A graphic on the role of bonds

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A graphic on the role of bonds

Postby grabiner » Sat May 04, 2013 8:45 pm

You hold bonds to reduce the risk of your portfolio, and most of the time, it doesn't matter which bonds you use. But when it does matter, you see that the lower yields of Treasury bonds are for a good reason.

Image

Blue - Vanguard Intermediate-Term Investment Grade (almost all corporate bonds)
Red - Vanguard Total Bond Market Index
Yellow - Vanguard Intermediate-Term Treasury
Green - Barclays Capital Aggregate Index (benchmark)

Orange - Morningstar average for intermediate-term corporate funds

From 1993 through 2007, the lines are very close; you wouldn't have a difference of more than a few percent no matter which fund you used. But in 2008, when everything else fell, investors fled to Treasuries, so the Treasury fund jumped, Total Bond Market (which has a lot of Treasuries) stayed on the trend line, and the corporate fund fell. When all else failed, Treasuries provided their full diversification benefit. In the 2009 recovery, once it turned out that relatively few corporate bonds would default, the lines came back together, and the corporate fund is slightly ahead now because Treasury yields have been so low.

And while it wasn't my intended point, you can also see how a small leak sinks a big ship. The orange line is the Morningstar category average of all intermediate-term corporate bond funds, and over nearly 20 years, it has fallen 19% behind the low-expense Vanguard fund by losing an average of 1% per year.
Last edited by grabiner on Sat May 04, 2013 9:16 pm, edited 1 time in total.
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Re: A graphic on the role of bonds

Postby livesoft » Sat May 04, 2013 9:09 pm

So, does this graph say to buy intermediate-term corporate bonds whenever they fall more than Treasuries? Does it say to exchange out of Treasuries after they have held their own in troubled times and are ready to revert to the mean?


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Re: A graphic on the role of bonds

Postby gkaplan » Sat May 04, 2013 9:12 pm

That's a terrific chart, David.
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Re: A graphic on the role of bonds

Postby bobcat2 » Sat May 04, 2013 9:34 pm

You can also hold bonds to match their maturities to future liabilities you are expecting to incur. In that case it does matter what type of bonds you hold. If the liability is nominal, you want to hold nominal bonds. If the liability is real, you want to hold real bonds. Individual investors are typically matching bonds to real liabilities (future consumption) and therefore want to be holding I-bonds and TIPS bonds. Holding a TIPS bond fund doesn't cut it in this case because the TIPS fund will have no set maturity date.

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Re: A graphic on the role of bonds

Postby staythecourse » Sun May 05, 2013 12:09 am

grabiner wrote:And while it wasn't my intended point, you can also see how a small leak sinks a big ship. The orange line is the Morningstar category average of all intermediate-term corporate bond funds, and over nearly 20 years, it has fallen 19% behind the low-expense Vanguard fund by losing an average of 1% per year.


Does your dollar growth chart show the effects of expense ratio drag on performance?? I don't think it does. The growth charts do not include the effects of expense ratios. I, of course, agree with you comment, but would not say the drag is from the expense ration BY the chart, but from MANY of the active bond funds in the orange line and thus the drag is from active management. Of course, the drag would be EVEN worse if one included the ravages of expense ratios.

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Re: A graphic on the role of bonds

Postby Winthorpe » Sun May 05, 2013 12:40 am

This also supports the views of David Swensen (Unconventional Success) and Larry Swedroe (Only Guide to Winning Bond Strategy) who advocate US treasuries, in part, for this very reason.

However, I have never seen this graphically before. Thanks for providing this. It's a good reminder when everyone seems to be reaching for higher yields.

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Re: A graphic on the role of bonds

Postby asset_chaos » Sun May 05, 2013 2:10 am

Nice graph, thanks. The main message I get is that for investment grade intermediate term bond funds low cost was much more important than the credit spread between treasuries and investment grade corporates over this period. In other words, I'd rather have been on any of the lines other than the orange line of high-cost management.
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Re: A graphic on the role of bonds

Postby z3r0c00l » Sun May 05, 2013 6:35 am

I enjoyed this post, but a person who bases their bond expectations on this time period is asking to be seriously disappointed.
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Re: A graphic on the role of bonds

Postby Random Musings » Sun May 05, 2013 6:47 am

z3r0c00l wrote:I enjoyed this post, but a person who bases their bond expectations on this time period is asking to be seriously disappointed.


I think the expectation that actives will underperform and why treasuries can be useful during troubled times will continue regardless of the trend of total returns, be it sideways, down or up.

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Re: A graphic on the role of bonds

Postby Blues » Sun May 05, 2013 8:05 am

Winthorpe wrote:This also supports the views of David Swensen (Unconventional Success) and Larry Swedroe (Only Guide to Winning Bond Strategy) who advocate US treasuries, in part, for this very reason.

However, I have never seen this graphically before. Thanks for providing this. It's a good reminder when everyone seems to be reaching for higher yields.

Best Regards,
Winthorpe


I wonder how VBIRX (Short-Term Bond Index fund) would have fared with its shorter duration and higher allocation to Treasury / Federal bonds as compared to TBM?

David, is there any way for you to add a line representing VBIRX?
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Re: A graphic on the role of bonds

Postby Call_Me_Op » Sun May 05, 2013 8:10 am

Whatever happened to "past performance does not guarantee..."
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Re: A graphic on the role of bonds

Postby livesoft » Sun May 05, 2013 8:42 am

Blues wrote:I wonder how VBIRX (Short-Term Bond Index fund) would have fared with its shorter duration and higher allocation to Treasury / Federal bonds as compared to TBM?

David, is there any way for you to add a line representing VBIRX?

This is something that you can investigate for yourself very easily. The web site is morningstar.com and the Bogleheads wiki has a page on how to make charts although it is really very easy.

Another thing you may wish to do is actually zoom in on the chart between 2007-2011.

And also note that the chart has log scale for the vertical axis. This usually happens when a long date range is charted.
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Re: A graphic on the role of bonds

Postby #Cruncher » Sun May 05, 2013 8:55 am

staythecourse wrote:The growth charts do not include the effects of expense ratios.
I'm pretty sure the charts do include the effect of expenses. Assuming Morningstar bases them on net asset value and distributions, they will implicitly be net of expenses. I know that the returns Vanguard reports on its web site are net of expenses. For example, the Vanguard Intermediate-Term Investment-Grade Fund Investor Shares (VFICX) Price and Performance web page reports the annual return from 11/01/1993 (fund inception) to 04/30/2013 as 6.48%. If I enter the same date range on the Morningstar's web site, it shows that $10,000 grew to $34,013.87. (1) This is a compounded growth rate of 6.48% (3.401387 ^ (1 / 19.5) - 1 = 6.48%), the same that Vanguard reports.

staythecourse wrote:... the drag is from active management.
VFICX is actively managed also. Perhaps its management is better than the average; but I still think that its lower expense ratio is the major cause of its better performance. The same Morningstar chart shows that $10,000 in "Intermediate-Term Bond" grew to $27,502.31 over the same 11/01/1993 - 04/30/2013 period, a compounded annual growth rate of 5.33% (2.750231 ^ (1 / 19.5) - 1 = 5.33%). This is 1.15% points less than VFICX's 6.48% return.

The VFICX Overview web page shows the fund has a 0.20% expense ratio and that it is "78% lower than the average expense ratio of funds with similar holdings". This would mean that the average expense ratio of such funds is 0.91% (0.20% / 22% = 0.91%). So it looks like about 0.71% points of the 1.15% point differential is accounted for by the difference in expense ratio.

(1) Click this link to bring up the Morningstar graph. You'll probably need to reenter the 11/01/1993 - 04/30/2013 date range.
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Re: A graphic on the role of bonds

Postby Blues » Sun May 05, 2013 9:01 am

livesoft wrote:
Blues wrote:I wonder how VBIRX (Short-Term Bond Index fund) would have fared with its shorter duration and higher allocation to Treasury / Federal bonds as compared to TBM?

David, is there any way for you to add a line representing VBIRX?

This is something that you can investigate for yourself very easily. The web site is morningstar.com and the Bogleheads wiki has a page on how to make charts although it is really very easy.

Another thing you may wish to do is actually zoom in on the chart between 2007-2011.

And also note that the chart has log scale for the vertical axis. This usually happens when a long date range is charted.


If my question offended you somehow, feel free to send me a PM, I'll be happy to reply. As I recall, this is an open thread and discussion and your condescending attitude is neither appropriate nor appreciated in light of my quick question addressed to David.
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Re: A graphic on the role of bonds

Postby nisiprius » Sun May 05, 2013 9:06 am

Call_Me_Op wrote:Whatever happened to "past performance does not guarantee..."
That disclaimer goes on mutual fund literature and refers to 1, 5, and 10 year returns. It means what it says: if a fund has earned an average 5%/year over the past 1, 5, or 10 years, that does not tell you that it will earn anything close to that number over the 1, 5, or 10 years.

Past behavior often tells us something fairly reliable about future behavior. And past fundamentals often tell us something fairly reliable about future behavior. For example, I have no idea what the Rydex S&P 500 Index Fund, RYSOX, with 1.5% expense ratio, will earn over the next 1, 5, or 10 years. Yet I am very confident that if the S&P does well it will do well, and that if the S&P 500 does poorly, it will do poorly. And I am also very confident, based on my fundamental understanding of the fact that it's an index fund with 1.5%, that it will continue to underperform the Vanguard 500 index fund each and every year in the future--on the rough order of a percent worse--just as it has every year in the past.

David Grabiner is calling attention to a fundamental characteristic of Treasuries compared to other bonds. Yes, indeed, they have lower return and, yes indeed, they do have lower risk. They do, they do, they really do. (Unless you engage in the sophistry that says anything with low return is "risky" because it has high risk of not having high return...) I think it is perfectly legitimate to say that it is characteristic of the asset class. I think it is a more reliable statement than many other general statements in investing. Furthermore, he's showing the size of the effect.

Now, personally, I would have put more emphasis on "doesn't matter which bonds you use" as long they're really bonds, they're intermediate-term or shorter, and they're investment grade, because in that category even the funds that dropped the most during 2008-2009 only dropped about 12%. I think it is less important to emphasize the relative safety of Treasuries within the class of safe bonds, and more important counter the faddish notion that dividend stocks are a reasonable substitute for bonds, or that high-yield bonds aren't enough riskier to matter. When stocks drop 48%, I don't think you want the "safe" part of your portfolio to drop 47% (yellow, the Vanguard Equity-Income fund recommended by Malkiel and Ellis), even if that's "less" than stocks as a whole. I don't think you want it to drop 27% (green, the Vanguard High Yield Corporate). But I don't think it's so terrible to have it drop 12% (blue, intermediate-term investment grade [corporate]).

I think the difference between getting a few percent boost in the "flight to safety" in the Treasuries (orange), versus sailing straight through (total bond, not shown) is certainly something to know about, but not hugely important. I think the difference between any investment-grade bond fund and high-yield bonds or dividend stocks, is essential to know about and hugely important. And, yes, even though I do not know what the performance of any of these assets will be in future, I think the behavior and the risk/reward characteristics will be similar in future to what they were in the past.

Image
Last edited by nisiprius on Sun May 05, 2013 9:13 am, edited 3 times in total.
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Re: A graphic on the role of bonds

Postby livesoft » Sun May 05, 2013 9:09 am

Blues wrote:If my question offended you somehow, feel free to send me a PM, I'll be happy to reply. As I recall, this is an open thread and discussion and your condescending attitude is neither appropriate nor appreciated in light of my quick question addressed to David.

I was not offended at all. I wanted to help you avoid waiting for results since you can do-it-yourself without any delay. After all, this is a DIY investing forum. :)
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Re: A graphic on the role of bonds

Postby Blues » Sun May 05, 2013 9:10 am

livesoft wrote:
Blues wrote:If my question offended you somehow, feel free to send me a PM, I'll be happy to reply. As I recall, this is an open thread and discussion and your condescending attitude is neither appropriate nor appreciated in light of my quick question addressed to David.

I was not offended at all. I wanted to help you avoid waiting for results since you can do-it-yourself without any delay. After all, this is a DIY investing forum. :)


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Re: A graphic on the role of bonds

Postby Blues » Sun May 05, 2013 9:59 am

Looks like TBM would have been as reasonable a choice for safety as ST-Bond (VBIRX) (and somewhat more profitable) over the recent period:

http://tinyurl.com/cp2rn42
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Re: A graphic on the role of bonds

Postby Doc » Sun May 05, 2013 11:02 am

grabiner wrote:From 1993 through 2007, the lines are very close; you wouldn't have a difference of more than a few percent no matter which fund you used.


A rolling return chart can do a better job of highlighting what happens in the short run during market/economic disruptions. By looking at both the growth chart and a rolling return chart you get a very good picture of the risk/reward tradeoff. In the '08 debacle there was some 25% difference in bond fund performance from top to bottom. That could have made a whole lot of difference if you were trying to rebalance into the bull market in equities.

Image

(I think I got my colors different from David. Go to the M* site for details.)

http://quote.morningstar.com/fund/chart ... %2C0%22%7D

Play with the "Rolling Period" and overall time frame to meet you personal risk/return attitudes.
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Re: A graphic on the role of bonds

Postby BigOil » Sun May 05, 2013 11:19 am

gkaplan wrote:That's a terrific chart, David.


+1
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Re: A graphic on the role of bonds

Postby Calm Man » Sun May 05, 2013 12:31 pm

Thank you for a very nice analysis Mr Grabiner. As often is the case, I will come up with a somewhat different conclusion. Yes, indeed, at the time of the crash treasuries did better. But after things cooled down, the investment grade fund (blue line) surpassed it again. So if the concern is seeing portfolio value while right in the midst of an equity collapse, sure, treasuries will hold more value. But long term I think as long as you have investment grade bonds in a fund, that should do better if starting interest rate is higher.
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Re: A graphic on the role of bonds

Postby Calm Man » Sun May 05, 2013 12:34 pm

livesoft wrote:
Blues wrote:If my question offended you somehow, feel free to send me a PM, I'll be happy to reply. As I recall, this is an open thread and discussion and your condescending attitude is neither appropriate nor appreciated in light of my quick question addressed to David.

I was not offended at all. I wanted to help you avoid waiting for results since you can do-it-yourself without any delay. After all, this is a DIY investing forum. :)


I was confused. I didn't see anything looking like being offensive or taking offense.
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Re: A graphic on the role of bonds

Postby Blues » Sun May 05, 2013 12:56 pm

Calm Man wrote:
livesoft wrote:
Blues wrote:If my question offended you somehow, feel free to send me a PM, I'll be happy to reply. As I recall, this is an open thread and discussion and your condescending attitude is neither appropriate nor appreciated in light of my quick question addressed to David.

I was not offended at all. I wanted to help you avoid waiting for results since you can do-it-yourself without any delay. After all, this is a DIY investing forum. :)


I was confused. I didn't see anything looking like being offensive or taking offense.


It's been handled amicably via PM and there's really no need for further discussion on the matter as it will only sidetrack the thread further.
My apologies for the short hiccup.

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Re: A graphic on the role of bonds

Postby SnapShots » Sun May 05, 2013 1:31 pm

BigOil wrote:
gkaplan wrote:That's a terrific chart, David.


+1

+2
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Re: A graphic on the role of bonds

Postby baw703916 » Sun May 05, 2013 1:59 pm

Doc wrote: In the '08 debacle there was some 25% difference in bond fund performance from top to bottom. That could have made a whole lot of difference if you were trying to rebalance into the bull market in equities.


+1

I think it matters a great deal how much one has in equities. For mostly bond portfolio TBM is a good choice (and you can't even tell 2008 happened by looking at its performance). But for a mostly equities portfolio both the return and the risk will be dominated by equities. So IMO it makes more sense to invest in an asset class that will experience a flight to safety should equities tank.
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Re: A graphic on the role of bonds

Postby dbr » Sun May 05, 2013 2:23 pm

baw703916 wrote:
Doc wrote: In the '08 debacle there was some 25% difference in bond fund performance from top to bottom. That could have made a whole lot of difference if you were trying to rebalance into the bull market in equities.


+1

I think it matters a great deal how much one has in equities. For mostly bond portfolio TBM is a good choice (and you can't even tell 2008 happened by looking at its performance). But for a mostly equities portfolio both the return and the risk will be dominated by equities. So IMO it makes more sense to invest in an asset class that will experience a flight to safety should equities tank.


If the risk is dominated by equities, why would it matter what nuances exist in the bond risk?

One advantage of an asset allocation that is not dominated by bonds is that 90% of the discussion current on this forum is of academic interest only. If your income stream is also reasonably diverse, the effect on one's income stream of issues in bonds is even less. For all of that, this can be done without taking excessive risks in stocks. A person with perhaps 1/3 or more of income from annuitized sources and a 50/50 asset allocation probably doesn't need to think too much about most of this.
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Re: A graphic on the role of bonds

Postby baw703916 » Sun May 05, 2013 2:43 pm

dbr,

I was talking from the point of view of someone in the accumulation phase, whose income is from salary and not from the portfolio.
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Re: A graphic on the role of bonds

Postby MN Finance » Sun May 05, 2013 2:46 pm

This clearly supports the idea that many of the professionals here hold: that bonds are for safety and should always be short and high quality. Risk should be taken on the equity side. Most people are willing to waive this idea given the rate environment but eventually that might be regrettable.
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Re: A graphic on the role of bonds

Postby dbr » Sun May 05, 2013 2:58 pm

baw703916 wrote:dbr,

I was talking from the point of view of someone in the accumulation phase, whose income is from salary and not from the portfolio.


Yes, the second half of my comment was narrow minded. However, the principle still applies: in accumulation you care even less exactly what your bonds do and don't do and you have less of them on average. It's not just that the risk comes from the stocks but also that on average the return does. Also having an income and still saving dilutes the already small role played by bond risk.
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Re: A graphic on the role of bonds

Postby Doc » Sun May 05, 2013 3:55 pm

dbr wrote:
baw703916 wrote:dbr,

I was talking from the point of view of someone in the accumulation phase, whose income is from salary and not from the portfolio.


Yes, the second half of my comment was narrow minded. However, the principle still applies: in accumulation you care even less exactly what your bonds do and don't do and you have less of them on average. It's not just that the risk comes from the stocks but also that on average the return does. Also having an income and still saving dilutes the already small role played by bond risk.


Given this scenario it makes sense to ignore the return from the bonds all together and that means low risk. Therefore looking at the bond side alone one would go with short Treasuries. But from the viewpoint of the entire portfolio one would want long Treasuries because of their expected negative correlation with the equities themselves even though the long Treasuries have more term risk than short Treasuries. In any case you don't have corporates, MBS or high yield in your FI portfolio. That is don't use a TBM fund at all.

As you and your portfolio mature you have proportionately less need for protection from the equity bear and more need for income so one should migrate towards more risk and income for the FI part of your portfolio while remaining investment grade. Still don't use that TBM fund.

In my opinion a good way to accommodate this maturing is to have a FI portfolio which includes short and intermediate Treasuries as well as intermediate investment grade bonds and to gradually change the mix as your portfolio matures. Say 100% Treasuries at age 20 and 100% corporate investment grade when you are age 100 for example. Once your portfolio is fully matured one could add TIPS and MBS and reduce your allocation to short nominal Treasuries because it takes less ammo to protect against the equity bear because you have fewer equities. OK maybe now the TBM fund starts to make sense but if you add TIPS to the TBM you are going back in the wrong direction. So still no TBM. :shock:

By the way, don't make the jump into TIPS too soon without at least adding a TIPS fund to David's original graph and see how it performed in '08. (Hint: It's not pretty.)
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Re: A graphic on the role of bonds

Postby nisiprius » Sun May 05, 2013 6:26 pm

Doc wrote:By the way, don't make the jump into TIPS too soon without at least adding a TIPS fund to David's original graph and see how it performed in '08. (Hint: It's not pretty.)
Agreed, and what's disturbing is that it jumps off the smooth curve for reasons that aren't obvious, suggesting liquidity issues. But be fair: what happened in 2008 was mostly the evaporation of a weird, anomalous rise in 2007. As is often the case, people aren't upset by anomalies when they are upward rather than downward.

One doesn't want anomalies in a bond fund at all.

Still, I think it is meaningful that the TIPS fund (blue) had an anomalous bump that was mostly above the Total Bond line (green), compared to corporates (orange) which was an anomalous pit below. I mean who wouldn't rather break an axle going over a bump rather than dropping into a pothole? Well, maybe that isn't the best analogy...

Image

It is hard to know what is a "fair" starting date to pick here, however. Obviously if you pick 12/31/2007 which is what I often pick when assessing 2008-2009, TIPS just crater. So, of course, this time I picked something different. And it doesn't look as neat if you pick Intermediate-term treasury instead of Total Bond. Then the TIPS are half above, half below, while corporates are all below. OK, OK, I admit it, I'm in love with the asset class and cannot believe it would ever really be unfaithful to me.
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Re: A graphic on the role of bonds

Postby Artsdoctor » Sun May 05, 2013 6:52 pm

David,

Thank you for the graph. The picture and your synopsis are right on mark. The intermediate corporate fund did not hold up during the depths of the bear market but did indeed rebound.

Doc,

Your summation perfectly dovetails into the point of the graph. As you mature, your asset allocation will most likely begin tilting away from equities and towards fixed income. Consequently, your bonds will start playing a different role in your portfolio. In 2008, with a 70/30 split, you would have wanted treasuries to sell in order to buy equities as they tanked; that would not have been as profitable if you would have had to sell your corporates. Likewise, if you were 40/60, you could have definitely kept those corporates (which may have been the majority of the fixed income portion of your portfolio), sustained the temporary losses only to see their worth rebound, but easily sell your treasuries (fewer in quantity because you didn't need to same bear protection) to buy equities as they tanked.

Whether or not someone might choose to use TBM for a portion of their portfolio is another debate. But keeping a handle on what sort of breakdown you have on the fixed income side of things would seem to be smart and offer the best opportunity for stability and income.

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Re: A graphic on the role of bonds

Postby TO39 » Sun May 05, 2013 6:57 pm

gkaplan wrote:That's a terrific chart, David.


+1
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Re: A graphic on the role of bonds

Postby Jack » Sun May 05, 2013 7:00 pm

nisiprius wrote:Agreed, and what's disturbing is that it jumps off the smooth curve for reasons that aren't obvious, suggesting liquidity issues. But be fair: what happened in 2008 was mostly the evaporation of a weird, anomalous rise in 2007. As is often the case, people aren't upset by anomalies when they are upward rather than downward.

The anomaly is easily explained by the hysteria about commodity price increases right before the financial crash. Even though all the signs were of very low inflation using core CPI, there were screams that the Fed needed to increase interest rates now, now, now or hyperinflation would eat us alive. Of course that all proved to be nonsense a few months later and there were big sell offs of TIPS because suddenly all the talk was about deflation, not inflation.

There seems to be a lot of speculation in TIPS, almost like a gold fund, depending on news media sentiment about prospects of inflation.
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Re: A graphic on the role of bonds

Postby Munir » Sun May 05, 2013 7:12 pm

Calm Man wrote:Thank you for a very nice analysis Mr Grabiner. As often is the case, I will come up with a somewhat different conclusion. Yes, indeed, at the time of the crash treasuries did better. But after things cooled down, the investment grade fund (blue line) surpassed it again. So if the concern is seeing portfolio value while right in the midst of an equity collapse, sure, treasuries will hold more value. But long term I think as long as you have investment grade bonds in a fund, that should do better if starting interest rate is higher.


+1.

I also do not understand basing one's longterm fixed income philosophy on one year's performance whether it is TIPS or Corporate Investment Grade as long as one "stays the course". The 2008 period TIPS debacle is occasionally mentioned in passing while the coporates are blamed again and again by those who admire treasuries (slight exaggeration for effect :happy ).

BTW, the ER for VFIDX (the Admiral version of VFICX) is only 0.10%.
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Re: A graphic on the role of bonds

Postby Doc » Mon May 06, 2013 11:02 am

Munir wrote: I also do not understand basing one's longterm fixed income philosophy on one year's performance whether it is TIPS or Corporate Investment Grade as long as one "stays the course".


It depends what you mean by "stay the course". If you mean buy and hold forever one year's data means very little. If you rebalance bi-annually one year's data is more important. If your IPS calls for aggressively rebalancing when you are out of your 5% bands and you are psychologically able to buy equities when the stock is tanking even a one year view may be too long.

But there is usually no reason to have your entire FI portfolio invested in that ultra efficient/safe security. You need just enough to rebalance or if in the withdrawal phase maybe just enough to not have to sell equities to meet your living obligation during that market upheaval. The reason safe withdrawal rates are significantly less than long term market performance is that taking out money during bear markets early in retirement can be catastrophic. Therefore short term FI performance can be as important as long term performance.

Regarding the TBM question: If you decide to add 50% TIPS or 25% short nominal Treasuries or 10% MM funds to cover short term contingencies you no longer have a TBM portfolio. Some people advocate adding TIPS to TBM in order to increase diversity. I suggest they are doing just the opposite. They may be diversifying their inflation risk but they are greatly reducing there credit risk by doing so which negates the balanced purpose of TBM which was the original premise,.
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Re: A graphic on the role of bonds

Postby garlandwhizzer » Mon May 06, 2013 12:08 pm

Question: If you are holding your bonds for the long term, what does it matter if they drop in value during a equity market collapse as long as they not only come back to the value of Treasuries but in the years after the collapse they consistently surpass the value of Treasuries. In the long term risk is rewarded in the bond market just like in the equity market. It is not a different animal. Notice the long term outperformance of both the Vanguard investment grade corporate fund and the Vanguard high yield bond fund over TBM and intermediate term Treasuries. The only reason I see for holding a Treasury-dominated bond portfolio is to rebalance into greater risk assets during market collapses and I suspect few actually do that. Otherwise in my view Treasuries are simply emotional Valium during those tough but temporary spells.

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Re: A graphic on the role of bonds

Postby Doc » Mon May 06, 2013 12:41 pm

garlandwhizzer wrote:Question: If you are holding your bonds for the long term, what does it matter if they drop in value during a equity market collapse as long as they not only come back to the value of Treasuries but in the years after the collapse they consistently surpass the value of Treasuries.


Because is you want or have to sell those bonds to finance rebalancing or retirement needs during the equity market collapse you are SOL.

The general consensus is "bonds are for safety" and "equities are for growth". If you start thinking about bonds for long term growth you have a different investment policy then most of us. If your portfolio is large enough to meet your needs with only the long term income from FI you are probably wasting your time reading these posts. :happy
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Re: A graphic on the role of bonds

Postby FinancialDave » Mon May 06, 2013 1:06 pm

z3r0c00l wrote:I enjoyed this post, but a person who bases their bond expectations on this time period is asking to be seriously disappointed.


This is so much of a quiet understatement, I had to chuckle.

Here is another great line in this thread:

... the behavior and the risk/reward characteristics will be similar in future to what they were in the past.


A couple more interesting statements (IMO) came out of Omaha this morning:

"investing in fixed income right now is sort of like bending down to pick up quarter ahead of a steam roller"

"it's silly to have some fixed ratio in bonds, like 30 or 40 or 50%, they are terrible investments right now."




By the way, anyone who thinks bonds are a "safety investment" may also be surprised in the future.


:sharebeer

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Re: A graphic on the role of bonds

Postby btenny » Mon May 06, 2013 2:38 pm

The first point you made is great but all you guys are missing EVEN BIGGER DISASTER IN TREASURIES GOING ON RIGHT NOW. Look at how fast the Treasury fund and the Total Bond fund are falling behind the corporate fund. That gap started in 2011 when the gov't reduced treasury rates way below market price. So all you guys invested in these funds are taking a loss that NEVER WILL BE RECOVERED. Very bad news versus the corporate speed bump in 2008 that was fully recovered in a year or so.

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Re: A graphic on the role of bonds

Postby FinancialDave » Mon May 06, 2013 5:51 pm

btenny wrote:The first point you made is great but all you guys are missing EVEN BIGGER DISASTER IN TREASURIES GOING ON RIGHT NOW. Look at how fast the Treasury fund and the Total Bond fund are falling behind the corporate fund. That gap started in 2011 when the gov't reduced treasury rates way below market price. So all you guys invested in these funds are taking a loss that NEVER WILL BE RECOVERED. Very bad news versus the corporate speed bump in 2008 that was fully recovered in a year or so.

Bill


Bill,
Maybe somehow the people who care so much about the price NEVER recovering in a stock that pays a dividend, somehow don't care at all when the price of a bond fund goes down and NEVER recovers.

The sad part is (for the investor in the bond that is) that the bond has a finite life span and will most likely have to be sold before it ever has a chance to recover - in both short term bonds (because they won't outlast the interest rate hike) and the long bonds (because the investors won't hang around in them.)

:oops:
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Re: A graphic on the role of bonds

Postby ziszew » Mon May 06, 2013 6:36 pm

btenny wrote:The first point you made is great but all you guys are missing EVEN BIGGER DISASTER IN TREASURIES GOING ON RIGHT NOW.
<<snip>>

Bill


From the outside looking in, it seems these discussions break down to two camps talking about different bond "needs"; for some it's a portfolio tool, for others it's a liability matching tool. Depending on the task, there are very different needs: as a portfolio tool, nothing beats treasuries as the fantastic chart in the OP shows (goes the "right" way when you need it to). For others in/closer to the liability matching phase, there are other bonds that do a better job of performing the task (income is more important than price stability).

Horses for courses, and thank you for the telltale little chart...
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Re: A graphic on the role of bonds

Postby baw703916 » Mon May 06, 2013 6:50 pm

In general, if stocks are doing well I don't really care how bonds are doing. I have a mostly equities portfolio and it would have done fine overall during the last four years even if I owned bonds that lost 5% in value every year. I only care that correlations go negative when stocks tank.
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Re: A graphic on the role of bonds

Postby grabiner » Mon May 06, 2013 11:09 pm

garlandwhizzer wrote:Question: If you are holding your bonds for the long term, what does it matter if they drop in value during a equity market collapse as long as they not only come back to the value of Treasuries but in the years after the collapse they consistently surpass the value of Treasuries.


It matters because your bond allocation is not static. When the stock market fell in 2008, many investors rebalanced out of bonds and into stock to maintain the same allocation (either on their own or through the balanced funds they held), and thus held fewer bonds during the 2009 recovery.

Also, you are looking in hindsight. The reason corporate bond values fell in 2008 is that there was a much greater risk of defaults. There weren't many defaults among investment-grade bonds, but we didn't know that.
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Re: A graphic on the role of bonds

Postby Valuethinker » Tue May 07, 2013 8:07 am

btenny wrote:The first point you made is great but all you guys are missing EVEN BIGGER DISASTER IN TREASURIES GOING ON RIGHT NOW. Look at how fast the Treasury fund and the Total Bond fund are falling behind the corporate fund. That gap started in 2011 when the gov't reduced treasury rates way below market price. So all you guys invested in these funds are taking a loss that NEVER WILL BE RECOVERED. Very bad news versus the corporate speed bump in 2008 that was fully recovered in a year or so.

Bill


Never say never.

The yield compression on corporate bonds over Treasuries is impressive. We must be down to record low spreads. Apple is borrowing at less than the US Treasury on the 5 year, I believe. Negative spreads on corporates? Who knew.

So that spread would blow out again if there was increased concern over the economy, risk of default.

To add spice to the soup, at least in Europe, more than half of corporate bonds are issued by *financial* companies. Regulators have made it clear that in future bank defaults, bank bondholders have risk capital, they will participate in the 'bail ins' as well as bailouts. Read massive loss of principal. I don't imagine US regulators will be any more merciful on that one.

Corporates pay higher yields, and that was my logic in buying them in 2009 and 2010 (and a little recently). But I have been very lucky, and if the economic cycle reverses, I shall pay for that luck.

Long run, except for ST corporate bonds, it doesn't look like the additional credit risk has been rewarded by extra returns ie the market efficiently priced defaults (defaults less recoveries in fact). ST corporate bonds I think there is a return anomaly (they don't lose as much as they should to offset fully the higher yields).
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Re: A graphic on the role of bonds

Postby dual » Tue May 07, 2013 12:22 pm

Although the increase in the value of the bond portfolio in the graph in the OP is impressive, the following graphic shows why this will almost certainly not occur in the future

Image

Here is the Matlab code to reproduce the graph. You will have to scrape the data from the link shown and save it in an Excel file.
------ Plot10YearTbondRate.m ----
%% Plot 10 year T-bond rates
% data scrapped from http://www.multpl.com/interest-rate/table
% following reads years since jan 1 1990 in 1st column and interest rate in second column
dat = xlsread('L:\Projects\Learn\Investments\10YearTbondRates.xls');
fh = figure;
plot(1990+dat(:,1),100*dat(:,2),'-k','linewidth',1.5);
axis([1990 2013 0 10]);
text(1998,9,'10 Year T-bond Rate','fontsize',20);
xlabel('year','fontsize',18);
ylabel('interest rate (percent)','fontsize',18);
set(gca,'linewidth',2,'fontsize',16);
set(fh,'color','white','position',[ 100 100 375 375])
% export the figure as png
% export as png
set(fh,'papertype','usletter')
figno = sprintf('-f%d',fh);
print(figno,'-dpng','-cmyk','-r100','L:\Projects\Learn\Investments\10YearTbondRates.png') % resolution 100 dpi
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Re: A graphic on the role of bonds

Postby FinancialDave » Tue May 07, 2013 2:19 pm

baw703916 wrote:In general, if stocks are doing well I don't really care how bonds are doing. I have a mostly equities portfolio and it would have done fine overall during the last four years even if I owned bonds that lost 5% in value every year. I only care that correlations go negative when stocks tank.


Here is the real problem with that logic. There really is no inherent correlation (negative or otherwise) between bonds and stocks as they are driven by two completely different mechanisms. Yes, there may be a secondary effect that when stocks go down people tend to move into bonds and vice versa, but if interest rates go up at the same time the stock market goes down, you will see a very strong positive correlation, which won't really mean anything.

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Re: A graphic on the role of bonds

Postby longview » Thu May 09, 2013 10:58 pm

Doc wrote:
grabiner wrote:From 1993 through 2007, the lines are very close; you wouldn't have a difference of more than a few percent no matter which fund you used.


A rolling return chart can do a better job of highlighting what happens in the short run during market/economic disruptions. By looking at both the growth chart and a rolling return chart you get a very good picture of the risk/reward tradeoff. In the '08 debacle there was some 25% difference in bond fund performance from top to bottom. That could have made a whole lot of difference if you were trying to rebalance into the bull market in equities.

Image

(I think I got my colors different from David. Go to the M* site for details.)

http://quote.morningstar.com/fund/chart ... %2C0%22%7D

Play with the "Rolling Period" and overall time frame to meet you personal risk/return attitudes.


Nice chart! It's worth checking out adding Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (VWITX) too -- which did pretty well (and made me happy). Better after-tax yield and it still held up somewhat in the crash.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)
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Re: A graphic on the role of bonds

Postby czeckers » Fri May 10, 2013 12:00 pm

Nice chart. The notion that during a crisis, switching bond allocation from treasuries to corporates, is an interesting one. However, one should also keep in mind that in such a situation, one ought to be selling some of the treasuries to rebalance back into stocks. The rebound of the stocks should be of a greater magnitude than the rebound of the corporates as I would think the value of stocks drops farther than corporate bonds during a stock market crash.

So during a big crash,

Step 1: Rebalance from treasuries into stocks

Step 2: If you have the need and capacity to take on even more risk, convert remaining treasuries to corporates may be an option. This would be less extreme than selling all bonds and going 100% stocks during a stock crisis.

Food for thought. I try to look at the market with an eye toward when it may be worth a gamble to be more aggressive and this is intriguing. The devil is in the details of the timing. If mistimed, one can have some serious regret.

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Re: A graphic on the role of bonds

Postby baw703916 » Fri May 10, 2013 5:57 pm

FinancialDave wrote:
baw703916 wrote:In general, if stocks are doing well I don't really care how bonds are doing. I have a mostly equities portfolio and it would have done fine overall during the last four years even if I owned bonds that lost 5% in value every year. I only care that correlations go negative when stocks tank.


Here is the real problem with that logic. There really is no inherent correlation (negative or otherwise) between bonds and stocks as they are driven by two completely different mechanisms. Yes, there may be a secondary effect that when stocks go down people tend to move into bonds and vice versa, but if interest rates go up at the same time the stock market goes down, you will see a very strong positive correlation, which won't really mean anything.

fd


But when would that actually happen (interest rates going up simultaneous to a severe bear market)? Usually a severe bear market is caused by a (real or anticipated) economic decline, and the Fed's usual response is to lower rates. You can have situations like in some European countries where interest rates went up in an economic downturn, but that's a consequence of 1) the Euro not being the world's reserve currency, and 2) the countries using a common currency that they don't control.

The more likely concern is a stagflation scenario. But in that situation how would owning TBM as opposed to Treasuries help you? I think a better solution is to own a combination of TIPS (inflation protection) and Treasuries (deflation protection).

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