Page 45 - DIY Investor Magazine - Issue 28

A quirk is that Bond ETFs have no fixed maturity date; Bonds are rolled so that the maturity range remains fairly constant. What returns (Yield) can you expect on Bond ETFs, then? THE RISK YOU TAKE (DURATION) Now you know Bond prices do not matter; what if I told you that you can also ignore coupon types, coupon rates or even Bond maturity dates? In fact all those metrics can be aggregated to compare different Bonds (and Bond ETFs); the essence of Bond risk is then captured in one metric – Duration. Yield to maturity is a good metric for what is earned over the life of a bond; duration is how long you need to hold the Bond ETF to earn that yield. Short term pain....you sometimes need to be patient – in a rising yield environment you are fully protected if you hold the Bond ETF for a period of roughly 2x duration (in years) This time can be shorter – it does matter when rates stop rising (hence my Bond ETF calculator) But in the most pessimistic scenario, over 2x duration period the increased rates dragging the ETF price down will be fully offset by newly issued Bonds’ higher coupons. In a nutshell, the longer the duration of the ETF, the more pain to endure. To illustrate, most Government or Aggregate Bond ETFs have a duration of 6 to 9 years, but some are longer. Remember, cash by definition has a duration (and yield) of 0. .... Long Term gain: Is there any possible (unexpected) upside opportunity of Bond ETFs? Yes, while holding Bond ETFs during the investment horizon as part of your portfolio allocation, rebalancing is probably the only thing you need to do Upside comes precisely from the fact that you won’t hold all of your Bond ETFs for the length of your investment horizon; selling during a crisis means that you may end up earning more than yield to maturity on some ETFs. In certain recessionary scenarios, as yields fall, Bond ETF prices will rise; while the long term yield is known, short term returns can be higher than expected (because investors rush into in-demand safe-haven assets during a crisis) - and you benefit. This happens when Equity prices in your portfolio may fall; Bond ETFs will become too large part of your portfolio and you are likely to sell them, exactly at a time when they increase in value. This ‘price- pop‘ is directly related to the ETF duration – the higher the duration, the better the protection. You can use that increase in price to sell Bond ETFs and buy cheaper Equities during a market crash. It’s part of a proper preparation to benefiting from the next recession! That’s why it’s key to compare yields for a certain duration (it’s the return you get for the risk you take). Enough said now play with the calculator > The calculator has two inputs - the Yield and Duration (the rest is optional); see some examples of the simulator in action IS THERE ANYTHING ELSE I NEED TO KNOW? Rising rates are most often driven by higher inflation. The returns you earn, and invested amount, are nominal; inflation reduces real purchasing power for Bond ETFs as it does cash. This is the (beta) version of the calculator – test it out for your preferred Bond ETF and let me know what you think. 45 DIY Investor Magazine | Apr 2021