As of the time of writing, the long-term bond ETF TLT is down by nearly a percent for the day. It’s down over 15% for the year. Leveraged bond funds are doing even worse, and bond funds in other asset classes (MUNI, JNK) are down too. There’s a big rush of capital outside of bond funds (this is a good article on the topic) as investors flee the market.
The reason is simple: interest rates are going up, and bond values are inverse to interest rates. So bond funds are finding their bond holdings go down in value as rates rise.
This isn’t a long-term calamity, and is actually a great opportunity for the well-managed bond funds. Managers who know how to profit from a rising interest rate environment will see the value of their bonds decline–but there will also be better yielding opportunities. It’s a matter of profiting from a changing yield curve.
The trick is knowing how the yield curve is going to change and finding the best bonds for such an environment. This is a mix of mathematical prowess and prognostication, and it is not outside of the abilities of the best bond managers.
Yet investors are scared, and their pulling their cash out for other options. This has resulted in some bond CEFs that normally trade in premiums to NAV suddenly trading at a discount. It’s also caused a lot of other income-yielding assets to hit some of the bullets as they ricochet off the bond warfield.
This is a great moment for investors to put to play their belief in fund management over their belief in macroeconomic or fundamental investment in particular equities or assets. If it’s true that some bond funds are being unfairly hit, there’s a chance to invest in some undervalued income-yielding funds that will yield tremendous short-term profits in addition to long-term passive income. What we’re seeing is the beginning of a real buyer’s market in bond funds for the first time since 2008.
The problem is that, to paraphrase Keynes, solvency can’t always outlast the market, and it could take a long, long time for the rise in interest rates to stop punishing bond funds and start yielding some asset appreciation from well-managed funds. The question investors need to ask is if they’re ready for the risk, and how long they think the knife is going to fall before they try to catch it.