[Travelhunter123]

Originally Posted by tophcfa

Hindsight is always 20/20. With any asset class you can find a historical time period that looks unusually good or bad. The last 15 years has been horrendous for bonds. The housing market crash of 2007/8, driven primarily by subprime mortgages, resulted in interest rates close to zero, and the Federal Reserve irresponsibly choose to keep rates artificially low for many years beyond the crisis. That was followed by a rapid increase in rates the last couple of years driven by hyperinflation. A perfect storm for bonds. A bonds return is driven by its yield as well as price changes. When interest rates go up, a bonds price declines and vice versa. When rates are close to zero, a bonds yield leaves little cushion to absorb losses due to price changes. Furthermore, when rates are close to zero, interest rates have little room to decline but lots of room to increase.

The difference between a bond fund and owning a single bond and holding it until maturity are very different. When you buy and hold a bond (assuming it doesn’t default or get called) your return is locked in, you earn the interest for the life of the bond and get your principal back at maturity. A bond fund’s return is very different, the fund never matures. Instead the fund is managed to constantly have a duration (for simplicity, duration is similar to maturity) within a tight range as outlined in the funds prospectus. The fund’s return is measured by total return, which changes daily. The main components of total return are both the funds yield and the underlying price of every bond held by the fund. Every day the funds holdings are “marked to market” based on changes in interest rates and perceived risk (credit and call risk) of the fund’s holdings. In general (credit and call risk aside), a bond fund’s expectation is not good when interest rates are unusually low, and are very good when rates are unusually high.

Lastly, no asset class should be looked at in a vacuum. Every asset class should be viewed in the context of a component of a diversified portfolio. Portfolios should be constructed with both returns and risk considerations. That requires looking at the correlations between various asset classes and the goals and objectives of the portfolio. In that context, bonds can be a valuable addition to a portfolio in the correct circumstances.

Thank you