Rethinking Bond Investing Steve Shaw Founder & President, BondSavvy steve@bondsavvy.com September 21, 2019
BondSavvy Disclaimer InvestorG2 LLC d/b/a BondSavvy is not registered as an investment adviser under the Investment Advisers Act of 1940, as amended (“Advisers Act”), or the securities laws of any state or other jurisdiction, nor is such registration contemplated. Any screenshots, charts, or company trading symbols mentioned are provided for illustrative purposes only and should not be considered an offer to sell, a solicitation of an offer to buy, or a recommendation for the security. As BondSavvy operates under the publishers’ exemption of the Advisers Act, the investments and strategies discussed in this presentation do not take into account an investor’s particular investment objectives, financial situation or needs . In making an investment decision, each investor must rely on its own examination of the investment, including the merits and risks involved, and should consult with its investment, legal, tax, accounting and other advisors and consultants. The information in this presentation is based on data currently available to Shaw, as well as various expectations, estimates, projections, opinions and beliefs with respect to future developments, and is subject to change. Neither Shaw nor any other person or entity undertakes or otherwise assumes any obligation to update this information. There are risks inherent in investing in bonds, which may adversely affect the bonds’ investment returns. These risks include, for example, market decline, interest rate fluctuations, inflation, default, liquidity, and asset class risks. There is no guarantee that investors will be able to meet their investment objectives. Past performance does not guarantee future results. Investors could lose all or part of their investment in a bond, particularly when investing in a high yield bond. Investing in bonds could also produce lower returns than investing in other securities. Investing in bonds does not constitute a complete investment program.
Let’s Challenge Long -Held Bond-Investing Beliefs • Best to ‘leave it to the fund experts’ – bond investing is too hard • Investors can’t beat the index • Always hold bonds to maturity • Build a laddered bond portfolio • Focus on a bond’s yield not the price at which you buy • Bonds only return 2-4% • If ‘interest rates’ rise, bond prices ALWAYS fall • A credit rating and a yield is all you need to evaluate a bond 3
Three Things You Need To Know Before Making an Investment • The price • How investment’s ‘value’ compares to similar investments • The ongoing costs of the investment 4
With Bond Funds, You Know “None of the Above” • Impossible to compare value of fund vs. fund — Thousands of securities owned and always changing — Funds priced to NAV not par value — Few ‘pure - play’ bond funds make it difficult to compare relative performance • High fund turnover drives high, undisclosed fees 5
Bond Funds: Impossible-to-assess prices and high turnover Bond Fund Net Assets $BB* Sep 18 Price Turnover* Vanguard Total Bond $229.3 11.03 54% Market Index Fund (VBTLX) iShares AGG $58.0 112.20 146% PIMCO Total Return $65.4 10.43 723% MetWest Total Return $75.6 10.99 268% *As of, or for the trailing twelve months ending, 12/31/18 for Vanguard, 2/28/19 for iShares AGG, 3/31/19 for PIMCO and 6/30/19 for MetWest 6
Advantage #1: Bonds vs. Bond Funds Individual corporate bonds are all quoted as a percentage of their face value, enabling investors to begin assessing a bond’s relative value “Discount” “Premium” “Par” How quoted 80.00 90.00 70.00 100.00 110.00 130.00 140.00 120.00 Value per $700 $800 $1,300 $1,400 $900 $1,000 $1,100 $1,200 bond 7
Other Advantages of Bonds vs. Bond Funds • Increase returns by owning ‘All - Star’ bonds and not bond -fund benchwarmers • Know exactly what you are investing in and invest based on your risk- return objectives • Limited trading costs since you control turnover • Greater opportunity for capital appreciation and improved tax efficiency Bond funds also take the “fixed” out of “fixed income” with no set interest payments and maturity dates 8
The Benefits of Being Selective ‘Buy low and sell high’ can apply to bonds and generate returns higher than a bond’s YTM Risk Investment Annualized Return Interest Bond Price: Investment Date vs. Sell Date Date YTM Through Sale Bond Credit Rate 85.07 95.32 Highest Apple 3.850% ’43 4.8% 6.4% Low 10/28/13 5/9/18 Higher Low Cablevision 5.875% ’22 79.25 99.12 10.1% 17.6% 12/8/15 1/9/18 Highest None 54.2% Toys R Us 10.375% ’17 83.08 102.59 24.6% 2/12/16 9/29/16 Please note: Selling bonds prior to maturity will not always result in returns in excess of the bond’s Yield To Maturity. Selling prior to maturity may result in lower returns than if the bond was held through to maturity. For Illustrative purposes only 9
Attributes of Individual Corporate Bonds Corporate bonds are issued by the same companies as stocks, but make up <1% of US investor portfolios in spite of their attributes: • Contractual interest payments and return of principal • Financial covenants that protect investors • Senior to common and preferred stock • Wide variety of risk/reward opportunities • Many areas of corporate bond market performed well when stocks collapsed in Q4 2018 10
Individual corporate bonds can help to balance stock market volatility JANUARY 3, 2019 PRICE PERFORMANCE Apple Stock Apple 3.45% ’45 Bonds Falls 10% from $158.34 to $142.09 Unchanged at 88.50* Images licensed from Getty Images. * Source: FINRA TRACE market data 11
How Not To Invest in Bonds 12
Advisors placing clients into bond funds… Investor Financial Advisor Bond Funds & ETFs 1% Fee 0.1-1% Fee …works well for everyone BUT the investor 13
Investing in large index funds – especially through an advisor – is a bad investment % Returns for Vanguard Total Bond Market Index Fund Admiral Shares and Advisor Fee Impact 3.00% 2.56% 1.60% 2.00% 0.63% Average 1.00% Annual Return 0.00% -1.00% -0.60% -1.03% -2.00% 2015 2016 2017 2018 VBTLX Return Financial Advisor Fee All-in 'Return' 14
After investing $100k over four years in VBTLX, the investor made $1,531 less than his advisor ‘15 - ’18 Returns Annual Investor Returns vs. Fees Paid to Advisor and Vanguard* $4,000 $4,040 $3,000 $2,585 Returns & Fees $2,000 $1,590 $1,000 $1,010 $1,036 $1,000 $994 $202 $0 ($600) ($1,000) ($1,067) ($2,000) 2015 2016 2017 2018 $2,509 Vanguard Fees Advisor Fees Investor Return * Reflects returns of Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) 15
The status quo rewards service providers at the expense of the investor 16
It’s the “Advisor to Vanguard Road to Nowhere” 17
Corporate Bonds 101 18
Corporate Bonds 101 – Coupon and Maturity Verizon 3.85% 11/1/42 Coupon: • Paid semi-annually until maturity Maturity Date: • Date at which company returns face value date (“par”) to investor ($1,000 per bond) • $38.50 in interest received • Price you pay for a bond could be higher annually for each bond owned ‒ $385 per year if owned 10 (‘premium’) or lower (‘discount’) than par value bonds 19
How Bonds Are Quoted & What You Pay Bid / Offer Quote Sell 1 Bond for: Buy 1 Bond for: 87.50 / 88.00 $880.00 $875.00 How bonds are quoted: Plus Interest Accrued • Percentage of face value Since Last Coupon • Face value of one bond is $1,000 • Online quotes before 0.1 pts markup/down 20
Current Yield vs. Yield to Maturity Verizon 3.85% 11/1/42 Current Yield Yield to Maturity Bid-Offer Quote 3.85% 3.85% If Bought at Par 87.50 / 88.00 4.70% 4.38% If Bought at 88.00 $880.00 to buy one bond $38.50 ÷ $880.00 Current Yield at 88.00 = 21
Technology Has Put Individual Investors on a More Level Playing Field with Institutional Investors 25 Years Ago Today Investing online enables investors to see broad inventory at competitive prices 22
Liquid Market That Enables Active Investing Corporate bonds trade in a competitive, two-sided market with generally reasonable bid-offer spreads Verizon 3.85% 11/1/42 – Depth of Book* Bids Offers Bid-Offer Spread 0.65 points 0.047% or 4.7 bps * Depth of book shown on Fidelity at 1:55pm EDT on March 13, 2019. 23
How Treasury Yields & Credit Spreads Impact Bond Prices Benchmark YTM Building Blocks 10.65% Treasury YTM 10.00% 8.00% + 7.97% 6.00% 4.72% Credit Spread 4.00% 1.76% 3.30% 3.13% 0.74% 0.64% = 2.00% 2.96% 2.68% 2.56% 2.49% 0.00% Corporate Verizon 3.85% '42 Verizon 4.6% '21 Alphabet 1.998% '26Albertsons 7.45% '29 Bond’s YTM Benchmark Treasury YTM Credit Spread 24
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