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Discussion Starter #1
I've been looking at vab and it has an ytd return of 5.75% and a Y TM of 1.4%. There seems to be a lot of focus on the YTM and i don't understand why you would focus on that rather than the return? I'm considering whether to add money to my gic ladder or add to vab.
 

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YTD is backward looking yield.
YTM is forward looking yield.

You're going to own it in the future, not the past.
 

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I don't understand how they can know what the yield would be in the future.
They know all the bonds they presently hold and they assume all coupons will be paid as scheduled and then re-invested at the same rate, so it's basically an internal rate of return expressed as an annual rate into the future. YTD is a nice to know value, but I would look to YTM as a better measure of what's about to occur in the near future. You can make your own guess at what interest rates will do, but that's a tough call. When evaluating fixed income, the best you have to work with is today's rates.

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I've been looking at vab and it has an ytd return of 5.75% and a Y TM of 1.4%. There seems to be a lot of focus on the YTM and i don't understand why you would focus on that rather than the return? I'm considering whether to add money to my gic ladder or add to vab.
Here's the way I think about it. Bond fund returns consist of two parts, which are added together:

The first part is the rate of return from the interest-bearing things it holds. These reliably increase in value at the portfolio's average yield. For example if the stuff inside VAB yields 2% then the overall price goes up, smoothly, at 2% annualized. This part is exactly like the return of a GIC portfolio; smooth and steady, at the yield %.

The second part is bond market volatlity and changes in the bond market. These can be really volatile moves, big swings up or down. But they are unpredictable and pretty random; you can't anticipate or do anything about these.

When we predict or forecast the future return of VAB, we assume that the second part averages out to zero. Instead we go with the first part, which is the predictable portion.

Yes in reality both are added together but the first part (the yield to maturity) is the best estimate for future return. And this does work out in reality... if you look at the YTM on a bond fund, then the next 10 year return, they usually match up pretty well.

I don't understand how they can know what the yield would be in the future.
A factor here is the time horizon we're talking about. The Yield To Maturity is a good estimate of the fund's return for the # of years to maturity. For VAB that's about 10 years.

We don't know the future yields. It could be that in year 8, year 9, the yields are very different than today. But YTM today is a good estimate of the overall return (CAGR) over the first 10 years.

What happens beyond 10 years is a whole different matter and I agree, completely unknown.
 

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Discussion Starter #6
Thanks for the explanations. I think i'll stick to adding money to my ladder. The advantage of bond funds - liquidity - is what i don't like as i was tempted to sell when stock markets dropped although i suppose i could have replenished them the next year. The temptation is gone now.
 

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The YTM is a measure of the expected return of a bond fund at current interest rates.*

If interest rates go up, the fund price will drop, giving a possible capital loss, which will then be offset over time as older bonds mature or are sold and replaced by newer bonds with higher interest rates. The exact opposite happens if interest rates fall. A lot bond fund of investors fear rising rates because of the potential capital loss they may cause, but over time the return will begin to rise again. The longer the maturity of the bond fund, the more volatile the price will be in response to interest rate changes, and longer it will take for the yield to change since it holds more long term bonds. Vanguard has published some good articles on this effect.

Many GIC ladder investors will cheer rising rates because newly purchased GICs will have higher rates. But the value of GIC ladders fluctuate exactly the same as the value of bonds and bond funds. The difference is there is no secondary market for GICs therefore no market price to fret over, and no opportunity to sell GICs before maturity. (Excluding redeemable GICs which usually have lower rates.)

But yeah, for many people the non-negotiability of GICs takes away the worry of tweaking your portfolio. I'm retired so keep a mix of GICs for absolute certainty of available cash on maturity, and bond ETF for liquidity and possibility of capital gains.

*Actually YTM-MER. MER can be a very significant drag on returns in traditional bond mutual funds, but on bond ETFs it is much less significant.
 

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I don't understand how they can know what the yield would be in the future.
In the case of a GIC, you know what the yield to maturity will be. For example you buy the GIC for $1000 and it guarantees to pay you 2% ($20) pa until it matures.

For a single bond, the same thing applies. You buy a bond today with a face value of $1000 that matures in 5 years at the current market price. Say $900. It promises to pay you 2% of the face value ($20) until it matures. Not same as GIC, because you only paid $900, so in effect you get a yield to that future maturity of $20/$900 = 2.22%.

For a bond fund, it is more complicated. It will hold a basket of such bonds with numerous face yields and maturity dates. The fund will also have to buy new bonds to replace shorter maturity bonds as they mature. Some math and some estimates required to predict expected future yield. More accurate in short term than long.

I never buy bond funds. Problem with them I see is, if interest rates start to climb, the fund will still be stuck with a basket of low yield bonds that will take some time to mature. Fund yield will therefore be lower than the new market rate. Some holders will then sell their fund units and as a result unit prices will go down. So you could end up with lower than market yield and a loss on your investment and pay the fund company to manage it for you!

You may be better with a 5yr ladder of 1-5yr GICs. You can't lose any capital and you may gain in yields if interest rates start to rise.

I don't own funds, so take my free advice for what it is worth ;)
 

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I never buy bond funds. Problem with them I see is, if interest rates start to climb, the fund will still be stuck with a basket of low yield bonds that will take some time to mature. Fund yield will therefore be lower than the new market rate.
How is that different than a GIC ladder in a rising rate environment? The investor will be stuck with a basket of low yield GICs that will take some time to mature. And GICs are not liquid if you do need money.


Some holders will then sell their fund units and as a result unit prices will go down. So you could end up with lower than market yield and a loss on your investment and pay the fund company to manage it for you!
Normally a bond fund's price is based on the aggregate of all its holdings and NAV and market price are very close. We did see in the recent crash that bond funds' market prices dropped below the NAV of their holdings, but that was a short term gap that normalized fairly quickly. I have seen debate whether the bond funds' prices were incorrect (beaten down by too many sellers as you said), or whether the published NAV of the bonds did not match their fundamentals because they were in a liquidity crunch and were not trading enough to be fairly valued.

It does emphasize that you should not hold long-term bond funds if you anticipate any short term need for cash from them.
 

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How is that different than a GIC ladder in a rising rate environment? The investor will be stuck with a basket of low yield GICs that will take some time to mature. And GICs are not liquid if you do need money.
Two differences really.
One is that you have control and receive the cash from GICs annually (or more often if desired) to re-invest at best rate available.
Second is that GICs don't lose capital. In a ladder, you get your capital back at least once a year without loss. A bond fund may be more liquid, but in an increasing interest scenario, you would likely take a loss when selling.

Personally, I have a mix of 58 individual bonds and GICs in a ladder (spread over 6 accounts). Maturities spread throughout year. All held to maturity. GICs no risk, but lower yield than bonds. Liquidity not a problem.
 

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The YTM is a measure of the expected return of a bond fund at current interest rates.*
This is a terrific one-line summary.

For a single bond, the same thing applies. You buy a bond today with a face value of $1000 that matures in 5 years at the current market price. Say $900. It promises to pay you 2% of the face value ($20) until it matures. Not same as GIC, because you only paid $900, so in effect you get a yield to that future maturity of $20/$900 = 2.22%.
In this example, 2.22% is the current yield.
To calculate the yield to maturity, you would also include the $100 gain from buying it below par. That makes the YTM 4.26%.

20214
 

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You are right, I oversimplified things to show that interest on bonds depends on the purchase price.
The other difference I should have made more clear, is that the fund has higher risk because of the type of bonds it holds. Any of those could default. This on top of the other risks already mentioned. As a result, you would need to get a much higher yield. Do bond funds provide that? Probably not.
Funds also tend to be held by retail investors. As a result they can be more volatile than their holdings would dictate.
A lot of people do hold these funds. I once did too, but learned the hard way that they were not for me.
 

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Bond funds are actually not too different than holding a GIC portfolio, except for the liquidity and the ability to sell. Ben Felix has a nice video comparing bond funds and GICs:

 

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The YTM is a measure of the expected return of a bond fund at current interest rates.*
Yes, but for individual bonds, it's a calculation of what the return WILL be. Current interest rates are irrelevant.

YTM has a very important disclaimer, it is the yield if held to maturity, and payments are made.

For an individual bond you can hold it to maturity.
For a bond fund, you can't hold to maturity.
 

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Yes, but for individual bonds, it's a calculation of what the return WILL be. Current interest rates are irrelevant.

YTM has a very important disclaimer, it is the yield if held to maturity, and payments are made.

For an individual bond you can hold it to maturity.
For a bond fund, you can't hold to maturity.
OP asked whether YTD return or YTM is a better measure for bond funds like VAB. YTD return to May 31 for VAB is 5.79%, which is not a realistic basis for estimating future returns because interest rates dropped this year, driving the price return up via capital gains. That's not likely to continue.

YTM is a better value to use for estimates of future returns of VAB, however it is based on the YTM of VAB's current holdings. Interest rate fluctuations will cause the YTM and return to change. That is why I said YTM is a measure of the expected return of a bond fund at current interest rates. You can't know future bond fund returns because you don't know future interest rates.

VAB has a duration of about 8 years, whereas a 5 year GIC ladder has a duration of about 2.5 years, much shorter, so VAB and 5 year ladders are not really comparable holdings. Investors holding VAB may suffer a capital loss if they hold it for a time period shorter than its duration. The video posted by J4B and the Vanguard paper to which I linked upthread explain it well.
 

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I was just trying to point out that for an individual bond YTM isn't an estimate.
It is an actual known value.
 

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I was just trying to point out that for an individual bond YTM isn't an estimate.
It is an actual known value.
One of the good reasons to own actual bonds (or GICs) vs funds.

But agree, not for everybody. You need enough bonds to provide diversification. And not all brokers offer much of a selection. Corporate bonds also need to offer higher returns over GICs because of greater risk.

Bonds aside, I would go with a GIC ladder over a bond fund anyday, unless the bond fund offered a significantly higher future yield.
 

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I don't hold bond funds (ETFs) either for reasons provided, but they are the best way for 'hands off' retail investors who do not want to actively manage their FI component. My ex is a perfect example.... She does not want to keep track of a 5 year GIC ladder, so she is in XSB. There is something appropriate for everyone.
 

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Ben Felix has a nice video comparing bond funds and GICs:
That was interesting. One of the things he mentioned is that foreign bonds are useful in a portfolio and that is something I do not have any exposure to directly. I'm wondering if folks have an opinion on what's available:

A quick look finds only currency hedged funds. I generally eschew currency hedging in equity funds. How cost effective is the hedging? I am used to it being expensive in MER, but relatively ineffective. Is there something about bonds that makes hedging cheaper and more accurate? Are there unhedged global bond funds worth owning?
 

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Without currency hedging, foreign bonds could easily wipe out any return. IOW, currency volatility can be much higher than return volatility in a foreign bond's native currency. Might as well just bet on the currency itself.

"Everyone" currency hedges foreign bonds to take that risk out. The reason the likes of Vanguard, Mawer, et al do it.
 
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