We Eat Dollar Weighted Returns: Where The Fare Is Yummy

We Eat Dollar Weighted Returns: Where The Fare Is Yummy

This is the first episode of “We Eat Dollar Weighted Returns” where the fare is yummy.  Here’s the twist: investors in some bond ETFs have done better than one who bought at the beginning and held.

Now, all of this is history-dependent.  The particular bond funds I chose were among the largest and most well-known bond ETFs — HYG (iShares iBoxx $ High Yield Corporate Bd), JNK (SPDR Barclays Capital High Yield Bond), and TLT (iShares Barclays 20+ Year Treas Bond).

As bond funds go, these are relatively volatile.  TLT buys the longest Treasury bonds, taking interest rate risk. iShares iBoxx $ High Yid Corp Bond (ETF) (NYSEARCA:HYG) and SPDR Barclays Capital High Yield Bnd ETF (NYSEARCA:JNK) buy junk bonds, taking credit risk.

Let’s start with TLT:

Date

Cash Flow

Buy & Hold Return

Cumulated

11/9/2002

248,935,892

1

8/31/2003

-73,889,166

12.31%

1.1231

8/31/2004

439,348,999

3.11%

1.15802841

8/31/2005

73,509,821

6.72%

1.235847919

8/31/2006

442,211,811

6.12%

1.311481812

8/31/2007

165,784,828

3.37%

1.355678749

8/31/2008

-344,202,681

9.54%

1.485010502

8/31/2009

887,336,789

12.30%

1.667666793

8/31/2010

120,142,522

-5.85%

1.570108286

8/31/2011

-452,062,384

4.64%

1.64296131

2/29/2012

-3,038,265,474

32.32%

2.173966406

IRR

Buy & Hold

Difference

11.47%

8.42%

3.05%

I analyzed this back in June, saw the anomalous result, an decide to sit on it until I had more time to analyze it.  The way to think about it is that investors reached for yield at a time when stocks were in trouble, and indeed, rates went lower.  The average investor beat buy-and-hold by 3%.

Here are the results for the junk ETFs:

HYG

4/4/2007

2/29/2008

2/28/2009

2/28/2010

2/28/2011

2/29/2012

Distributions

-9,708

-92,708

-358,324

-512,979

-694,209

Net Additions

371,140

1,989,303

1,781,425

3,201,608

5,840,594

Net Assets

352,636

2,089,054

4,611,414

8,257,928

14,258,718

Investment Return

-8,796

-160,176

1,099,260

957,884

854,406

ROA

-4.57%

-13.12%

32.81%

14.89%

7.59%

4/4/2007

9/16/2007

8/29/2008

8/29/2009

8/29/2010

8/30/2011

2/29/2012

13.40%

IRR

-361,432

-1,896,594

-1,423,100

-2,688,629

-5,146,384

14,258,718

6.04%

Buy-and hold

7.36%

Difference
JNK

11/28/2007

6/30/2008

6/30/2009

6/30/2010

6/30/2011

6/30/2012

Distributions

-9,011

-111,409

-361,521

-616,525

-735,822

Net Additions

404,658

1,481,309

2,180,582

2,366,102

3,928,526

Net Assets

394,346

1,900,709

4,301,252

6,915,538

10,780,535

Investment Return

-1,302

136,463

581,481

864,710

672,292

ROA

-0.61%

11.89%

18.75%

15.42%

7.60%

IRR

11/28/2007

3/14/2008

12/29/2008

12/29/2009

12/29/2010

12/30/2011

6/30/2012

13.22%

IRR

-395,648

-1,369,900

-1,819,061

-1,749,577

-3,192,704

10,780,535

6.49%

Buy-and hold

6.73%

Difference

Both funds were small in advance of the credit crisis, and investors bought into them as yields spiked, and bought even more as income opportunities diminished largely due to the Fed’s low-rate monetary policies. The average investor beat buy-and-hold by 6%+.

Now, the  junk funds were small during default, and grew during the boom, amid unprecedented monetary [policy from the Fed.  (Note: I think that Bernanke will rank below Greenspan in the history books in 210o, and both will be judged to be horrendous failures.  It is better to let things fail, and clear out the bad debt, rather than continue malinvestment.  We need fewer banks, houses, and auto companies, among others.  The government, including the Fed and the GSEs, should not be in the lending business.  Lending should be unusual, and applied mostly to financing short-term assets.  Long-term assets should be financed by equity, or at worst, long-dated debt.

For all three funds, we have the historical accident that the Fed dropped Fed funds rates to near zero, leading to a yield frenzy.  But what happens when defaults spike?  What  happens when no one want to buy long dated Treasuries at anything near current levels?

I think bond investors are more rational than stock investors; they have more rational benchmarks to guide them.  Bond investors have cash flows to analyze against EBITDA (earnings before interest, taxes, depreciation and amortization.  Stock investors wonder at earnings, which are easily gamed.

The real question will come when we have the next credit crisis?  How many holders of HYG or JNK will run then?  Or when inflation starts to run, and the Fed stops buying long Treasury bonds, and even starts to sell them, what will happen to dollar-weighted returns then?

This is an interesting piece for bond assets in a bull market.  We need to see bear market results to truly understand what is going on.

Full disclosure: long TLT for myself and clients

By: alephblog

For exclusive info on hedge funds and the latest news from value investing world at only a few dollars a month check out ValueWalk Premium right here.

Multiple people interested? Check out our new corporate plan right here (We are currently offering a major discount)






About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Be the first to comment on "We Eat Dollar Weighted Returns: Where The Fare Is Yummy"

Leave a comment