changes based on the average maturity of the bonds it holds. As most bond investors know, you get a higher yield by owning longer maturities. So these bond fund managers have simply increased the average duration of the bonds in their portfolios.

This is all well and good as long as rates are steady or dropping, as they have been for the last 30 years. But when rates rise – as they inevitably will as the economy improves and the Federal Reserve ends its quantitative easing policy – these bonds (and bond funds) will get hurt much more than those with shorter maturities.

Dumb Moves
Another way bond managers goose returns is by buying “junkier” bonds. This too, of course, is riskier than owning bonds of higher credit quality.

And, thirdly, many bond managers are using leverage. That means they borrow money to buy extra bonds and thereby further increase yields. This is the equivalent of buying stocks on margin – and shareholders can expect the same result when the bond market sells off (which it will when interest rates rise).

In short, at the tail end of a 30-year rally in bonds – the longest and most massive in history – investors are piling into precisely the wrong investment. They are buying actively managed funds (with high expenses) that own longer maturities and riskier credits using leverage.

If you don’t understand what is going to happen here, visit your local old-timer and ask him what happened to his fixed-income portfolio in the early ’80s.

It wasn’t pretty.

And while it’s unlikely we’ll see the sort of hyperinflation that plagued investors three decades ago, bond fund buyers are in for a rude awakening when they see what happens to their supposedly “safe” fixed-income investments in a rising interest rate environment.

All fixed-income investors face an important choice. They can switch to low-cost, passively managed short-term bond ETFs and index funds, or they can stick with the active fund managers and learn the hard way.

The wise will opt for the former. As Ben Franklin said, “Experience is a dear school but fools will learn in no other.”

Good investing,

Alex

P.S. For those who depend on fixed income, I suggest you check out the work from my friend and colleague Steve McDonald. His strategy is truly the only safe way to navigate fixed income in our current interest rate environment

To view all of Steve’s work, click here.

Source: http://www.investmentu.com/2013/April/the-trouble-ahead.html

http://www.investmentu.com

Copyright © 1999 - 2011 by The Oxford Club, L.L.C All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Investment U, Attn: Member Services , 105 West Monument Street, Baltimore, MD 21201 Email: CustomerService@InvestmentU.com

Disclaimer: Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Investment U Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife