As Markets Churn, Bond Funds Start Ugly Dog Contest
What to do with your bond and emerging market funds? It's the question I've been asked most often in the past two weeks. With further declines in prices today, it's starting to look ugly. The numbers look since the beginning of May certainly aren't pretty:
Emerging Market Debt ETF: down 9.8 percent.
Emerging Markets ETF: off 9.7 percent.
Total Bond ETF: slides 3.0 percent
Here are a few thoughts:
A 3 percent decline in Total Bond doesn't sound like much, but consider that AGG has a duration of around 5 years, so a 1 percent increase in rates will translate into a fall in its value of nearly 5 percent. Because it's only yielding 2.5 percent, you have just lost money.
Investors have a few ways to respond:
1) Sell bonds. Lots of people think holding bonds is a net losing position over the next 5 years. You could simply reduce your bond exposure. "This (strangely) may be the most rational route," Matt Hougan at IndexUniverse told me.
2) Move to short-term bonds. The iShares 1-3 Credit Bond Fund, a short-term corporate bond ETF, has dropped much less than the iShares 10 Credit Bond Fund, a long-term corporate bond ETF. The CLY has dropped 9 percent since May 1, the CSJ only 0.4 percent. The downside: Very little potential for appreciation and tiny yields--about 1.4 percent in the case of the CSJ.
Similarly, the SPDR High Yield Bond, which is down 4.5 percent since May 1, has a short-term alternative: the SPDR Short Term High Yield Bond, which offer similar yields in the 5 to 6 percent range with less interest rate risk, and is down 2.3 percent since May 1, half the decline of the JNK.
3) Switch to bank loans or floating rate debt. PowerShares Senior Loan Portfolio are institutional loans that have floating interest rates. Here, you have almost no interest rate risk but still yield near 5 percent. There is some credit risk.
You can also buy floating rate notes, which fluctuate with interest rates: the iShares Floating Rate Note has attracted significant assets recently. Here, you own an index of securities that have a maturity of greater than or equal to one month and less than five years, all of which moves up or down with interest rates.
3) Go Active: hiring an active manager at Fidelity, Vanguard, or Bill Gross. But active management, as is well-known, doesn't necessarily outperform: PIMCO Total Return is down 3.3 percent since May 1, worse than the 3 percent decline in the AGG.
Finally: what to do with emerging market holdings? This is a tougher call. If you look at the main emerging market ETF (EEM), it has routinely swung in a 25 percent range every six months for the past several years. That is a lot of volatility. Right now it is in one of its frequent downtrends, but still within the range it's been in since mid-2009.
Timing investments in this asset class is almost impossible. I won't even try. But if you have a long-term belief that this asset class is worth owning, then a good case could be made for doing nothing, particularly if you bought in some time ago.
—By CNBC's Bob Pisani