I began investing seriously in August 2008. I started with common stock investments because I understand them better than other securities. Luckily, I did not invest all my money in the first couple of months and have done pretty well with the stocks purchased from October through April of 2009.Now I would like to put some money into fixed income investments, so I have been reading about fixed income investments and visiting this board regularly. As noted in many posts, this is a poor time to begin investing in bonds. Since I have a strong view that interest rates will be going up over the next few years and, consequently, I have been reluctant to invest in fixed income securities so far.I saw a reference today to the Rydex Inverse Government Long Bond Styrategy Fund (RYJUX), which is designed to increase in value when interest rates go up. As I see it, even though this has "Fund" at the end of the title, it is a derivative instrument that bets on the increase in long-term interest rates (or shorts long-term bonds). As a derivative, I would consider an investment in this fund as a speculation. However, if I want to expand my portfolio into the fixed income arena, I should be able to shop for long-term bonds with reasonable interest rates (at a range of yet to be defined default risks I find acceptable) and hedge the interest rate risk with a comparable investment in RYJUX.I would appreciate any feedback on this strategy. Also, if there are better vehicles out there for this kind of operation, I would appreciate hearing about them. I have not yet spent any time on due diligence on RYJUX or any specific bond issues that I would consider.
Oops! I need to do a better job of proofing my posts. It should read: I have a strong view that interest rates will be going up over the next few years and, consequently, I have been reluctant to invest in fixed income securitites so far.
you can not hedge. There is no such thing. You gonna place a dollar on red, then place another dollar on black, and then let the pitman spin the wheel? For why you do this? Double ought will eventually get you.Speculation does not care how you define 'derivative'. It matters not. You go to cash, buy AAPL stock, or CAT bonds, or USTs, or CDS on Uruguay, it does not matter, you are taking a position, you are speculat'n.Timing interest rate rises is something Louise Yamada has been studying foar longer than most of us have been in this game. She says, the change from dropping rates to rising rates can take a surprisingly long time. Go to LYA-Advisors and check out the Bloomberg interviews she did last year.If you want to take a position that profits from rising UST yields, then go for it. But you can't hedge that position. You either take the position, or you do not take the position. Putting in a 'hedge' is the same as increasing the cost of doing nothing, ie staying out of that position.I think UST yields have further to DROP. But what I think does not affect effect the market. So I stand aside, awaiting emotional confirmation that my take is correct and that I should buy TLT. If the confirmation is not there, then I do not take that TLT position.I happened to be thinking about this when you posted, I am not giving advice, just wording out my current thesis.Ti - sold most all my REE stuff today as prices went insanely up, and sold my goldsilver as it dropped. No yield positions just now, but I watch as my web sends back, currently, no vibrations. Over 80% MMF. a very little bit of burnables, materials, goldsilver and REEs.
Ti, thanks for the response (I gave you a rec for your thoughts). I understand what you are saying. However, if what I am looking for is a fixed return and I want to limit the exposure to interest rate risk, I should be able to hedge the interest rate risk and still receive the interest income. I would give up the opportunity for capital gain on the underlying security but I would still collect the interest. It is not quite the same as your roulette analogy (maybe the double zero is the default risk?). It would be interesting to hear from someone who has done this, how they did it and what was the result.I have seen lengthy threads about whether there is a disctinction between investing and speculating and I did not intend to begin another one of those arguments. The derivative comment is mainly my opinion about those instruments.
If you buy long-dated bonds and, at the same same, you buy a derivative that is an inverse of long-dated bonds, all you've done is to spend money to go market-neutral. Why bother? Why not just sit in cash? If you want to bet on the direction of interest-rates, then do so boldly and trail a stop. If you want to side-step having to bet on direction, then buy the underlying with the intention to hold until maturity. (Or create an collared options strategy on interest-rate futures, etc.)In other words, you need to figure out why you want to play the bond game other than for reasons of an irrational belief that you need exposure to the asset-class. You don't, just as no one does. Good portfolios can be built without bonds.However, bonds are an extremely interesting asset-class, and if used properly and shrewdly, they can be hugely profitable, as Chris, Scott, Howard, myself, and others can confirm from our own involvement with the asset-class. Also, as all of us will affirm, the opportunities aren't all gone, because the opportunities in any asset-class are never all gone. The shopping has merely gotten harder than it used to be, just as eventually it will get easier again, because all markets are cyclical. Therefore, now isn't a bad time to begin the learning process, so that when the prime buying time comes 'round again, you'll be ready, because that's who makes the good money in bonds, those who have learned by actually doing bond-investing, rather than those who have just read about bonds in a book (or in the god-awful FAQ that is mistakenly touted on this board to beginners). To repeat, if you want to trade RYJUX, then trade it. But if you want to learn to how to invest in bonds, then focus on that. The two don't have much to do with each other, nor are they mutually exclusive. But one's a trading gig, and the other's an investing gig. Decide what you want to do, and then go for it.
Thanks, Charlie and Ti. You guys have convinced me. I guess I just have to learn the Etrade screens and get my hands dirty with the dd on specific issues. I think I have a reasonable tolerance for default risk but I am more shy about the interest rate risk in the current environment.
"I am looking for is a fixed return and I want to limit the exposure to interest rate risk", unquote from Wong#.you want a fixed interest rate of return, but you want to limit exposure to interest rate risk? You want apples but you don't want apple trees? I do not understand. But.......So, fine, buy something that has the interest rate you want. You do not need to hedge it, as 'it' produces what you are 'looking for'. You can get a nice yield by buying strips or long maturity USTs. Not a problem, the market opens in 10 hours or so. Go forth and buy.'I should be able to hedge the interest rate risk and still receive the interest income.' unquote from Wrong#. I am reasonably sure that Charlie will step in to put the take on this. BUT, why do you want to hedge interest rate risk in a position that distributes the interest rate that you desired?This is pretty deep for me, but I stick with my take. If you could take a position of fixed return and at the same time limit the exposure to interest rate risk you would end up with the fed funds rate, which is dang near zero.Again, not a slam on WongNujmber, but I do not get it. If it was this easy it would already be done. you can write a strangle or a condor but to what effect?If you think UST rates are going up then take that position, or don't.Ti - out of goldsilver just now but that is not a trend. I await other opines as I do not understand this hedging a position thesis.
Now, finally, you're talking sense. I love E*Trade for bond-shopping. The results of a scan can be dumped into Excel for further analysis, such as building yield-curves. That's one thing you need to learn how to do. Also, you need to learn how to pull and evaluate T&S. Plus, you need to develop a way of evaluating the issuer's fundamentals. And you need to learn to do this stuff fast while the lot you're investigating is still available. Also, now wouldn't be a bad time to poke around at Investopedia whose explanations of bond-terms and bond-investing strategies are really solid. In other words, practice, practice practice, so that when you see something that seems like an opportunity, you can do your DD in a timely manner and then execute (or back away) without regret. And then do it again, and again, and again, as you build and manage that portion of your portfolio.
WrongNumber,As I re-read this thread, after a good night's sleep and a bit of time to think about the broader issues that underlie your original question/goal, I have to conclude that I've been hasty and sloppy.In the scheme that you proposed, you were trying to protect what, typically, is only a small portion of a bond's total-return. Unless a bond is bought at par or above, it will offer cap-gains in addition to a coupon. But a change in the level of interest-rates subsequent to purchase won't affect the coupons paid, only the market-price of the bond and its potential cap-gains IF THE BOND IS SOLD. Thus, if the bond is held to maturity, interest-rate risk can be side-stepped without hedging. (And it is only downside-risk that would need to be hedged in any case.)Now let's look at two, possibly-serious problems, default-risk and inflation-risk. Default-risk can be side-stepped by buying principal-protected instruments, or it can be managed in the same way that investment-risk is managed generally. Just make sure across your basket of bonds that profits are bigger than losses. Bingo! Default-risk goes away. Inflation-risk is what will kill you. If you're in the 25%-30% tax-bracket, and if your personally-experienced rate of inflation is running 5%-6%, then you need a yield of about 8% just to break even with respect to preserving your purchasing-power. In other words, if you're accepting the low rates of return that average bond-investors readily accept, then you are really just losing money, which isn't necessarily A Bad Thing. It all depends on one's goals and skills. If you're pulling down 20%-40% elsewhere in your portfolio, then accepting bond-yields of 4%-5%, might be a shrewd strategy. It's "parked money". It's "low-effort and little hassle" money, which isn't a bad thing to have (in judicious amounts). So, my suggestion would be this. Decide what your overall investment-goals are, and then try to figure out how bonds might help you to achieve that goal (or not). My advice would be to try to learn bond-investing only if you intend to commitment serious money and time to the asset-class. Otherwise, focus on what you have already discovered is working well for you, and then push your skills in that area up to the next level. If you're a good stock-investor and making good money, why not try to become a better one? Why do the equivalent of going back to the end of the line and starting all over again, which will be the case if you try to break into bond-investing? Some people can do both well, but most can't. (Heck, most people don't do either well.) So make your choices carefully. In other words, investing is no different than fishing. By and large, you fish the waters local to you, and you focus on the species and methods that interest you. The choice between stocks or bonds is like the choice between bass or trout. Some people fish both, but most really do prefer one or the other and don't worry about what they might be missing. Charlie
"Rydex Inverse Government Long Bond Styrategy Fund" When I see a name that long, and with a word like "inverse" in it, I think it anagrams out to.."Give us your money" or "we like fees" I don't know anything about the fund, but those are my two cents.
"It would be interesting to hear from someone who has done this, how they did it and what was the result." What I did was bought $25,000 in zero-coupon stripped treasuries, through Zions. These typically have a slightly higher yield than treasury notes and bonds. The ones I bought were going to mature in about 20 years. I then sold an out-of-the-money call option on the March 10-year note futures contract, through Ira Epstein (sp)?. This went good for 6 months, I pocketed the premiums for the call option, with little increase in the bond prices. Charlie jinxed the market last spring by "calling a market top", and interest rates began to drop and bond prices went up. The increase I got in the zeros did not compensate for the money I lost on that last call option I was holding...I think it was Sept contract at a 120 strike price. So I closed out of both positions. All told, it was profitable, I might made 7-8% annual return on my money...might have been more like 15% except for interest rates dropping further last April or May. Remember that zeros, t-notes, t-bonds, and futures do not always move in step with each other. Right now I'm mostly on the sidelines, holding some corporate bonds, sold others for 10% to 20% capital gains. I'm staying away from this play for now.
After a couple months of bemoaning the lack of opportunity, I got a bond called in my IRA. After studying the screens and doing some DD I had another look at Ally bank. This is the old General Motors Acceptance. Now it is 56% owned by the government, only 16% owned by GM, and a couple groups of private folks are in there. I chose a 2019 maturity because that is a major hole in my bond ladder. It pays a 6 3/4% coupon and was discounted to 93 and change. YTM close to 8%, and it is callable. When I get bonds at a discount, there is no objection to having them give me my money back early. The disadvantage is that as now, if they call it, I must find a parking place for money at an inconvenient time. Issuers call bonds because they think they can refinance at a better rate. It also pays interest in June and December, the low point in my bond income stream. So it fit my portfolio and my objectives. Lots of folks are still holding their nose at Ally because of the historical association with GM, but the position I took is small and I think the default risk can be managed. Meanwhile one bond that was called a few months back turned into nice new windows for my house, and another called bond turned into shares of stock with an out-of-the-money covered call written against them for income in addition to the dividend the stock pays. So there are a lot of choices available. Best wishes, Chris
Thank you everyone for your input. A light bulb went off during reading and I realized that what folks are saying is that, if you hold a bond to maturity, you do not have any interest rate risk. You will collect your coupon and receive your principle at maturity (barring a default). You would only have interest rate risk if you planned to sell the bond prior to maturity. Therefore, the only reason to buy the RYJUX fund is if you want to speculate on an increase in interest rates, which we may be expecting but have no idea as to when.I also appreciate the counseling about whether I should learn bond investing. I am more comfortable at this point with equities. However, I am 60 yrs old and retire from my current job in June. Therefore, I am reluctant to commit all of my portfolio to equities. Also, I have a strong aversion to mutual funds/ETFs because they often have to buy when the retail investors are buying and sell when the retail investors are selling (read: buy high/sell low). I will be thinking more about this over the next few months.
Chris, Are you saying that the highest price paid yesterday, 93.421 (all-in) for 10 bonds, was your trade? If so that makes your YTM 7.83%, not 8% (at least according to how Excel calculates yield). What strikes me as strange is how flat GMAC's yield-curve is. That's worrisome, no matter the fundamentals. Also, without doing the comparative work, I don't know if their B3/B rating is credible. But 10 bonds is a small position, and it should be a manageable risk. Congrats on finding some yield. Welcome to the junk-bond club. Charlie
I also appreciate the counseling about whether I should learn bond investing. I am more comfortable at this point with equities. However, I am 60 yrs old and retire from my current job in June. Therefore, I am reluctant to commit all of my portfolio to equities. Also, I have a strong aversion to mutual funds/ETFs because they often have to buy when the retail investors are buying and sell when the retail investors are selling (read: buy high/sell low). I will be thinking more about this over the next few months. WrongNumber, Bond-funds are trading vehicles. Period. End of story. If an investor uses them at all, he/she intends to get out in response to rising interest-rates if/when that happens. Bonds, however, can be held to maturity. As to rotating into fixed-income in response to increasing age --which is exactly what the boomers are doing-- I'd humbly suggest that you step back and give the matter a bit more thought. Conventional wisdom suggests that bonds are less risky than stocks. In the most trivial sense, that is true. That's also why they offer less return. But if it can be assumed that reward is proportional to risk, then it isn't the broad profile of the asset-class that matters, but the risk characteristics of your specific holdings and the investment skills of their owner. In other words, there are "safe" bonds and there are "risky" bonds, just there are safe stocks and risky stocks, just as there are prudent, responsible investors, and there are reckless, careless ones. But let me ask you this. Who is more likely to be able to keep themselves out of trouble? an experienced stock investor who sticks to stocks, or the same person who tries to venture into bonds?In other words, if you're 60, and if you've spent the last 10-20-30 years learning your craft as a stock-investor, why would you walk away from that wealth of experience and try to break into bonds, just when conditions are turning unfavorable? That don't make me a lick of sense. If you want relatively-steady, relatively-safe returns, why not try to do it from the equity-side of things where you have a clear advantage of experience and judgment? Note: this isn't an original thought on my part. Peter Lynch laid out the case for an all-stocks portfolio many years ago in an issue of Worth magazine. The numbers were compelling. Charlie
Wrongnumber,"Thank you everyone for your input. A light bulb went off during reading and I realized that what folks are saying is that, if you hold a bond to maturity, you do not have any interest rate risk."I think there are a few things to note here, so let me take a stab:Bond returns can be thought to be composed of the following:1) Inflation Return - Market expectation of inflation2) Real Rate Return - Market desire for a real return above inflation3) Credit Risk Premium - Market yield demand for protection against default / partial recovery4) Liquidity Premium - Market discount (or premium) for lack of (easy of) marketabilityTreasuries primarily trade on #1 and #2. People who talk about "holding to maturity" as a protection against rate changes are ONLY talking about #2. If inflation changes (upwards) as a bondholder, you lose, period. Holding to maturity may save you a nominal loss, but inflation ate your return. But sometimes real rates on bonds simply increase, because either investors demand it, or there is just a supply demand imbalance.By running a bond portfolio in a hedged manner (assuming you can do so with reasonable cost which I find highly doubtful) there is value in isolating the return components of #2 - 4 and trading off the #1 and #2 of treasuries. The Treasury futures market is likely the only place where you can do this with reasonable cost, but you would likely have to use high leverage to make this work.Just wanted to clarify my thoughts on this.As to hedging with inverse funds, if you walk through the mechanics of how shorting works, and apply it to a long only vehicle, I think you will see that the effective cost associated with these long type short vehicles is completely unacceptable, but that hasn't stopped them from getting p1mped by sales forces far and wide trying to get people to believe in free lunches.My 2 cents. Exploiting liquidity issues and real rate changes are a good way for the retail investor to do well in bonds. Predicting inflation and credit risk is a harder game to play in my experience for those of us with fewer resources (generally speaking). The tough thing (as you see from comments here) is that separating inflation expectations from the bond market, and real rate expectations is somewhat hard to do, and sounds mostly academic, but is important.Ben
Charlie, Yup, that was my trade. I consider 7.83% "close to 8%". There's nothing in the investment grade lists that interests me. I think Ally may be better than that credit rating. It had been a Ford Credit bond that most recently got called, so I figured I could replace it with another junk bond position. Best wishes, Chris
Ben,In trying to identify the factors that contribute to bond-yields, you over-looked a couple that the article at Wikipedia calls, “market segmentation” and “preferred habitat”. (See the link below.) But my take on such discussions is that they are interesting, but irrelevant, if a bond portfolio is tiny, say less than $10 million or so, which describes most retail investors. In other words, if the money under management is tiny, and if pay-out obligations are fairly flexible, then an investor can –but doesn’t have to— reduce the identified risks he defends against to just two: recovery-risk and inflation, and in either case, holding to maturity can be a viable strategy provided the bonds are well-bought. But that’s exactly where most would-be bond investor fail. They don’t understand the risks they accept when they chase yield, nor do they obtain enough yield to properly manage those risks. Rather than talk generalities, let’s consider a bond already mentioned in this thread, GMAC’s 6.75’s of ’19. The bond is a relatively near-term, lower-tier single-B, and it is priced to offer about 7-7/8ths. To buy the bond is to bet on the direction of credit-worthiness of the issuer, and Chris is making a case that the risks are less than the rating/pricing would imply. Is she right or wrong? Who cares, right? What matters is what happens if she’s wrong, which is why a 10-bond position is prudent, given the size of her other assets (which with she can offset her risks). In other words, if the position blows up, no biggie. The damage to her portfolio will be minimal. After the workout, it might be as little as 0.25% of her AUM, which is trading noise. OTOH, if the position works, all she’s achieved is a scratch trade (after taxes are paid and a realistic rate of inflation is subtracted.) So the question I would ask is this. Why do the trade? And she offered an answer. She had extra cash and wanted to park it. But is 7-7/8ths a good rate of return for junk? To my way of thinking about bonds, yields in the range of 8% are characteristic of triple BBBs. Bonds that are two tiers lower –if properly rated/properly priced— ought to be offering closer to 13%. So, this question has to be asked. Who’s wrong about this bond, if anyone? The raters? The traders? The buyers? This argument can certainly be made. Because the bond is offering so little yield, the risks might really be very low. In which case, yet another question has to be asked. What has been the direction of pricing, and where is it likely to go? Is buying now a smart play, or would it be better to wait out the market a bit before buying? What might be accomplished by waiting? Confirmation that the issuer is sound, or that the issuer is in trouble, because right now, two contradictory things are going on in the bond market. The Fed –through its tricks– is trying to keep rates low. But traders aren’t going along with the plan. Charlie------------------- http://en.wikipedia.org/wiki/Yield_curve
If held to maturity, it is a scratch trade. It will help my cash flow a little bit at a time of year when this is useful. I like monthly income to be fairly evenly spread over the year; extra in the June/Dec months when my real estate taxes fall due would be nice. So the bond fit my portfolio. If the issuer calls the bond at the first opportunity, the yield to call can be 20% plus. So there is that possibility. If the perceived credit worthiness of the issuer improves in the next year or so, the issuer might well be able to issue new bonds at a rate enough lower to justify calling these bonds and issuing new ones at a lower coupon. I spent some time fretting about the credit worthiness of Ally and decided they were OK. Not great, not impeccable, but OK. So I made the plunge. Best wishes, Chris
I would consider an investment in this fund as a speculation. Yep! I should be able to shop for long-term bonds with reasonable interest rates (at a range of yet to be defined default risks I find acceptable) and hedge the interest rate risk with a comparable investment in RYJUX.So - like, if you wanted to park some money for 3-5 years and you were worried about rates going up you could:1) - go long a 3/5 year UST for about 1% return a year which sounds so yummy.OR2) - go long 50% in a 30 year UST for about 4.5% and 50% in RYJUX and then when you sell in two years you should be about whole on principal [if rates went up then your bond went down and RYJUX went up, if rates went down your bond went up and RYJUX went down....] and instead of 1% you collected 2.25%....assuming you can get the effective duration numbers for the fund and cacluate out the real percentages you would need but the point is - YES, you can use the fund to HEDGE!!!!Or,You can use the fund to place a bet!!d(HEDGE)/dTYou can select what risks you want to be exposed to. If you split the risks up to the individual points - Inflation, credit etc. then you can specifically hedge those risks and leave only what you want... And yes - sometimes it costs enough you are just going sideways...
2) - go long 50% in a 30 year UST for about 4.5% and 50% in RYJUX and then when you sell in two years you should be about whole on principal [if rates went up then your bond went down and RYJUX went up, if rates went down your bond went up and RYJUX went down....] and instead of 1% you collected 2.25%....According to Morningstar, RYJUX has expenses of 1.41%. Doesn't that put you back below 1%?
Is there a contango issue with RYJUX a la VXX and VXN?
I know nothing about RYJUX but since it uses derivatives/futures there may be a contango issue like with VXX/VXN (track the VIX).As I understand how this kind of fund works, if the managers are buying futures on treasuries or shorting them (?) then time decay diminishes their value as expiry is approached. In order to maintain the position the fund has to constantly be rolling the position forward by selling whatever is near expiry and buying the next month or three (?) out.So basically aside from the direction of interest rates, which is going to be a speculative bet, they would always be buying high (i.e. buying derivatives with significant time value) and selling low (selling futures after a significant decay of time value due to approach of expiry).Note: The above is just guesswork. Does anyone know if any of it is plausible?