Bond Fund Purgatory | Seeking Alpha

When Fed Chairman Jerome Powell said that his aggressive interest rate hikes would “bring some pain” for Americans, he wasn’t kidding.

While stocks are down big (S&P down 20%, NASDAQ down 30%) in 2022, the $10 Trillion bond and bond fund market is down a whopping 30 to 40%.

Investors that followed the advice of brokers to invest a significant portion of their net worth at the start of the year in bonds and bond mutual funds find themselves in “bond fund purgatory” with massive losses and anemic yields.

Liquidity needs, such as a new roof on a house, college expenses, tax payments, funding a divorce, or worse, meeting margin calls on a declining portfolio, may force investors to unload low yielding bond funds at a huge loss to generate cash needs.

Starting in the spring of 2022, the Federal Reserve began to aggressively raise interest rates to fight inflation. The rising rates made bond yields less attractive and pushed down bond prices.

Some of the biggest losses this year are in long-term bond funds and ETFs. The $25 billon iShares 20+ Year Treasury Bond ETF (TLT) is down 30%; PIMCO 25+ Year Zero Coupon U. S. Treasury Index ETF (ZROZ) is down 40%; the $78 billion iShares Core U.S. Aggregate Bond ETF (AGG) is down 15%.

The Catalyst Interest Rate Opportunity Fund (IOXIX) is shutting down after losing 30 percent of its net asset value (NAV) in just one month. Other bond mutual funds are seeing huge monthly outflows which could force the funds to sell bonds further suppressing prices and leading to outsized NAV markdowns. Such fund outflows have exceeded $400 billion so far this year.

To add insult to injury, bond funds may be in worse shape than they appear due to inflated net asset values that don’t reflect the true value of the bonds.

Individual bonds haven’t fared much better, according to data provider BondCliq, a diversified investment grade bond portfolio of 10 major sectors ranging from technology to utilities, energy and financials is down 34 percent this year. Long duration bonds are down even more.

Unfortunately, many brokers ignored interest rate or duration risk and recommended that their clients invest a significant portion of their “safe money” in long-term bonds, bond funds and ETFs to generate yield to meet their living expense and retirement needs. Brokers sold 10, 20, 40 even 50 year bonds with annual yields of 2-3%. Those “safe” investments are now deep in the red.

This over-concentration in bonds and bond funds has quickly become the “high risk” portion of portfolios without any warning to investors.

Retirees and conservative investors with low yielding long-term bond losses should discuss with their brokers rotating out of these bonds and cutting their losses. If interest rates remain high for some time as is expected, investors may want to escape “bond purgatory” and invest consistent with their real needs and goals.