Negative returns on bond funds?

[dave559]

Please excuse me if this is a very stupid question (I am fairly new to investing).

I am looking at the various fixed income bond funds offered by Vanguard, and notice that the returns in previous years vary, and in some cases are negative.

I am assuming that the returns vary over time as different bond holdings in the fund mature at different times and then are replaced by new bonds offering different returns, but I don't understand how it is possible for there to be negative returns on bonds? Or is it the case that because of financial problems affecting the companies (or even the governments?) who are offering the bonds, some bonds may end up not being repaid to the investors?

[colin]

When investors as a whole require a higher interest rate than previously to tempt them to buy bonds then they just refuse to buy until the market price drops to the point where the higher interest rate becomes worth paying for. it's like offering less money for a car because you don't think it offers enough MPG compared to the competition but if you can get it for a cheaper price then the difference will pay for the extra petrol.

[AleisterCrowley]

Yes, and if the fund holds all bonds to maturity there is no permanent loss - but not sure how long it would take to 'recover'. Guess it depends on the maturity dates/weightings. I haven't got to that chapter yet...

[dave559]

When investors as a whole require a higher interest rate than previously to tempt them to buy bonds then they just refuse to buy until the market price drops to the point where the higher interest rate becomes worth paying for. it's like offering less money for a car because you don't think it offers enough MPG compared to the competition but if you can get it for a cheaper price then the difference will pay for the extra petrol.

Thanks, that's a good way to visualise it. So does that mean that the negative return indicates that the market isn't keen to buy the fund (or the bonds in it) at the price being asked, and therefore the value of the fund will drop until an acceptable price is reached (meaning that the fund holds bonds deemed to be currently less desirable)?

I suppose my next question, then, is, do bond funds tend to hold the bonds that they have invested in until each of those bonds mature, or are they in turn able to buy and sell the bonds in the fund at other times (times other than initial offering and maturity) as well? I'm sensing that there may potentially be layers of turtles all the way down?

Is there any way that you can get a feeling for what returns you, as an individual investor, are likely to get from a bond fund, or is it basically the case that if the value of the fund as a whole is increasing, hopefully you should get more, and if it is descreasing, you will probably get less?

[Alaric]

Is there any way that you can get a feeling for what returns you, as an individual investor, are likely to get from a bond fund

The return from a fund of bonds will be the running yield (income divided by market value) plus or minus the effects of changes in interest rates and if it's not a fund of government bonds, changes in the risk premium.

Bond funds are frequently managed so that the average outstanding term to maturity remains constant over time. That's likely to require periodic sale and repurchase rather than holding to maturity.

[tjh290633]

Yes, and if the fund holds all bonds to maturity there is no permanent loss - but not sure how long it would take to 'recover'. Guess it depends on the maturity dates/weightings. I haven't got to that chapter yet...

It all depends on what price they bought them at. It bought when first issued, fine, but otherwise the redemption yields could well be negative.

TJH

[Lootman]

Yes, and if the fund holds all bonds to maturity there is no permanent loss - but not sure how long it would take to 'recover'. Guess it depends on the maturity dates/weightings. I haven't got to that chapter yet...

It all depends on what price they bought them at. It bought when first issued, fine, but otherwise the redemption yields could well be negative.

Even if you buy at issue there could still be a structural loss built in. For various periods in recent years the offering yield on some Swiss bonds has been negative, i.e. they were issued at above their redemption value.

Investors were happy to accept that guaranteed loss because of the credit quality of the issuer, the potential currency gain due to holding Swiss francs and the potential for capital gain if prevailing rates went even more negative.

I believe some German bonds were issued with negative redemption yields as well, even though issued in Euros.

[AleisterCrowley]

Rare exceptions I would have thought -No reason to buy with a negative redemption yield, unless you forced into a percentage bond holding (pension funds?)

[Lootman]

Rare exceptions I would have thought -No reason to buy with a negative redemption yield, unless you forced into a percentage bond holding (pension funds?)

Remember that the issuer of the bond only chooses the nominal coupon of the bond. The actual price paid, and therefore the true yield, is subject to the results of the auction that places the bond.

So if an entity issues a bond paying 0.1%, and the volume of bids is such that it is oversubscribed, then the price paid for that bond may involve a loss. And investors will often accept that. You and I might not, as we can get 0% from a bank account. But the institutional investors with millions to put to work think about where they can park large sums of money safely, and a Swiss government bond with a redemption yield of -0.5% might seem attractive compared with the alternatives.

[AleisterCrowley]

Going back to the OP, I can't see a bond fund buying anything with a negative yield

Of course the natural slope of any bond bought at a premium is down towards par (plus final coupon?) so £105 for a 5%

[colin]

Going back to the OP, I can't see a bond fund buying anything with a negative yield

The OP's question concerns negative total returns ( I assume) from bond funds, not funds buying bonds on negative yields.

So does that mean that the negative return indicates that the market isn't keen to buy the fund (or the bonds in it) at the price being asked,

Previous years negative return indicate that over the year in which the price fell investors were not keen to buy at the price previously quoted, once the price of the fund fell then assuming no actual defaults or other changes the yield subsequent to the fall in capital will rise thus providing a higher rate of interest.

I suppose my next question, then, is, do bond funds tend to hold the bonds that they have invested in until each of those bonds mature, or are they in turn able to buy and sell the bonds in the fund at other times (times other than initial offering and maturity) as well? I'm sensing that there may potentially be layers of turtles all the way down?

They all act differently, one provider of passive Gilt funds holds all the bonds to maturity but with their corporate bond funds they sell when the bonds are a year from maturity, managed bond funds will do whatever the manager deems appropriate.

Is there any way that you can get a feeling for what returns you, as an individual investor, are likely to get from a bond fund, or is it basically the case that if the value of the fund as a whole is increasing, hopefully you should get more, and if it is descreasing, you will probably get less?

It's too complicated a question for a short answer because there are many different reasons why the value of a fund will fall and how your returns will be affected over time .As a fund falls in price subsequent returns will be determined by factors such as average time to maturity, credit quality, overall interest rates and direction of economic growth, borrowed money that the fund may have employed to enhance returns and the price level of new bonds bought buy the fund as older bonds mature. Personally i think it's better to think of a strategy to manage uncertainty rather look for absolute answers to such questions. But you certainly need to study the characteristics of different types of bond rather than see them as all behaving the same.

[dave559]

Going back to the OP, I can't see a bond fund buying anything with a negative yield

Of course the natural slope of any bond bought at a premium is down towards par (plus final coupon?) so £105 for a 5%

I may have worded my question badly, because this is an area that I don't know much about.

If you look on the Vanguard fund listing (vanguardinvestor co uk/ what-we-offer/ index-active-products) (I can't post proper links yet, I'm afraid), for example, switch the button at the top from "Overview" to "Detailed", and look at the Fixed Income Funds section, quite a number of the bond funds show a negative performance in some years, and that's what I was puzzled about, how that situation could arise?

[Alaric]

quite a number of the bond funds show a negative performance in some years, and that's what I was puzzled about, how that situation could arise?

Interest rates rise, bond prices fall. If they fall by more than the income on the fund, the return over a year will be negative.

[GeoffF100]

Rare exceptions I would have thought -No reason to buy with a negative redemption yield, unless you forced into a percentage bond holding (pension funds?)

People buy bonds on negative yields because they fear that they would lose more money in other investments. If you want a fixed sum in the future and the yield is negative, you just buy more of them.

[AleisterCrowley]

I can (perhaps) see the point with index linked bonds - pay £100k now for £98k 'spending power' in x years,regardless of inflation

[nmdhqbc]

I may have worded my question badly, because this is an area that I don't know much about.

If you look on the Vanguard fund listing (vanguardinvestor co uk/ what-we-offer/ index-active-products) (I can't post proper links yet, I'm afraid), for example, switch the button at the top from "Overview" to "Detailed", and look at the Fixed Income Funds section, quite a number of the bond funds show a negative performance in some years, and that's what I was puzzled about, how that situation could arise?

Yeah, I see where the confusion lies. I too struggled with this for a time. I really am not that knowledgeable on the subject but I'll try below. I'll probably get all sorts of terms wrong but hopefully you'll get the gist as I understand it...

Holding an individual bond to maturity (i.e. they pay you back) it is a binary Lose it all if the company / country goes bust or get paid the coupons and your money back at the end. So with no bonds going bust you may think a bond fund would never lose money. Problem is they don't have a maturity date of the whole fund. They just go on buying and selling (or they mature) bonds in perpetuity. So that pay back date is never reached. So the value of funds is based on the market value which can go down when interest rates go up or if a bonds backers have financial difficulty.

It seems to me that rather counter intuitively in some ways holding your own individual bonds can feel less risky as you know the out date of the investment. If you know it matures on year x the fluctuations in it's market value do not matter so much. All that really matters is the company / government does not go bust and fail to pay you your cash back.

[nmdhqbc]

Actually reading your original post it seems you understand all I just said already so not sure where your confusion comes from.