Search This Blog

Tuesday, September 21, 2010

Think You Know What You Own When You Own An Actively Managed Bond Fund ? Think Again

Bonds form an important part of one's asset allocation. That allocation can include bonds of varying credit quality and maturity. But it is important to know the composition of one's bond allocation with regard to these characteristics. The best way to do this is to purchase bond etfs which are designated to match the characteristics of a particular bond index.

Yet many bond investors purchase actively managed bond funds often it seems engaging in performance chasing. Yet because these funds can often engage in purchases any time of bonds and sometimes can even short bonds, invest in credit derivatives or even hold equities the investor never knows exactly what he owns, As a consequence he never knows the risk parameters of his portfolio . Rather than having his bond holding as a stable counterweight to his equity holdings the investor is simply betting on the skill of the fund manager. In addition to the equity risk and fixed income market risk in a portfolio composed of bond and stock index instruments the holder of actively managed "go anywhere' bond funds has added "manager risk".

Today's wsj gives evidence (my bolds and comments in blue)

After rushing to the safety of Treasurys this year, Bill Gross of bond-fund company Pacific Investment Management, or Pimco, and Jeffrey Gundlach of DoubleLine Capital in recent months have pared back their holdings of U.S. government debt.

 This one is particularly shocking that bond alliocation in your protfolio which is invested in a major actively traded bond fund might actually be short treasury bonds:

Meanwhile, for the first time ever, fund firm Dodge & Cox is shorting Treasurys futures in some of its bond portfolios, betting they will fall in value, mainly as a way to manage interest-rate risk, said Daniel Culloton, associate director of fund analysis at research firm Morningstar. Dodge & Cox declined to comment.

If you are invested in the world's largest bond fund it would be difficult for you to know where your bond exposure is since it changes so drastically

In Pimco Total Return Fund, the world's biggest bond portfolio with about $248 billion in assets, U.S. government-related holdings fell to 36% at the end of August from 63% in June, according to Pimco's website. The holdings include Treasurys, Treasury inflation-protected securities and agency securities, among other things. A Pimco spokesman declined to comment.

The same would be the case for holders of the fund of one of the mutual fund world's "hot" bond fund managers:

DoubleLine's chief executive and co-founder, Mr. Gundlach, who predicted in June that the 10-year Treasury yield would fall to 2.5% or lower, reduced his positions in government-backed securities in DoubleLine Core Fixed Income Fund to 36% in August from 52% in July. The changes weren't prompted by a bearish view on Treasurys, Mr. Gundlach told investors in a conference call last week, as much as by the alternative opportunities available.

and if you hold the core bond fund from another fund company you now own a health chunk of non US bonds:

Meanwhile, managers of the Loomis Sayles Bond Fund, which is up 7.7% year to date through August, have been buying longer-term, investment-grade corporate bonds, as well as bonds from other countries, such as Canada, which the team believes to be in better fiscal shape and will benefit from growth in emerging markets, said Matt Eagan, one of the portfolio managers of the fund.
It seems pretty clear that holding actively traded bond funds to a portfolio can add plenty of extra risks there is only one sure way to avoid this: own exchanged traded funds tied to an index that are tied to a particular sector of the market. That is the only way to clearly know at all times the composition of one's bond holdings in terms of duration, issuer, and credit quality.

I caught a commentator on the morningstar website who observed that while there is a trend of funds flowing out of actively managed equity funds into etfs but no such trend in fixed income indicating perhaps that investors feel that active management works better in fixed income than in equities. Perhaps what s actually happening is that investors are chasing performance. Their money is flowing to actively managed funds with high returns,. And we know that the actively managed bond funds with the highest returns have been those that have been rewarded for taking the biggest risks in terms of long duration and high credit risk.

So far the strategy has paid off. But do the investors know the risks inside those actively managed bond portfolios ?

And how many of those managers will be as skillful in a bear market for bonds as they were in this great bull market ?

How many active bond fund investors will find out that they were "fooled by randomness" after all everyone is a genius in a bull market.

No comments: