Stress Test Your Bond Funds
How much risk is your fund packing?
How much risk is your fund packing?
As you're probably well aware, it isn't easy to figure how a stock fund will fare in a bear market. Every bear is different and stock funds frequently change strategies and make portfolio shifts.
It's a lot easier with bond funds, though. Bond fund risks can be mostly boiled down to three main risks: interest-rate, credit quality, and emerging-markets exposure. Further, because most of the big bond funds have been run in a similar fashion for years, the past is a very good guide. You can put a tangible return number on that risk pretty easily.
Want to know how much interest-rate exposure your fund is packing? Check out its total returns in 1994 and 1999. For emerging markets exposure, 1994 and 1998 should give you a good idea. And credit quality became a problem in 2000, so you only have to look back to last year to see how junky your fund is. Lets follow six of the better known funds to see what kind of risks they've been packing.
The Bond Market's Bellwether Years | |||||
Annual Return 1994 ( % ) | Annual Return 1995 ( % ) | Annual Return 1998 ( % ) | Annual Return 1999 ( % ) | Annual | |
Alliance North Am Govt Inc ANAGX | -30.24 | 30.96 | 6.54 | 7.86 | 18.74 |
Fidelity Intermediate Bond FTHRX | -2.01 | 12.81 | 7.32 | 0.96 | 9.75 |
Harbor Bond HABDX | -3.76 | 19.15 | 9.56 | -0.33 | 11.34 |
Kemper High-Yield A KHYAX | -1.77 | 14.46 | 1.28 | 2.39 | -9.22 |
Loomis Sayles Bond Instl LSBDX | -4.07 | 31.96 | 4.70 | 4.50 | 4.36 |
Vanguard Long-Term U.S. Trs VUSTX | -7.04 | 30.09 | 13.05 | -8.66 | 19.72 |
1994
This was maybe the worst year for bonds on record. Interest rates surged and the peso crisis created a panic in emerging markets. However, U.S. junk bonds did pretty well as their high coupons absorbed some of the blow of rising rates and a strong economy made defaults seem unlikely. Thus, Kemper High-Yield [ticker khyax] lost just 1.77%--an illustration of how high-yield funds often are well-protected against rate risk. Fidelity Intermediate Bond [ticker fthrx] and Harbor Bond [ticker habdx] don't have much in junk, but they also steer clear of emerging markets and have only moderate risk. Thus, their losses were mild, too.
Loomis Sayles Bond [ticker lsbdx] is more adventurous. It has the broadest charter of the six here and it will buy foreign bonds and junky stuff, too. In 1994, they roughly cancelled each other out and the fund lost just 4.07%. Vanguard U.S. Long-Term Treasury [ticker vustx] fell harder, losing 7%. That fund has tons of interest-rate risk but, obviously, no credit or emerging-markets risk. The lesson here is that just because there's no chance of default doesn't mean you can't get socked with losses. Finally, there's Alliance North American Government [ticker anagx] which had a lot more in Mexico and Argentina than some of its shareholders would have guessed. The end result: a 30% bath!
1995
This was a great year for bonds. Loomis, Alliance, and Vanguard all snapped back to gain more than 30% a piece. This is telling, too: No bond fund makes 30% in a year without packing some risks. Starting in 1995, Fidelity Intermediate Bond [ticker fthrx] began playing it much closer to the vest. No big interest-rate bets and easy on the junk.
1998
Asia's emerging markets had a rough go of it, but they didn't hurt any of these funds too badly. Even Alliance North American Government [ticker anagx] posted a fine return.
1999
Emerging markets and junk have a fine year, but inflation rears its ugly head. Harbor manager Bill Gross is leaning toward the long side of the market and his fund has a weak year, losing 0.33%. Vanguard Long-Term U.S. Treasury shareholders are the ones in pain, though. They lost 8.66%.
2000
The free ride for junk bonds ends. High-yield funds enjoyed an awesome run but it might have made investors think they were getting a free lunch. The average high-yield fund lost 9% in 2000--the worst year for junk since the Milken-implosion of 1990. Kemper High Yield sheds 9.22%. Tellingly, that's pretty close to the worst loss that Vanguard Long-Term U.S. Treasury suffered. Loomis Sayles Bond has a good chunk in junk but its other holdings produce a decent return and the fund gains a modest 4%. The other funds earned double that or more.
Note that none of these years caused a loss of more than 4% for Fidelity, Harbor, or Loomis. I wish my stock funds had such a limited downside.
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