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And what happens when nearly everyone indexes? And when indexing with a bond fund, do you really want to be buying negative yield bonds?

by notadoc 10y ago

Hermel 10y ago
If the less informed shareholder move to passive allocations, the market actually gets more efficient: http://www.philosophicaleconomics.com/2016/05/passiveactive/ http://www.philosophicaleconomics.com/2016/05/passiveactive/
- infinite8s 10y ago
  Until no one is left doing price discovery. The end state of the indexing craze isn't 100% passive investing, but some equilibrium between active and passive management.
cloudjacker 10y ago
I think at this point we can just ignore the yields on bonds. The majority of the "income" from government bonds has come from capital gains, not the coupon. Then the yield decreases it is because the bond itself has become more expensive. Sell the bond at the higher price. Negative yield is an annual rate. Taking a short position is more expensive. Holding a CDS is more expensive. If you expect negative yields to continue or go deeper, then bonds are a good investment. Now, if you are in more illiquid corporate bonds, then you may be forced to hold them till maturity.
anonu 10y ago
This is the beauty of the markets. If everyone indexes then this will create arbitrage opportunities for the active manager. People will chase the opportunities - and the cycle continues.
Spooky23 10y ago
With interest rates on the floor, why would you want any bond index fund? You're better off putting your bond allocation in high yield savings accounts. That's the thing about index/robo people that I don't get. The magic formula can do dumb things.
- refurb 10y ago
  Because bond prices move in the opposite direction of equities (generally)? Also, you're not just collecting interest off those bonds since prices move based on the market's interpretation as to where future interest rates are going. I'm sure my explanation sucks, but if the economy starts to improve, the expectation is that rate will go up, so bond prices fall. And the inverse. Take a look at Vanguard's bond fund (BND). It went from $80.5 to $84 since January 2016. That's a 4.3% return over 8 months and it wasn't because of the interest the bonds pay. It was also at ~$84 back in 2013. As the economy improved the price dropped then went back up again. Basically, bonds provide a way to diversify to an asset that is not correlated with equities. Investing in bonds reduces your overall return (vs. just equities), but it also reduces the risk level. If you find that sweet spot you can optimize for slightly reduced returns at a much lower risk. This is standard Boglehead theory. Folks who know more than me can correct my explanation.
- justin66 10y ago
  One thing a bond fund can offer that a savings account simply cannot is access to TIPS. TIPS bought and held to maturity are about the safest investment there is, and bond funds can capitalize on that (although I'm not sure how great any of the popular TIPS-based funds actually are). There are other answers to your question, of course, depending on the situation. Munis or treasuries will have different tax advantages and so on, while the money your high (ahem) yield savings account pays will probably be taxable income. You probably know all this, just thought it worth pointing out that all of this stuff can be used sometimes for a good reason...

And what happens when nearly everyone indexes? And when indexing with a bond fund, do you really want to be buying negative yield bonds?

by notadoc 10y ago

And what happens when nearly everyone indexes? And when indexing with a bond fund, do you really want to be buying negative yield bonds?

Hermel 10y ago

If the less informed shareholder move to passive allocations, the market actually gets more efficient: http://www.philosophicaleconomics.com/2016/05/passiveactive/ http://www.philosophicaleconomics.com/2016/05/passiveactive/

infinite8s 10y ago
Until no one is left doing price discovery. The end state of the indexing craze isn't 100% passive investing, but some equilibrium between active and passive management.

cloudjacker 10y ago

I think at this point we can just ignore the yields on bonds. The majority of the "income" from government bonds has come from capital gains, not the coupon. Then the yield decreases it is because the bond itself has become more expensive. Sell the bond at the higher price. Negative yield is an annual rate. Taking a short position is more expensive. Holding a CDS is more expensive. If you expect negative yields to continue or go deeper, then bonds are a good investment. Now, if you are in more illiquid corporate bonds, then you may be forced to hold them till maturity.

anonu 10y ago

This is the beauty of the markets. If everyone indexes then this will create arbitrage opportunities for the active manager. People will chase the opportunities - and the cycle continues.

Spooky23 10y ago

With interest rates on the floor, why would you want any bond index fund? You're better off putting your bond allocation in high yield savings accounts. That's the thing about index/robo people that I don't get. The magic formula can do dumb things.

refurb 10y ago
Because bond prices move in the opposite direction of equities (generally)? Also, you're not just collecting interest off those bonds since prices move based on the market's interpretation as to where future interest rates are going. I'm sure my explanation sucks, but if the economy starts to improve, the expectation is that rate will go up, so bond prices fall. And the inverse. Take a look at Vanguard's bond fund (BND). It went from $80.5 to $84 since January 2016. That's a 4.3% return over 8 months and it wasn't because of the interest the bonds pay. It was also at ~$84 back in 2013. As the economy improved the price dropped then went back up again. Basically, bonds provide a way to diversify to an asset that is not correlated with equities. Investing in bonds reduces your overall return (vs. just equities), but it also reduces the risk level. If you find that sweet spot you can optimize for slightly reduced returns at a much lower risk. This is standard Boglehead theory. Folks who know more than me can correct my explanation.
justin66 10y ago
One thing a bond fund can offer that a savings account simply cannot is access to TIPS. TIPS bought and held to maturity are about the safest investment there is, and bond funds can capitalize on that (although I'm not sure how great any of the popular TIPS-based funds actually are). There are other answers to your question, of course, depending on the situation. Munis or treasuries will have different tax advantages and so on, while the money your high (ahem) yield savings account pays will probably be taxable income. You probably know all this, just thought it worth pointing out that all of this stuff can be used sometimes for a good reason...