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I have about 300K alloted for fixed income, inside an IRA. I start distributions next year, about 15K/year to start with.

I could build a conservative bond ladder or pay .5% to some guys to manage it.

The management guys say "we will make adjustments to duration when interest rates start to go up". So their approach is to become pro-active, buy sell, adjust as necessary to improve my Total Return over time.

Their Total return performance year by year for 10 years matches very close to Barclay Capital Inter. Gov't/Credit index. Except for 2008 they got 8.5% return as opposed to index which got 5.5%. All other years they were very very close. They don't make comissions on trades, just .5% fee each year.

Question is....Ladder myself or Active Management for .5%

Their goal would be to generate good returns relative to the benchmark in all interst rate invironments. Moderate total return.

I have no idea how a conservative bond ladder would have performed compared to the index for the last 10 years.
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<Question is....Ladder myself or Active Management for .5% >

I would say, without a shadow of a doubt, that you should manage your own ladder.

In a low interest rate environment, 0.5% is a major portion of the income. And make no mistake -- we will be in a low interest rate environment for safe investments for at least a few years.

As an individual, you have access to advantaged fixed income investments, such as bank and credit union CDs and I-Bonds (if they ever become sweet again), which the investment professionals can't touch.

These have provided us with a higher yield than the Treasury bond index. Since we hold to maturity, we always get our principal back.

To get a higher yield than Treasuries in the market, the bonds have higher risk.

It's not that hard to set up a bond ladder yourself. Please feel welcome to run your ideas past the Bonds Board.

Wendy
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Gibson,

I think the questions are: how much time do you want to spend futzing with choosing bonds and how much do you trust these managers. Keep in mind that if they pace the average, you will do average - .5%, which is not an ugly management fee.

I believe it is possible to outperform the averages. Not only do I think you can outperform I think you can do so with less risk than the ratings imply if and only if you are willing to put the time and effort into finding the better choices. It doesn't have to be a full time job but it definitely is a time consuming hobby.

The 8.5% bounce probably came from price appreciation as people drove prices up seeking safety. If the assumption is true they were smart enough to sell when prices were high, that is a good sign. You might want to call and ask. Interview the heck out of them, you are essentially hiring an employee.

jack
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I think the questions are: how much time do you want to spend futzing with choosing bonds and how much do you trust these managers. Keep in mind that if they pace the average, you will do average - .5%, which is not an ugly management fee.

I believe it is possible to outperform the averages. Not only do I think you can outperform I think you can do so with less risk than the ratings imply if and only if you are willing to put the time and effort into finding the better choices. It doesn't have to be a full time job but it definitely is a time consuming hobby.


Hi Jack,

Why do you say that 'we' can outperform the avg's, when the pro's spend 8 hrs. a day, and are unable to do so? At least, the guys the OP mentioned.

rk
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When investment managers give you percentages like that, THEY pick a time frame that makes them look good.
Last year bonds were volatile. Pick a starting point when the bond market was down and an ending point when it was up, and the numbers will look very good.

If you are buying bonds issued by entities that will faithfully pay their coupon on time, and return principal when the bond matures, that really is all you ask. If you go to a site like e-Trade and look at all the bonds, and make choices--they will help you if you ask--you will do very well. Buy bonds issued by companies you trust.

In an IRA, you will not be buying municipal bonds as a rule. The situation where you might would be very unusual.

The good thing about bonds is that a future date will come when they promise to give you back your principal, plus interest at a stated rate. With stocks you don't know that. With bond funds you don't know that either, because bond funds do not mature. Fund managers must buy when they have available cash, and that will tend to be when prices are high. People flee bond funds when prices are low, too, so the fund manager is saddled with a bias to buy high, sell low. You don't have to do that. You buy XYZ bond paying 6% until 7/1/2020, you are convinced the company is not going out of business and in fact will use the proceeds from the bond offering to grow its business, and forget about it. Daily price fluctuations can drive you nuts. Sit back and collect the coupons.

Spread your 300K over 10 or more bonds. $25000 for each issue is a big enough chunk that the bond dealers will give you extra service.

You will be ahead by 0.5% annually.

That isn't a bad fee, as investment advisors go, but your purpose is not to trade bonds--it is to generate income for your retirement.

Note that there is no guarantee what your annual income will be from a bond fund. If interest rates go down, many bonds in the fund will be called, and the manager must buy--at the wrong time. If interest rates go up, the net asset value will go down, some fund owners will panic, and the manager must sell--at the wrong time.

You can do better.

Best wishes, Chris
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rk,

Mostly because we are small. What would be a very marginal upside for a larger fund is significant to our little pile. We also can pick and pluck ones and twos rather than rounder 10's and 25's and 100's. Finally, if we manage our friction costs we can often do better than paid for services.

One other advantage is that we are managing our money for our needs specifically. Any money manager or fund manager has multiple clients and thus they have to make broad decisions for all. They don't have time to shop for each and every client so the shopping is bundled. If we want to buy a new car in 3 years we can fund it, specifically. If we are more nervous or optimistic we can act accordingly. Some managers refuse to "dabble" in junk or are required to avoid junk, which means they must dump something they are holding if it dips below commercial grade, usually at a loss. We don't have to if we think the company can muddle through and keep paying the coupon and returning our face value to us in the end. We can also dip in the "junk" trunk if a company we know is being unfairly punished. Basically we can be more nimble and adaptive if needed.

By being nimble and specific we can create a portfolio that better fits us.

jack
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Hi Jack,

Thanks for your succint reply! One more question. Do you think that 'we' could outperform the pros. if we restricted ourselves to only 'true' AA and AAA bonds? Also, if one would buy into a bond CEF, instead of a bond mutual fund, he could eliminate some of the problems you listed, since the stockholders are trading the 'float', and the managers don't have any redemptions to screw them up. They can concentrate on the portfolio.

rk
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rk,

I haven't looked in a while but CEF's often are pretty tight for profit taking. In other words it is tough to catch the good ones at a good price.

Do you think that 'we' could outperform the pros. if we restricted ourselves to only 'true' AA and AAA bonds?

um, maybe. First this is a pretty tight range and here's the rub, some firms are worthy of AA but are not rated that way; so these can occasionally be bought for a decent price. The flip side can be true, there are companies that carry AA rating but don't currently deserve it; we can pay too much for these. And then there is the bouncing company; An AA company downgraded to A or less and then bounces back up, we can catch these for a decent price if we are careful.

Most importantly, and this is where we can make or lose money, not all equally rated companies are equal. Within any band of grades there are companies that belong and companies that are marginal. Figuring out who is who is vital.

I use a pretty fundamental approach for both stocks and bonds which often leads me to firms the big players are avoiding, at least today. I like shopping on the various disfavored lists. Honestly I chuckle half the time I see downgrades or bottom tier ratings for good companies. Schwab uses a A - F scale, good companies can often be found in C - F and since the market isn't pleased with them at the moment bargains can be found. This works for both stocks and bonds.

Take CAT for instance, their stock price hasn't been this low in a long long time. They are going to benefit from Auto's big three renegotiating with UAW and suppliers. They are usually considered best of breed in their industry. True, construction is going to be off for a bit, which is why they can be had for a decent price. In the near term the dividend will do. For a brief period some of their bonds went on sale, I don't know how they are priced now.

Clear as mud?

jack
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Closed end bond funds can also be decimated by calls, and the manager have to buy at the wrong time.

If you must have units in a pool, there are unit investment trusts. The brokerage that puts it together and the broker who sells it to you both get hefty commissions, but there is the little wrinkle that the thing begins at a certain time, and after that date no more buying will be done. Therefore, when bonds are called, the manager distributes the money to the unitholders and you can go find another investment just as you would if your bond had matured. The sponsor will make a market, and if unitholders want out early, the manager will sell enough bonds to meet the redemption, (for a fee, of course). At the outset, you know the maturity dates of the bond in the trust, so it has an end date when the last bond matures or gets called.

Best wishes, Chris
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Do you think that 'we' could outperform the pros if we restricted ourselves to only 'true' AA and AAA bonds?

Rk,

Pick any benchmark you choose and a dedicated amateur should always “beat” fund managers on a total returns basis, on average and over the long haul, for two reasons:

(1) The amateur is working for free. (Thus, expenses tend to be less.)
(2) The amateur isn’t burdened with stupid shareholders who yank money away at market bottoms (when the buying needs to be done), and throw money at the fund at market tops (when everything is too expensive and the selling should be done).

However, two further things must be recognized:
(1) The typical fund manager has access to research and trading advantages that the typical amateur, no matter how dedicated, cannot match.
(2) The good fund managers have a passion for the game and a depth of experience that the typical amateur, no matter how dedicated, will probably never match, much less exceed.

Thus, in a one-to-one contest, where each person was only running his own portfolio, the typical dedicated amateur would probably lose to a good fund manager. But in a contest in which an amateur was benchmarking his results against those achieved by mutual funds with the same investment objective, a top 5% performance isn’t hard to achieve. If a top 5% performance is “beating the pros”, then, yes, an amateur can do it.

The question becomes: Does he want to do it? How valuable his is time? What would he rather be doing than managing his own money? If he has a passion for the game, then he’s playing for the personal challenge of it and beating the fundies is just one way of keeping score.

To answer your specific question about restricting bond purchases to AAA and AA, my suggestion is that such a thing shouldn’t be attempted (if you’re thinking of just corporates), because the parameters are too narrow. Pull a list of all companies rated both AAA and Aaa. You can name them on one hand or two at the most. That’s too small an investing universe to bother with. If you include in the AAA/Aaa group agencies, munis, and treasuries, then, yes, the investing universe has now become big enough to discover the sorts of exploitable inefficiencies that a small and nimble player can use to his advantage. If the universe is extended to also include companies that proper due diligence could demonstrate were “genuine” double AA/Aa’s, then the universe gets more interesting.

But the “benchmarking” problem would still remain. No one in the fund world restricts their buying to AAA/AA. They all go at least one tier lower to include single-A’s. Those three levels describe “top-tier”. There’s a few funds that restrict their buying to top-tier, but not many. Thus, if you restrict yourself to AAA/AA, you’d have no one to compete with but yourself, which might not be a problem. There is no requirement that an individual investor has to "beat" an external benchmark as “proof” of the worthiness of his investment goal. Excellence for its own sake can be its own goal.

If you are really and truly serious about this project of seeing just how far you could push the limits of achievement within the constraint of “only AAA/AA”, then start a new thread and I’ll play devil’s advocate. Your idea has merit, but you’re overlooking some things you should consider, such as how you intend to establish “true AAA/AA”, how you intend to manage downgrades, how you want to handle position sizing, etc. In short, you need to create a very detailed investment plan of What? When? How Much? How long?

But if the goal of your project is the Holy Grail of “better-than average returns with safer than average risks”, then stop right here, because you’re wasting your time. That cannot be done. But Ben Graham’s “low-effort, low-risk and reasonable returns”? Yes, that can be done, although an artificial constraint like “only AAA/AA” will make the project harder, not easier, nor safer. In fact, just the opposite will probably be true. As I said, think it through very carefully what it is that you’d like to achieve and then start a new thread (or not).

Best wishes, Charlie
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RK,

ARRGH. Me and my big mouth and jumping to conclusions.

I went back and reread your original post more carefully. The question you should be asking isn’t whether you could beat the pros, but which pros could beat which pros?

Let me explain. If the benchmark for the advisors you’re considering is the Barclay’s US 5-10 Yr Gov’t/Crdit Index, then why not just buy a fund, such as VBIIX, that tracks that index? Since the inception date of fund, 03/01/94, VBIIX has returned 6.36% (expenses included). Since 03/01/94, the underlying index has returned 6.50%. Your advisors will deduct 50 bps. Therefore, if they do no better than track the index over an equivalent period going forward, VBIIX should beat them by 36 bps/year.

https://advisors.vanguard.com/VGApp/iip/site/advisor/investm...

With $300k to work with as merely the fixed income portion of your portfolio, you obviously are dealing with a lot of money, enough money that any fund company would give you personalized service. Simply find a fund company you want to do business with and turn the money management problem over to them. If you want to learn the bond game for the challenge, then set aside $50k to play with. Likely, you’ll have fun, as well as do quite well. Bond investing isn’t hard to do. But managing a portfolio takes time, and if you’re old enough to be dealing with RMD’s, then time is more precious to you than money. Farm the money out to someone you can trust and get on with your life.

If you want names of firms you should consider, then focus on “value shops” like Oakmark, Third Avenue, Tweedy Brown, Dodge and Cox, Long Leaf Partners, etc.

Again, best wishes, Charlie (who manages his own money because he was too small when he started for anyone to be willing to fuss with.)
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As an experiment, I put together a sample portfolio just now of corporate bonds restricted to those rated AA/A2 or better to see what sort of yields might be obtained. Pickings were slim, but here’s the summary result:

CY, 6.89%
YTM, 6.61%
Avg.Mat., 23 years
-----------------------

YMMV
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