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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35387  
Subject: Re: Bond NAV and derivatives Date: 4/23/2006 11:38 PM
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For Nerds' Eyes Only:

Some interesting new angles on the shrinking NAV issue:

First, it looks like the realized capital gain on the Intermediate Index Fund is much more substantial than on the Total Bond Index Fund—a point worth pursuing for its own sake, in the ongoing attempt to understand how the Total Index works (I think more complicated than the Total Stock Market Index). Anyway, looking at the annual capital returns listed by Vanguard and comparing with change in NAV, over 10 years the annualized realized capital gain on the Intermediate Index was .367%, as was the total capital gain, while an estimate for total capital gain based on change in yield and an educated guess for duration would be around .6% annualized. With the Total Index, the realized gain was only about .176% annually, with the total capital return being .097%, again with an estimate for predicted capital return of about .6%. So, the realized capital gain (per Dan's suggestion) is much more important in accounting for leakage with the Intermediate Fund.

Now, if we break down the numbers over 5 and 10 year periods, things look very different.

Consider Total Index Fund: Over 10 years for 1996-2005, the total capital return was .97%, with 1.76% realized gain and loss of .79% to NAV ($10.14-$10.06), with yield dropping from 6.11% to 4.75%. From 2001-2006, the total capital return was 1.4%, with NAV rising from $9.96-$10.06, about 1%, so only about .4% of capital gain was realized. Yield dropped from 6.67% to 4.75%, so with 4.5 duration, we'd predict a total gain of about 8.6% (way less than 1.4%). From 1996-2000, the total capital return was -.43%, with a +.36 realized return and a loss of NAV of -.79% (I can't quite get the numbers to add up). The yield went from 6.11% to 6.67%, so with 4.5% duration, the predicted loss would be about 2.5%, over 2% more than the actual loss of .43%.

At any rate, even though the 10 year period and the most recent 5 year period show capital return leakage, for the first 5 years, there is actually some capital return improvement.

Something similar happened with the Intermediate Fund: Over 10 years, total capital return was 3.67%, all of it realized gain. Predicted gain was about 6% with yield drop from 5.87% to 4.88%. For 2001-2005, total capital return was 5.25% with 3.5% gain in NAV from $10.02 to $10.37 and 1.75% from realized capital gain (.35% annual). The yield went from 6.45% to 4.88%, with a duration of 6 predicting a gain of 9.42%, more than 4% below the actual 5.25% return. However, from 1996-2000, the total capital return was -1.58%, The NAV lost 3.375%, so the realized gain was 1.8% (.36% annualized). The yield went from 5.87% to 6.45% predicting a loss of 3.48% (with duration 6), almost 2% worse than actual loss.

Again, during the 1996-2000 period, when interest rates went up, the capital returns on both funds were about .4% better annually than predicted. During the 2001-2005 period, when interest rates fell, the Total fund fell short by about 1.4% annually, while the Intermediate Fund fell short by about 1% annually.

What any of this means, I do not have a clue.
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