[quote=Philo Kvetch]How does owning individual issues 'guarantee' against interest rate risk?[/quote]

This is going to be good. Idiots don't look too good when they go up against Philo.

If a client really doesn't like the idea of getting back less than they put in, I will use individual bonds. Otherwise, I use bond funds or ETFs.

Because with a bond, I can tell a client that the $25K bond will pay them back EXACTLY $25K on July 20, 2014, regardless of what interest rates do (if the company is still around). I can't say that with a bond fund.

I personally prefer bonds funds over individual bonds. I know it will come as a shocker, but I think Bill Gross is smarter than me.

[quote=now_indy]

If a client really doesn't like the idea of getting back less than they put in, I will use individual bonds. Otherwise, I use bond funds or ETFs.

Because with a bond, I can tell a client that the $25K bond will pay them back EXACTLY $25K on July 20, 2014, regardless of what interest rates do (if the company is still around). I can't say that with a bond fund.

I personally prefer bonds funds over individual bonds. I know it will come as a shocker, but I think Bill Gross is smarter than me.

[/quote]

That sounds like an awfully long surrender period, to me.

[quote=Philo Kvetch]How does owning individual issues ‘guarantee’ against interest rate risk?[/quote]

Guarantee is probably a poor choice of words, but they will offer some protection if interest rates decline over a period of time-as clients continue to collect the higher coupons from a specific bond.

This is a good thread, has given me some useful information and some provoctive thoughts as well.

BTW-it is not that I disagree with the idea that for most bond funds or ETF’s are better.  It’s just that some investors want GUARANTEES.

Oh-and I would dispute your point, AllREIT that only govies, agencies, and munis carry truly legit guarantees…

What about GE paper, for example?

[quote=Philo Kvetch]How does owning individual issues ‘guarantee’ against interest rate risk?[/quote]

Because even if interest rates go up, the person holding the bond will (worst case) still get all of their money back at maturity. (assuming they didn’t buy the bond at a premium)

Interest rate risk, by definition, is that if rates rise above current levels, the

current value of the paper you now hold will decline. Buying an individual

issue assumes and accepts interest rate risk.



Looks to me like you can’t differentiate between interest rate risk and

principal risk.

[quote=Philo Kvetch]Interest rate risk, by definition, is that if rates rise above current levels, the

current value of the paper you now hold will decline. Buying an individual

issue assumes and accepts interest rate risk.



Looks to me like you can’t differentiate between interest rate risk and

principal risk.













[/quote]

By owning the bond outright, your pricipal is protected against rising interest rates (interest rate risk,) because at maturity, you get all your principal back, no matter how much interest rates have risen.

With a bond fund, there is no such protection because there is no maturity date.

[quote=ManagedMoney]

[quote=Philo Kvetch]Interest rate risk, by definition, is that if rates rise

above current levels, the

current value of the paper you now hold will decline. Buying an individual

issue assumes and accepts interest rate risk.



Looks to me like you can’t differentiate between interest rate risk and

principal risk.













[/quote]By owning the bond outright, your pricipal is protected against

rising interest rates (interest rate risk,) because at maturity, you get all

your principal back, no matter how much interest rates have risen.With a

bond fund, there is no such protection because there is no maturity date.

[/quote]



What you’re describing is principal risk, not interest rate risk. Even in

your current confused state, you still haven’t shown any 'guarantees’

against interest rate risk. You’ve shown how the investor ASSUMES ALL of

the interest rate risk.

[quote=Philo Kvetch]


What you’re describing is principal risk, not interest rate risk. Even in

your current confused state, you still haven’t shown any 'guarantees’

against interest rate risk. You’ve shown how the investor ASSUMES ALL of
the interest rate risk.[/quote]



I think managedmoney, (at ML right?) needs to review his training module on fixed income.

The only thing you know with an individual security, is that it will be
redeamed at par at some time in the future, and therefore current price
will converge on par value.



Thats only important if you plan to hold a bond to maturity. Of course
if you have a bond portfolio, you rarely do that. Why? because the
durration of bond goes down as it gets closer to maturity, so if you
want to keep a portfolio with a target durration you have to roll bonds.



If managed money sells a widow a 30 year long bond and says it has no
interest rate risk, then interests go up, and it trades at 80… There will be many lawyers happy to take the case.



2. Credit risk is the risk of not getting principal/interest because the obligor defaults or refuses to pay.



If this bothers you, buy treasury bonds or else keep a very diverse
portfolio with no credit sensitive bond being more than 1% of the
portfolio. If you run a big fixed income account (i.e you are PIMCO or
an insurance company), you can also play cute tricks with bond
futures/options to greatly lower portfolio durration at fairly low cost.



Or just avoid this whole mess by using a bond fund, and explaining to the client that it may bounce around a small bit.

That is a good summary of the risks in investing bonds Allreit.  Thanks.

This is exactly why I do not offer fixed bonds at this time unless the client is very very sure that they are going to be able to accept the interest rate risk.   Those are usually my very elderly clients who just want to have a fixed income until death and buy bonds with the Death Put feature.

Most individuals don't have the funds to be able to construct a good bond portfolio.  Bond funds are where I'm at for income clients with some ETFs thrown in to juice the yield.

[quote=ManagedMoney] [quote=Philo Kvetch]Interest rate risk, by definition, is that if rates rise above current levels, the
current value of the paper you now hold will decline. Buying an individual
issue assumes and accepts interest rate risk.

Looks to me like you can't differentiate between interest rate risk and
principal risk.

[/quote]

By owning the bond outright, your pricipal is protected against rising interest rates (interest rate risk,) because at maturity, you get all your principal back, no matter how much interest rates have risen.

With a bond fund, there is no such protection because there is no maturity date.

[/quote]

In the meantime, while interest rates are rising, your client  is holding a sub par valued bond paying less interest than most bank cds are paying.  He is royally pissed at you because he can't sell his bond, unless he wants to take a principle loss, to get a higher yield.   Your client is stuck with this loser investment until rates go back up or until it matures. 

Every month he looks at his statement, sees that 10,000 bond valued at 7,000, sees that he is getting 5% and even bank cds are paying 6 to 7% and he gets mad at you all over again.   He forgets that 5% seemed like a good rate at the time. If you didn't explain the consequences to him of this and DOCUMENT that you did you are setting yourself up for a really big fall or at least a mad client who is going to tell everyone about how you screwed him

[quote=AllREIT]

If managed money sells a widow a 30 year long bond and says it has no
interest rate risk, then interests go up, and it trades at 80… There will be many lawyers happy to take the case.




Or just avoid this whole mess by using a bond fund, and explaining to the client that it may bounce around a small bit.



[/quote]

AllREIT I agree with much of what you post, and you clearly are a bright fella.

Having said that-

1.)  Anyone who sells a 30 year bond or a mortgage pass through to an 80 year old without fully educating them as to risks, and documenting the discussions, DESERVES to get hauled into arbitration.

2.)  As to your “bounce around a bit” comment, I’m guessing you’ve been fortunate enough to never have the experience of having a bond fund blow up under you.  It sucks.

As I said before, I agree with you that generally bond funds are better for most.  But specific fixed income works well for certain folks too.  Just offering a different POV.

[quote=AllREIT] [quote=Philo Kvetch]

What you're describing is principal risk, not interest rate risk. Even in
your current confused state, you still haven't shown any 'guarantees'
against interest rate risk. You've shown how the investor ASSUMES ALL of the interest rate risk.[/quote]

I think managedmoney, (at ML right?) needs to review his training module on fixed income.

1. Interest rate risk related to the possiblity of the current market value of a security going up or down due to changes in interest rates. All fixed income securities have this, and "durration" describes this sensitivity.

Floating rate securities are conceptually a series of smaller short term securities so they have very low durrations. Securities with embedded options (callable bonds, mortgages, etc) have variable durrations and are a PITA to price and value.

The only thing you know with an individual security, is that it will be redeamed at par at some time in the future, and therefore current price will converge on par value.

Thats only important if you plan to hold a bond to maturity. Of course if you have a bond portfolio, you rarely do that. Why? because the durration of bond goes down as it gets closer to maturity, so if you want to keep a portfolio with a target durration you have to roll bonds.

If managed money sells a widow a 30 year long bond and says it has no interest rate risk, then interests go up, and it trades at 80... There will be many lawyers happy to take the case.

2. Credit risk is the risk of not getting principal/interest because the obligor defaults or refuses to pay.

If this bothers you, buy treasury bonds or else keep a very diverse portfolio with no credit sensitive bond being more than 1% of the portfolio. If you run a big fixed income account (i.e you are PIMCO or an insurance company), you can also play cute tricks with bond futures/options to greatly lower portfolio durration at fairly low cost.

Or just avoid this whole mess by using a bond fund, and explaining to the client that it may bounce around a small bit.

[/quote]

No, that's still not right.  Credit Risk is the possibility that an issuer may not meet his obligations in a timely manner, or default entirely on  the service of the debt.  Principal Risk is the threat of loss of principal.  In other words, an investor may receive all interest payments in a timely manner, yet still lose his/her principal if the company cannot return the face amount of the instrument.  An investor may lose interest payments (if, for example, the company files for protection from creditors), yet still not have principal at risk.

[quote=AllREIT] [quote=Philo Kvetch]

What you're describing is principal risk, not interest rate risk. Even in
your current confused state, you still haven't shown any 'guarantees'
against interest rate risk. You've shown how the investor ASSUMES ALL of the interest rate risk.[/quote]

I think managedmoney, (at ML right?) needs to review his training module on fixed income.

1. Interest rate risk related to the possiblity of the current market value of a security going up or down due to changes in interest rates. All fixed income securities have this, and "durration" describes this sensitivity.

Floating rate securities are conceptually a series of smaller short term securities so they have very low durrations. Securities with embedded options (callable bonds, mortgages, etc) have variable durrations and are a PITA to price and value.

The only thing you know with an individual security, is that it will be redeamed at par at some time in the future, and therefore current price will converge on par value.

Thats only important if you plan to hold a bond to maturity. Of course if you have a bond portfolio, you rarely do that. Why? because the durration of bond goes down as it gets closer to maturity, so if you want to keep a portfolio with a target durration you have to roll bonds.

If managed money sells a widow a 30 year long bond and says it has no interest rate risk, then interests go up, and it trades at 80... There will be many lawyers happy to take the case.

2. Credit risk is the risk of not getting principal/interest because the obligor defaults or refuses to pay.

If this bothers you, buy treasury bonds or else keep a very diverse portfolio with no credit sensitive bond being more than 1% of the portfolio. If you run a big fixed income account (i.e you are PIMCO or an insurance company), you can also play cute tricks with bond futures/options to greatly lower portfolio durration at fairly low cost.

Or just avoid this whole mess by using a bond fund, and explaining to the client that it may bounce around a small bit.

[/quote]

You sound like a bond fund manager who manages for total return. Most people with significant bond portfolios invest for income, not total return.

Even though MM may not have stated it as well as he/she could have, that individual issues have maturity dates can be a significant safety net in a rising interest rate environment. The interest risk possibilities should be handled with the client up front. As should all the risks involved with bond funds including the FACT that it is possible that the fund may lose and not recover all or part of the client's investment.

My experience with large fixed income portfolios is that these clients tend to be in the market on a continuous basis thus building portfolios that mirror interest rates. Certainly noone wants a 4% bond in a 5% market. Generally speaking it is accepted by experienced bond buyers, with little or no whining. The flip side is having 6 or 7% bonds in a 5% market. Experienced bond buyers know it works both ways which is why they usually don't complain. Tax swaps are a handy tool to get rid of any problematic bonds we no longer wish to hold.

I use funds only for high yield munis. Outside of that, the risk, and the cost makes buying funds a nonstarter for all but the smallest investors.

As more and more advisors offer fund only solutions to high net worth investors my "buy individual bonds" solution is becoming more and more of a unique niche.

[quote=BondGuy]

You sound like a bond fund manager who manages for total return. Most people with significant bond portfolios invest for income, not total return.

Even though MM may not have stated it as well as he/she could have, that individual issues have maturity dates can be a significant safety net in a rising interest rate environment. The interest risk possibilities should be handled with the client up front. As should all the risks involved with bond funds including the FACT that it is possible that the fund may lose and not recover all or part of the client's investment.

My experience with large fixed income portfolios is that these clients tend to be in the market on a continuous basis thus building portfolios that mirror interest rates. Certainly noone wants a 4% bond in a 5% market. Generally speaking it is accepted by experienced bond buyers, with little or no whining. The flip side is having 6 or 7% bonds in a 5% market. Experienced bond buyers know it works both ways which is why they usually don't complain. Tax swaps are a handy tool to get rid of any problematic bonds we no longer wish to hold.

I use funds only for high yield munis. Outside of that, the risk, and the cost makes buying funds a nonstarter for all but the smallest investors.

As more and more advisors offer fund only solutions to high net worth investors my "buy individual bonds" solution is becoming more and more of a unique niche.

and that was because I wrongly assumed that everyone here would know that I was referring to the principal protection one gets in a rising interest rate enviroment by owning individual bonds, rather than being in a bond fund. 

You are still not getting it.  There is no principal protection in a rising interest rate environment.  Yes, the client will get their funds back when the bond matures.  However, in the meantime their principal has been severely eroded.  If the bonds have call features, in a rising interest rate environment you can bet that the bonds will not be called.  The bond you sold to your client cannot be sold without a loss.  There is no liquidity.  In some cases as I stated this isn't a problem. The client doesn't need liquidity and is satisfied with the income stream.  But you will find that most clients, even those you thought were suitable for bonds, will be screaming their heads off at you when rates go up.  Note: I don't say if.  I say when.

Apparently, the fact that it is possible that a bond fund may lose and not recover all or part of the client's investment is an issue that no one here wants to acknowledge.  It's like the big elephant in the room.

I don't think anyone is in denial that bond funds wont'/can't lose money if rates go up.  Having seen this happen over the years I can also tell you that the bond fund is more likely to recover in principal (share price) because as rates do go up they are able to gradually add new higher yielding bonds that eventually stablize the portfolio and allow the share prices to go up as more new money is invested to take advantage of the new higher yield.   An individual bond is just stuck at the lower evaluation.

I use a combination of funds, bonds (TIPS or indexed), short term bonds and ETFs.  All depending on the client's age, income needs, liquidity needs, risk tolerance....among other factors.

[quote=babbling looney]

and that was because I wrongly assumed that everyone here would know that I was referring to the principal protection one gets in a rising interest rate enviroment by owning individual bonds, rather than being in a bond fund. 

You are still not getting it.  There is no principal protection in a rising interest rate environment.  Yes, the client will get their funds back when the bond matures.  However, in the meantime their principal has been severely eroded.  If the bonds have call features, in a rising interest rate environment you can bet that the bonds will not be called.  The bond you sold to your client cannot be sold without a loss.  There is no liquidity.  In some cases as I stated this isn't a problem. The client doesn't need liquidity and is satisfied with the income stream.  But you will find that most clients, even those you thought were suitable for bonds, will be screaming their heads off at you when rates go up.  Note: I don't say if.  I say when.

Apparently, the fact that it is possible that a bond fund may lose and not recover all or part of the client's investment is an issue that no one here wants to acknowledge.  It's like the big elephant in the room.

I don't think anyone is in denial that bond funds wont'/can't lose money if rates go up.  Having seen this happen over the years I can also tell you that the bond fund is more likely to recover in principal (share price) because as rates do go up they are able to gradually add new higher yielding bonds that eventually stablize the portfolio and allow the share prices to go up as more new money is invested to take advantage of the new higher yield.   An individual bond is just stuck at the lower evaluation.

I use a combination of funds, bonds (TIPS or indexed), short term bonds and ETFs.  All depending on the client's age, income needs, liquidity needs, risk tolerance....among other factors.

[/quote]

BL, bond funds also erode in up rate environments. The primary difference being that with a fund there is a possibility that you may never get back to even. Bond fund performance and the inabilty of BF managers to recoup loses, guess correctly, and in some cases act in their sharehoders best interest, WAS graphically illustrated by the bond market collapses of 94 and 98/99. The problem was and still is that for managers to keep their jobs managers they need to perform this quarter. That short term thinking led to a lot of locked in loses by managers repositioning to improve performance going forward. Many of these managers added to the misery by guessing wrong a second time. That many bond funds that were operating in 94 have not recovered to their previous levels shows the real risk investors are taking with bond funds. The disconnect between bond fund investors, who probably wouldn't mind if it took a couple of years to get the money back, and managers whose jobs were on the line became a glaring red flag to all bond fund investors. With individual bonds the investor has full control, can take loses or hold, or buy mori. There is no conflict of interest.

Also, in your example of a client losing 30% of their investment and being locked into a bond on a rising rate market, have you ever had that happen? That's one hell of an interest rate move! In fact, I've never had it happen. We've gone to the low nineties on munis and high eighties on Ginnies but 30%? However, I understand the point you were making, just the numbers struck me as way off.

Forum Rule #1...never argue bonds with BondGuy...politics perhaps, but never bonds...

I'm not arguing bonds with Bond Guy, just discussing some of the different strategies and pointing out some pitfalls to Managed Money.

Bond Guy: my example was exagerated, but I have seen bonds take considerable dumps back the the early 90's.  And I also agree that bond funds can erode in any interest rate environment.  I guess the point is that there is nothing 100% safe and I wanted to point out the falacy that Managed Money has in his thinking that bonds are a way to protect principal. (Technically they are)  What is even worse than just interest rates rising on a bond portfolio is the double whammy of rising interest rates and downgraded credit quality  (GMAC) eeek.

Yes, you get your money back when the bond matures. So your principal is protected.  But to the client who is looking at the short term where his statement si showing his bond is down in value because interest rates went up, this is really cold comfort.   He doesn't think his principal is protected, much. 

"Well, Mr Client. Your GMAC bond that was $45,000 is now worth $32,000.  (Explanation of bond ratings and pricing to the client....again) The good news is that if it is called which could happen beginning 2 years from now or when it matures in 2019 you will get 100% of your principal back . Plus in the meantime you will still recieve your interest of 5.65% (cough cough unless the company goes belly up and they default on the whole thing cough cough)"

True story.  I thankfully didn't sell him this bond. This is the only bond he owns and represents almost all the money he has in the world. The client just doesn't understand and is worried sick. There are a lot of people out there who bought this stuff from Jones brokers who were just selling the rate and didn't explain the risks.  Jones never explained the risks to the newbie brokers either.  Never sell the rate.

Most clients don't have sufficient funds to construct a really good bond ladder and don't have the additional funds or guts to buy more when the bonds have gone down in value.  You and I understand how this works.   Most clients don't.   It's our job to manage the expectations and risk levels that the clients have by choosing a variety of investments and strategies.

BL…that wasn’t necessarily directed at you…just a general acknowledgement that just about all of us can learn much on bonds from BG.  The placement of my comment admittedly made it appear directed at you, but it’s no more at you than it is at me.