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On March 12, 2020, one of many headlines read, “Dow plunges 10% in biggest one-day percentage drop since 1987.” I usually take solace that my high quality bond funds will act as a shock absorber.
This time they didn’t.
The Vanguard Total Bond Market ETF (BND) closed down 5.44%, while the iShares Core U.S. Aggregate Bond ETF (AGG) did a bit better, dropping 4.00%. They both follow slightly different versions of the Bloomberg Barclays U.S. Aggregate Bond Index, comprising roughly 63% U.S. government obligations (Treasuries and agency) and 37% investment-grade corporate bonds.
In the trading chart below (from Yahoo Finance), you can see the variations were highest in the first and last part of the trading day. As to why they got clobbered, and why BND did so much worse than AGG, I really can’t say with any certainty, but below is what I’ve learned so far.
The first thing is that I took some comfort seeing that the trading was going on below net asset value (NAV)—BND was trading at a discount, I thought. For example, BND closed at $80.33 on March 12, 2020, while Morningstar shows a NAV of $85.61. That difference is huge.
Unfortunately, Ben Johnson, Morningstar director of global ETF research, burst that bubble for me. He told me the NAV is based on stale prices for the bonds in the portfolio; thus, it is a bit like clocking the Olympic 100m dash with a stopwatch that only counts in 10-second increments.
The lessons here? A few.
The price of the ETF is likely a more accurate representation of the worth of the basket of bonds at any given point in the day, because it represents the collective opinions of buyers and sellers in real time.
When volatility spikes, it is anyone’s guess what NAV will become at day’s end, so the discount authorized participants require before they step in to do their work inevitably gets bigger. This, of course, is not unique to ETFs—we’re seeing spreads widen everywhere.
And why did BND lag AGG by so much? I posed this question to Vanguard, who replied:
Bond ETFs across the industry experienced uncharacteristically large discounts to NAV concurrent with extreme levels of volatility across financial markets. Though discounts of this breadth and magnitude are quite rare, bond ETFs have been tested during prior bouts of volatility and are functioning as they should, given the rapidly evolving macroeconomic, interest rate and credit environment. Importantly, bond ETFs are serving as a vital source of price discovery and liquidity for fixed income investors during a relatively less liquid period in fixed income markets.
Our advice to fixed income investors in this volatile and illiquid market is to stay focused on long-term goals and avoid trading until markets stabilize, if possible.
I’m not even close to understanding what is going on right now. And that’s pretty rare for me to be this baffled by markets.
A small part of the reason for bonds dropping is that intermediate-term rates actually rose during the week after hitting an all time low on Monday. Still, that doesn’t remotely fully explain it. And why did BND so badly underperform AGG? Perhaps there was more price discovery going on in one of the two funds, though that’s pure speculation.
I’m going to grit my teeth and stay the course, as Vanguard suggests, yet I’m still trying to understand. AGG losing 1.6% year to date or BND losing 3.8% does not make me happy, but it’s better than the 23.9% loss in the Vanguard Total Stock Market ETF (VTI) and the 27.7% loss in the Vanguard Total International Stock ETF (VXUS). And at least high quality did better than high yield, as the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) is down 11.5% YTD.
Our ship is in rough seas at the moment, and our stabilizers aren’t working as well as we’d hoped. Until further notice, all I can say is, hold on tight!
Postscript: As of 10:03 a.m. ET on March 13, BND had recovered most of the shortfall vs. AGG.
Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at ar@DareToBeDull.com, or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.