Why Corporate bond "tilt" (LQD))

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Raspberry-503
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Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

I'm in the process of simplifying the portfolio designed by a financial advisor I am no longer working with.
I had kind of forgotten that their recommendation for my 40% fixed income allocation was:

2% cash
15.2% Total Us bond market: BND (ER 0.035%)
15.2% Total Int'l Bond Market: BNDX (ER 0.08%)
7.6% Investment grade corporate bonds LQD (ER 0.14%)

BND is mostly treasuries and Gvt's asset-backed, but also has 2.2% commercial and 17% industrial, I think representing the corporate market weight?
LQD only does investment-grade (something like almost 90% of the portfolio is BBB or better) and is pretty long duration (SQLD does shorter durations)

I would think that BND is diversified enough, between staying way from riskier bonds and the long duration, I'm not sure LQD adds more upside in terms of diversification? Was this a "tilt" a good idea from the advisor or just another way to justify their existence?

BTW I'm also no longer 2% in cash. Too much of a drag, especially in tax-advantaged accounts where I can't touch it for another 10 years
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mrpotatoheadsays
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Re: Why Corporate bond "tilt" (LQD))

Post by mrpotatoheadsays »

Raspberry-503 wrote: Wed Oct 27, 2021 9:01 am Was this a "tilt" a good idea from the advisor or just another way to justify their existence?
It depends upon your goals. I'm sure your advisor discussed your life goals, right? Ha ha ha ha!!!

If you want to generate income off your bond holdings (to meet some budget need or whatever), you might seek higher yields. Corporate bonds provide higher yields than Treasuries and other papers. You could also consider junk bonds which yield even higher. These higher yields come with higher risk. It should come as no surprise that, in a down stock market, corporates could have significant losses (e.g. S&P 500 down 30%; junk bonds down 20%, investment-grade corporates down 10%).

I prefer and recommend a different approach. Bonds should be the stable part of your portfolio and be able to withstand a disaster. The "best" way to do this is via a mix of Treasury bond funds; short and intermediate; normal and inflation-adjusted. Will you get high yield? No, you're not in it for yield. All the risk you want to take should be in equities. Want more risk, own more equities. Want less risk, own more Treasuries.

Bogleheads will recommend the Total Bond fund, but this holds agency, corporate, long-term and unrated bonds. It's diversified, but more risky than pure Treasuries. It part long-term, so raising interest rates will be a drag compared to short/intermediate Treasuries. Right now, its yield is significantly less than inflation-adjusted Treasuries. Hmmmm...

I use:
Intermediate-term Treasury bonds (30%)
Intermediate-term TIPS (20%)
Short-term Treasury bonds (30%)
Short-term TIPS (20%)
via:
Vanguard Intmdt-Term Trs Idx Admiral VSIGX
Vanguard Inflation-Protected Secs Adm VAIPX
Vanguard Short-Term Treasury Idx Admiral VSBSX
Vanguard Shrt-Term Infl-Prot Sec Idx Adm VTAPX
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Raspberry-503
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Re: Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

Yeah i look at bonds as ballast, take your risk on the equity side. We did discuss life goals with the adviser (we haven't won the game yet but are in good shape and moderate growth a la 60/40 feels right for the remaining 10 years to retirement and beyond).

LQD doesn't even seem "aggressive enough" if you were chasing yields.

Thanks for sharing your mix of fixed income, since I'm trying to simplify i may call BND "good enough". I'm also one of those weirdos that thinks international diversification in bonds is a good idea for the long term, so i agree with the advisor on having a position in BNDX

Edit: I'm also building a position in I-Bonds as part of my inflation protection plan. I'm shooting for 2+ years of retirement expenses in I-Bonds by the time I retire. (Currently i call my I-Bonds holdings my emergency fund, and i had to talk the advisor into it vs HYSA)
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Re: Why Corporate bond "tilt" (LQD))

Post by ApeAttack »

Raspberry-503 wrote: Wed Oct 27, 2021 10:33 am Edit: I'm also building a position in I-Bonds as part of my inflation protection plan. I'm shooting for 2+ years of retirement expenses in I-Bonds by the time I retire. (Currently i call my I-Bonds holdings my emergency fund, and i had to talk the advisor into it vs HYSA)
The good thing about I-Bonds is you can liquidate them and put the money in a HYSA if those rates get significantly higher than I-Bond interest rates. Of course, there are the usual warnings that you will lose 3 months interest in you don't wait 5 years, etc.

Since I get inflation protection with I-Bonds, the difference in interest rates would have to be substantial for me to do that.
May all your index funds gain +0.5% today.
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Re: Why Corporate bond "tilt" (LQD))

Post by ruralavalon »

Raspberry-503 wrote: Wed Oct 27, 2021 9:01 am I'm in the process of simplifying the portfolio designed by a financial advisor I am no longer working with.
I had kind of forgotten that their recommendation for my 40% fixed income allocation was:

2% cash
15.2% Total Us bond market: BND (ER 0.035%)
15.2% Total Int'l Bond Market: BNDX (ER 0.08%)
7.6% Investment grade corporate bonds LQD (ER 0.14%)

BND is mostly treasuries and Gvt's asset-backed, but also has 2.2% commercial and 17% industrial, I think representing the corporate market weight?
LQD only does investment-grade (something like almost 90% of the portfolio is BBB or better) and is pretty long duration (SQLD does shorter durations)

I would think that BND is diversified enough, between staying way from riskier bonds and the long duration, I'm not sure LQD adds more upside in terms of hidiversification? Was this a "tilt" a good idea from the advisor or just another way to justify their existence?

BTW I'm also no longer 2% in cash. Too much of a drag, especially in tax-advantaged accounts where I can't touch it for another 10 years
For shorter effective duration, and lower expense ratios still with good credit quality, you could consider:
1) Vanguard Intermediate-term Bond Index Fund (VBILX) , ETF share class (BIV), ER 0.07%, 1/2 corporate bonds, 1/2 government bonds, no mortgage backed securities (MBS); or
2) Vanguard Intermediate-term Investment-grade Bond Fund (VFIDX) ER 0.10%, about 83% corporate bonds; or
3) Vanguard Intermediate-term Corporate Bond Index Fund (VICSX), ETF share class (VCIT), ER 0.07%.

We use Vanguard Intermediate-term Bond Index Fund (VBILX) ER 0.07% as our only fixed income investment, held in my rollover IRA. I think it's worth it for a little higher return using more corporate bonds.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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Re: Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

Good point, my 401(k) which holds about 1/3 of my total bonds right now is in VBILX (Vanguard Intermediate-term Bond Index Fund) because it didn't have any other options like BND, LQD, etc...

I posted in another thread about advice on tax location, where I suggest I go 100% bonds in my 401(k), so that would end up in VBLIX. It would still be only 1/2 of my total 40% bond allocation after moving things around for asset location, and I would complement the rest of my 40% fixed income allocation in my separate Trad IRA So VBILX provides exposure to commercial, even more reasons to skip LQD

I may then do another 20-30% of my total bonds in BNDX (or is there a better "total international bond market" choice?) and the balance in BND or a similar more treasury-centric fund, or just KISS and keep all domestic bonds in VBILX, because in the end, it's anyone's guess.

VBILX is also BIV as an EFT, I think it doesn't;t matter which I pick since it's a vanguard fund, even though I'm buying into a Fidelity account right?
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Re: Why Corporate bond "tilt" (LQD))

Post by ruralavalon »

Raspberry-503 wrote: Wed Oct 27, 2021 2:45 pm . . . . . .

I may then do another 20-30% of my total bonds in BNDX (or is there a better "total international bond market" choice?) and the balance in BND or a similar more treasury-centric fund, or just KISS and keep all domestic bonds in VBILX, because in the end, it's anyone's guess.
I suggest not using an international bond fund.

Bernstein: "Don’t Bother With Int'l Bonds".

"Should You Include International Bonds In Your Portfolio?"


Raspberry-503 wrote: Wed Oct 27, 2021 2:45 pmVBILX is also BIV as an EFT, I think it doesn't;t matter which I pick since it's a vanguard fund, even though I'm buying into a Fidelity account right?
At Fidelity there is a fee to buy regular mutual funds from Vanguard.

But Vanguard ETFs trade commission-free at Fidelity, so use he ETF share class.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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Re: Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

Vanguard lifestyle growth Fund has almost 30% of its bonds in foreign bonds, and the Vanguard article does suggest it might help stability at least a little by increasing diversification.
I guess I have a "reverse home bias" and worry about tying my investments too closely to one country, regardless of how great at the moment, but the thoughts on hedging in the first article make a good point too.
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Re: Why Corporate bond "tilt" (LQD))

Post by ruralavalon »

Raspberry-503 wrote: Wed Oct 27, 2021 8:15 pm Vanguard lifestyle growth Fund has almost 30% of its bonds in foreign bonds, and the Vanguard article does suggest it might help stability at least a little by increasing diversification.
I guess I have a "reverse home bias" and worry about tying my investments too closely to one country, regardless of how great at the moment, but the thoughts on hedging in the first article make a good point too.
If you want a large international bond allocation, and want a single all-in-one fund for a one-fund portfolio, then either a Vanguard target date fund or a Vanguard LifeStrategy fund would be very good choices.
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Re: Why Corporate bond "tilt" (LQD))

Post by nisiprius »

Raspberry-503 wrote: Wed Oct 27, 2021 9:01 am...I would think that BND is diversified enough, between staying way from riskier bonds and the long duration, I'm not sure LQD adds more upside in terms of diversification? Was this a "tilt" a good idea from the advisor or just another way to justify their existence?...
I wouldn't think ill of the advisor. Putting you in LQD doesn't line their pocket. It's a popular mainstream idea.

Bond categories have a remarkably consistent relation between risk and return. Me, I am happy with the "too-conservative" BND and keep wondering why I don't even go to 100% Treasury, but that's me.

John C. Bogle was quite definite about thinking that most ordinary retirement savers ought to have more in corporates than BND has. For everyone with that opinion there's someone else with the opposite opinion. That's all it is, opinion and taste and how much credit and liquidity risk you yourself want to take.

No, the effect of LQD isn't completely meaningless, although by the time you put it in the context of a portfolio with stocks it is.

Here we have bonds alone, past performance, backtesting, rounding numbers a bit... LQD and BNDX were not crazy things to hold:

Source

Image

But hold them together with 60% stocks and it starts to look like meaningless fine tuning:

Image
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Re: Why Corporate bond "tilt" (LQD))

Post by nisiprius »

I used slightly different funds in order to go back farther. I omitted international bonds because the only dollar-hedged fund I can think of has a high expense ratio. I used the Total Stock mutual fund, VTSMX, instead of VTI--same things--and VBMFX instead of BND--again, same things. For corporate bonds, I used the VFICX, the Vanguard Intermediate-Term Investment-Grade bond fund, which is corporate-heavy and behaves a lot like a corporate bond fund.

So what we're looking at here is a 60/40 all-US portfolio, and the effect of putting ⅕ of the 40% into corporates (blue) versus keeping all of it into Total Bond.

It's almost funny, isn't it? But advocates of adding corporates will say that it's not fair to look at that long a period because the Aggregate index and thus Total Bond didn't really start to have "too much" in government issues until recently.

Source

Image
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Re: Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

Thanks, love the detailed analysis!
Since my 401(k) only had VBILX (BIV) and that's where I plan to hold my bonds, i think I'll do VBILX there (more commercial) and BND in my IRA to complement and be more treasuries centric there, and drop LQD altogether.
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Re: Why Corporate bond "tilt" (LQD))

Post by ruralavalon »

The differences are small, but they are there. With a 60/40 portfolio of total stock market and intermediate -term bond index there is a little higher return, a little higher Compound Annual Growth Rate (CAGR), a little higher volatility,and a little better risk adjusted return. Portfolio Visualizer, 2001-2021.
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Re: Why Corporate bond "tilt" (LQD))

Post by prioritarian »

ruralavalon wrote: Thu Oct 28, 2021 1:24 pm The differences are small, but they are there. With a 60/40 portfolio of total stock market and intermediate -term bond index there is a little higher return, a little higher Compound Annual Growth Rate (CAGR), a little higher volatility,and a little better risk adjusted return. Portfolio Visualizer, 2001-2021.
The differences are not small for longer duration treasuries which are the main source of the enhanced performance of total bond+equities.

https://www.portfoliovisualizer.com/bac ... tion5_3=40
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Re: Why Corporate bond "tilt" (LQD))

Post by Raspberry-503 »

Is that universally true or only true of the last decade or so? aren't longer duration more likely to suffer from inflation and intermediate could have them beat in the future?
The funds all used in the last example all seem to have a healthy amount of corporate bonds, which was my original question.
Instill don't think I'm going to bother with LQD when I have VBILX
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