What causes a closed end bond ETF to drop in net asset value over time?
February 12, 2016 4:16 PM Subscribe
Looking at closed end high yield bond ETFs, some of them maintain their NAV (net asset value) and some have been continually dropping in net asset value (not market price although that usually happens too) over 1-2 years. What causes this and how can one anticipate a long term drop in NAV?
Also, how can one determine when the NAV will stabilize? An example is the ticker symbol DSL from Double Line company. It has a very good dividend rate, the fund manager has a good reputation, but the NAV keeps dropping. This has happened even while the Fed has kept interest rates low and steady. Why is this happening? What are the factors that cause an extended drop in high yield bond NAV?
Also, how can one determine when the NAV will stabilize? An example is the ticker symbol DSL from Double Line company. It has a very good dividend rate, the fund manager has a good reputation, but the NAV keeps dropping. This has happened even while the Fed has kept interest rates low and steady. Why is this happening? What are the factors that cause an extended drop in high yield bond NAV?
Response by poster: FMV? Future value? Actually high yield bonds have been one of the few assest classes that have performed well year to date while stocks have been getting hammered, until this week when they have corrected. My main high yield fund, BBN is up 10% and still giving an almost 8% yield. The high yield bond funds that have been dropping in price are the ones that also have a market price that has been dropping over the past year. This is what spurred my question. The HY funds that have held their price and still have good yield are the ones that have a stable NAV. Selecting high yield funds seems to be at least partially dependent on a stable NAV, or you lose money on the market price even while getting good dividends.
I'm not familiar with FMV... could you explain that? What factors determine FMV?
posted by Tazmaniac at 5:24 PM on February 12, 2016
I'm not familiar with FMV... could you explain that? What factors determine FMV?
posted by Tazmaniac at 5:24 PM on February 12, 2016
Sorry, fair market value. The NAV will just be the FMV of all the assets the fund owns divided by all the outstanding units. In theory, your NAV is the cash each unit would get if the assets of the fund were sold and the cash distributed.
posted by jpe at 5:40 PM on February 12, 2016
posted by jpe at 5:40 PM on February 12, 2016
Response by poster: So, do you have any idea why the fair market value would be dropping over time? It implies to me that the fund is not well managed and is not making money on their investments to cover the dividends, but some of the managers of the funds I follow have good reputations.
posted by Tazmaniac at 6:57 PM on February 12, 2016
posted by Tazmaniac at 6:57 PM on February 12, 2016
Well, Ok. If you are invested in an income fund:
1. The fund holds a bundle of investments that may vary in type and include hedging, but let's say this fund just holds 100% corporate bonds.
2. The bonds, unless they are in default, periodically pay interest which is received into the fund as income. This income, net of the funds expenses is what you receive as the fund dividend when the fund distributes income.
3. At the same time, these bonds are being traded between counterparties on whatever market. If they are traded frequently, they may be priced from the market. If not, the fund is determining a Fair Value for the bond based on broker quotes, inherent value, or some other methodology.
So, what is happening is that your fund is still receiving income because the companies that issued the debt are still paying their interest back, but the price of the underlying securities is diminishing because people are not wild about them as an investment for whatever reason, or the perceived credit risk of the securities is increasing. Since as noted above High Yield is in kind of a bad place right now and all sorts of people are worried about economic pressures on companies, this is not very surprising.
There are probably other factors at play in terms of the value diminishing, but I am not a trader or broker and can't speculate.
posted by selfnoise at 7:34 PM on February 12, 2016 [1 favorite]
1. The fund holds a bundle of investments that may vary in type and include hedging, but let's say this fund just holds 100% corporate bonds.
2. The bonds, unless they are in default, periodically pay interest which is received into the fund as income. This income, net of the funds expenses is what you receive as the fund dividend when the fund distributes income.
3. At the same time, these bonds are being traded between counterparties on whatever market. If they are traded frequently, they may be priced from the market. If not, the fund is determining a Fair Value for the bond based on broker quotes, inherent value, or some other methodology.
So, what is happening is that your fund is still receiving income because the companies that issued the debt are still paying their interest back, but the price of the underlying securities is diminishing because people are not wild about them as an investment for whatever reason, or the perceived credit risk of the securities is increasing. Since as noted above High Yield is in kind of a bad place right now and all sorts of people are worried about economic pressures on companies, this is not very surprising.
There are probably other factors at play in terms of the value diminishing, but I am not a trader or broker and can't speculate.
posted by selfnoise at 7:34 PM on February 12, 2016 [1 favorite]
So, do you have any idea why the fair market value would be dropping over time?
What selfnoise said. HY bonds are in an odd spot now. People are worried about the economy, so they worry about HY defaults, which puts downward pressure on prices.
The relevant question for judging thr manager isn't the ups and downs, but how the value is relative to other HY managers.
posted by jpe at 7:40 PM on February 12, 2016
What selfnoise said. HY bonds are in an odd spot now. People are worried about the economy, so they worry about HY defaults, which puts downward pressure on prices.
The relevant question for judging thr manager isn't the ups and downs, but how the value is relative to other HY managers.
posted by jpe at 7:40 PM on February 12, 2016
It has a very good dividend rate, the fund manager has a good reputation, but the NAV keeps dropping. This has happened even while the Fed has kept interest rates low and steady. Why is this happening?
Defaults.
posted by LoveHam at 9:14 PM on February 12, 2016
Defaults.
posted by LoveHam at 9:14 PM on February 12, 2016
Response by poster: The prices dropping (market value) is different that NAV (net asset value). NAV is independent of the current perception of bond risk (except when the underlying holdings that affect NAV are changing due to market perception). The market price of closed end high yield funds is dependent partly on market opinion (and on NAV, and premium/discount status, and yield, etc.). The difference between the two is the premium/discount of the closed end ETF and you normally want to buy at a discount (when market opinion is low), as long as the net asset value is stable.
The answer from selfnoise above partly answered the question about what affects NAV, but as he touched on, it depends on what securities the fund holds, and whether or not they are leveraged.
Thanks for your replies.
posted by Tazmaniac at 9:39 PM on February 12, 2016
The answer from selfnoise above partly answered the question about what affects NAV, but as he touched on, it depends on what securities the fund holds, and whether or not they are leveraged.
Thanks for your replies.
posted by Tazmaniac at 9:39 PM on February 12, 2016
The NAV of all bond funds fluctuate as interest rates also fluctuate. But the overall long term trend of high yield bond funds is down at a rate of about 1% to 2% per year. The reason for this is that high yield bonds default at a rate of about 4.5% per year. A default does not mean that the bond loses all value. It may lose 40% of its value so the overall loss is 1% to 2% per year. When that money due to default is gone, it is gone forever so the assets of the fund per share decline over time, and therefore the NAV declines over time. Short term fluctuations are superimposed on this long term decline.
The interest rate for high yield bonds is high because of this default risk. This higher interest compensates for the loss of NAV over time. You are trading higher interest for capital loss. For this reason high yield bond funds are at a disadvantage in a taxable account.
posted by JackFlash at 9:58 PM on February 12, 2016
The interest rate for high yield bonds is high because of this default risk. This higher interest compensates for the loss of NAV over time. You are trading higher interest for capital loss. For this reason high yield bond funds are at a disadvantage in a taxable account.
posted by JackFlash at 9:58 PM on February 12, 2016
Response by poster: Thanks for the information about default risk. What I am seeing in some of these funds, including highly rated ones (but none that I hold) is that the NAV has dropped 50% or more in the past year in some cases. This is way above any reasonable default rate. There is something else going on affecting the NAV dramatically that I am trying to discover with this funds. As an example, a comparison is DSL to DBL, both from Doubleline company. DSL is dramatically losing NAV while DBL is not. Both have good fund managers, so I'm trying to discover what impacts these funds.
I am interested in these funds now because SOME of them are holding their value well and still giving 8% dividends. Others are dropping NAV (and market price) dramatically to null the benefits of high yield.
posted by Tazmaniac at 11:08 PM on February 12, 2016
I am interested in these funds now because SOME of them are holding their value well and still giving 8% dividends. Others are dropping NAV (and market price) dramatically to null the benefits of high yield.
posted by Tazmaniac at 11:08 PM on February 12, 2016
Think about how bond math works. If i own something that had 20 years to maturity and a coupon of 7 that i bought at par and people price that to yield 12 then the value of the holding is down about 35% - so my nav has declined while yield has actually gone up, but the underlying move in perceived riskiness isn't very big by historic standards. So the 50% move in Nav makes sense -especially if they own energy high yield or em debt.
In your example one of those funds is mostly mortgage debt -although low quality mortgage debt - where pricing has been ok, while the other has a huge em exposure which has been a tire fire.
posted by JPD at 6:33 AM on February 13, 2016
In your example one of those funds is mostly mortgage debt -although low quality mortgage debt - where pricing has been ok, while the other has a huge em exposure which has been a tire fire.
posted by JPD at 6:33 AM on February 13, 2016
If the NAV of a high yield bond fund is declining sharply in the short term, more than can be explained by a market interest rate increase, then it is because of default risk. Bonds have to be marked to market and if traders think there is higher risk of defaulting a bond because of a change in conditions, then that bond will sell at a discount. If a bond is traded at a discount in the market, then the bond fund must mark down the value of the same bond that they hold. This is called mark to market. You mark the value of your holding by the market trading price daily, the same as if a stock declined in price.
posted by JackFlash at 9:11 AM on February 13, 2016
posted by JackFlash at 9:11 AM on February 13, 2016
I'm not trying to imply anything about your personal intelligence, because I believe that this segment of the financial market thrives largely in obfuscation and even outright deception of the majority of its customers, but you should ask yourself why you are investing in an asset class when you don't understand the basics of its pricing dynamics.
I am interested in these funds now because SOME of them are holding their value well and still giving 8% dividends.
This particular kind of thinking--"I want to buy this black box because the returns look good"--is an absolute invitation to losing your shirt, if not in the obvious catastrophic ways, than in the more subtle ones of overpaying in fees and other costs. Ninety percent of people are better off in a few simple Vanguard index funds.
posted by praemunire at 9:33 AM on February 13, 2016 [3 favorites]
I am interested in these funds now because SOME of them are holding their value well and still giving 8% dividends.
This particular kind of thinking--"I want to buy this black box because the returns look good"--is an absolute invitation to losing your shirt, if not in the obvious catastrophic ways, than in the more subtle ones of overpaying in fees and other costs. Ninety percent of people are better off in a few simple Vanguard index funds.
posted by praemunire at 9:33 AM on February 13, 2016 [3 favorites]
Response by poster: JPD, you mentioned a coupon at 7% being priced to 12... how does that work? Through leverage? Or do you mean you get 12% after the market price drops enough to change the dividend to 12%?
My holdings in these funds are up about 7% in the last 3 months while the Vanguard index funds are down over 12%, so not bad for now. But I want to understand these better to protect against long term risk. The stock market in general is heavily manipulated now by commercial banks and high frequency traders, so I'm looking for other asset classes with less volatility. How much return from a bond fund can be expected and maintain reasonable price stability? 5% ? 8% ?
Buying and holding index funds is no longer a reasonable way to invest under the current economic and market conditions.
posted by Tazmaniac at 1:14 PM on February 13, 2016
My holdings in these funds are up about 7% in the last 3 months while the Vanguard index funds are down over 12%, so not bad for now. But I want to understand these better to protect against long term risk. The stock market in general is heavily manipulated now by commercial banks and high frequency traders, so I'm looking for other asset classes with less volatility. How much return from a bond fund can be expected and maintain reasonable price stability? 5% ? 8% ?
Buying and holding index funds is no longer a reasonable way to invest under the current economic and market conditions.
posted by Tazmaniac at 1:14 PM on February 13, 2016
Praemurie is giving you good advice. You should listen to them.
A bonds price and yield are related. If yield goes up because credit risk goes up or interest rates go up then the price of the bond goes down. So if a bond that once yielded 7% now yields 12% because people demand more compensation for risk then people who bought it at 7% have to see a loss or a decline in NAV.
The bond market is way less transparent than equities - especially the kind of instruments discussed here.
posted by JPD at 2:16 PM on February 13, 2016 [1 favorite]
A bonds price and yield are related. If yield goes up because credit risk goes up or interest rates go up then the price of the bond goes down. So if a bond that once yielded 7% now yields 12% because people demand more compensation for risk then people who bought it at 7% have to see a loss or a decline in NAV.
The bond market is way less transparent than equities - especially the kind of instruments discussed here.
posted by JPD at 2:16 PM on February 13, 2016 [1 favorite]
I'm looking for other asset classes with less volatility.
Then you absolutely do not want to invest in high yield bonds. They are practically the definition of volatility in the bond market. High yield, more appropriately called junk bonds, have volatility that is highly correlated with the ups and downs of the stock market. When the stock market goes in the tank, junk bond defaults increase meaning that their NAV goes down at the same time the stock market goes down.
If you want low volatility steady returns you should look for an intermediate term bond fund like the Vanguard Total Bond Fund.
posted by JackFlash at 3:20 PM on February 13, 2016 [1 favorite]
Then you absolutely do not want to invest in high yield bonds. They are practically the definition of volatility in the bond market. High yield, more appropriately called junk bonds, have volatility that is highly correlated with the ups and downs of the stock market. When the stock market goes in the tank, junk bond defaults increase meaning that their NAV goes down at the same time the stock market goes down.
If you want low volatility steady returns you should look for an intermediate term bond fund like the Vanguard Total Bond Fund.
posted by JackFlash at 3:20 PM on February 13, 2016 [1 favorite]
How much return from a bond fund can be expected and maintain reasonable price stability? 5% ? 8% ?
There is no free lunch. Higher risk brings higher returns. That's the way it works. If you buy a bond with a higher coupon rate, you get higher price volatility and higher risk of default.
Buying and holding index funds is no longer a reasonable way to invest under the current economic and market conditions.
This is nonsense. You're talking like a trader, not an investor.
posted by LoveHam at 6:47 AM on February 14, 2016
There is no free lunch. Higher risk brings higher returns. That's the way it works. If you buy a bond with a higher coupon rate, you get higher price volatility and higher risk of default.
Buying and holding index funds is no longer a reasonable way to invest under the current economic and market conditions.
This is nonsense. You're talking like a trader, not an investor.
posted by LoveHam at 6:47 AM on February 14, 2016
This thread is closed to new comments.
Does that answer the question or am I missing something?
posted by jpe at 5:02 PM on February 12, 2016