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Subject:  Re: Beginner's Qs on Bonds Date:  7/15/2004  11:25 AM
Author:  jbking Number:  10464 of 35909

Greetings CMW,

1) What's the economic difference between a long-term, intermediate-term, short-term, or full bond market index fund?

The term refers to how long the bond will be around assuming it isn't called. Long-term bonds are usually 20-30 years in length, intermediate is shorter like 7-10 and short-term is 2-3 roughly. Typically, the longer the term the more sensitive the bond will be to interest rate shifts as if rates go up 1% this means more if the bond isn't maturing for another 20 years compared to a bond maturing in another year or two so shorter-term is usually less volitile. A full bond market index fund will hold bonds of all maturities and thus has a mix of short, intermediate and long which should make it move like an intermediate with a bit more kick but that is just a guess from my part.

2) This is what I found under the section marked "Risk Attributes"

Historic Volatility Measures as of 05/31/2004
Benchmark R-squared* Beta*
Lehman Long Government/Credit Index 1.00 0.99
Lehman Brothers Aggregate Bond Index 0.93 2.17

*R-squared and beta are calculated from trailing 36-month fund returns relative to the associated benchmark.

What do R squred and beta mean?

Definition time from M*:

R-Squared vs. Standard Index
R-squared ranges from 0 to 100 and reflects the percentage of a fund's movements that are explained by movements in its benchmark index. An R-squared of 100 means that all movements of a fund are completely explained by movements in the index. Thus, index funds that invest only in S&P 500 stocks will have an R-squared very close to 100. Conversely, a low R-squared indicates that very few of the fund's movements are explained by movements in its benchmark index. An R-squared measure of 35, for example, means that only 35% of the fund's movements can be explained by movements in its benchmark index. Therefore, R-squared can be used to ascertain the significance of a particular beta or alpha. Generally, a higher R-squared will indicate a more useful beta figure. If the R-squared is lower, then the beta is less relevant to the fund's performance.

Beta vs. Standard Index
Beta, a component of Modern Portfolio Theory statistics, is a measure of a fund's sensitivity to market movements. It measures the relationship between a fund's excess return over T-bills and the excess return of the benchmark index. Equity funds are compared with the S&P 500 index; bond funds are compared with the Lehman Brothers Aggregate Bond index. Morningstar calculates beta using the same regression equation as the one used for alpha, which regresses excess return for the fund against excess return for the index. This approach differs slightly from other methodologies that rely on a regression of raw returns.

By definition, the beta of the benchmark (in this case, an index) is 1.00. Accordingly, a fund with a 1.10 beta has performed 10% better than its benchmark index--after deducting the T-bill rate--than the index in up markets and 10% worse in down markets, assuming all other factors remain constant. Conversely, a beta of 0.85 indicates that the fund has performed 15% worse than the index in up markets and 15% better in down markets. A low beta does not imply that the fund has a low level of volatility, though; rather, a low beta means only that the funds market-related risk is low. A specialty fund that invests primarily in gold, for example, will often have a low beta (and a low R-squared), relative to the S&P 500 index, as its performance is tied more closely to the price of gold and gold-mining stocks than to the overall stock market. Thus, though the specialty fund might fluctuate wildly because of rapid changes in gold prices, its beta relative to the S&P may remain low.

It seems to measure how closely this fund tracks with a given benchmark. Is that right?

That's pretty close. R-squared is how much of the movements of the fund can be attributed to the index while beta is what multiplier it should have if one did a linear regression on the returns.

Why is it important to my investment decision?

Because you may want to know how well a fund follows a benchmark if you want to try to get different asset classes. It doesn't make a lot of sense to buy a small-cap fund if it behaves just like a large-cap fund, if you want a somewhat extreme example here. Beta is sometimes used as a risk measurement where some like lots of volitility and others want it as low as possible.

3) Could you recommend links/readings/etc. that would bring me up to speed on investing in bonds.

Here are a few ideas: