Just curious: Wondering why bond fund would hold 0.01% bonds?

[Dollar Slice]

So, this isn't something that will affect my investments, but I just noticed something tonight and am getting really curious about it (and 20 minutes of googling got me nowhere!).

Long story short, I was doing some finance-nerd type googling/reading tonight and I ended up looking at the holdings of the bond fund I hold (VNYTX). You can see the top 25 holdings here: http://portfolios.morningstar.com/fund/holdings?t=VNYTX&region=usa&culture=en-US

My question is: why would they be investing so heavily in bonds like the fourth and seventh ones listed (New York St Dorm Auth + New York St Hsg Fin Agy St Per Var) when they have a return of just 0.01%? This seems stupid and wrong - and since I don't believe Vanguard is hiring stupid and wrong people to run their funds, I'm quite sure I'm missing something important. I was hoping one of you smart mustachioed types might know the answer (or at least be better at googling than I am).

[okits]

Not an expert or part of the industry, so this is a guess.

1.  They may be holding those bonds to achieve a target duration for the fund.

2.  They bought the bonds at a discount, and are hoping to sell them for a profit prior to maturity.

(Those two are not mutually exclusive.)

I'm pretty certain, however, that the fund managers didn't fork over full par value for those bonds, simply for the 0.01% interest income.

[seattlecyclone]

That's my guess as well. Seems like a 0.01% coupon is practically indistinguishable from a zero-coupon bond. See https://en.wikipedia.org/wiki/Zero-coupon_bond for more information about how anyone manages to sell those.

[Dollar Slice]

Thanks for the replies. I did read the wiki article about zero coupon bonds earlier, but it seemed kind of crazy to me that you'd buy a bond in 2016 that would have zero return until the 2030s. Especially when you're expecting interest rates to rise - why would you want to lock in the low rates of 2016? I can't imagine many VNYTX investors will still be in the fund by then and would be better served by buying bonds that pay out now.

But maybe it's more about the buy/sell price and they are not planning to hold for that long?

My guess would have been something like: the issuer is in trouble and can't pay the interest, and it's been lowered (by some legal process) to a minimum interest rate so they can stay solvent, and the purchase was speculative and at a very deep discount... But I know very little about the bond market! I've been a bit skeptical of it ever since I tried to cash in a mature $1000 bond I'd been given and they told me it wasn't worth $1000... ;-)

[Heckler]

It's price (or its close cousin) appears to be a very stable $100.  I wonder if this is the cash holding equivalent but since it's a bond fund, it needs to hold bonds per se.

https://www.bondview.com/price-check/bond/64983WH25

[seattlecyclone]

Thanks for the replies. I did read the wiki article about zero coupon bonds earlier, but it seemed kind of crazy to me that you'd buy a bond in 2016 that would have zero return until the 2030s. Especially when you're expecting interest rates to rise - why would you want to lock in the low rates of 2016?

I think the theory is that resale value will provide a decent return for people who want to redeem before maturity. If you plan to pay me $20 in 20 years, I might loan you $10 (or whatever) this year, but if I need liquidity in 10 years, someone else might pay me $15 for the right to claim $20 in 10 more years.

How well that works in practice is a mystery to me. I don't know much about the bond market either!