Looking for EUR holy grail bond strategy

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toine
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Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 04, 2018 5:40 am

My first post here after a lot of reading. I have a lumpsum investment. I live in an AAA rated EU country. My investment horizon is long, 30+ years. I chose for 75% equity and 25% bonds, and am looking for a strategy that does not tempt me to make changes to it based on market changes.

A good passive equity strategy seems straightforward (Global All Cap market-capitalisation weighted index). I was fortunate enough to buy VTI/VXUS before they became inaccessible to EU citizens (otherwise would have gone for e.g VWRL). To balance them correctly I took the USA percentage of VT for VTI (and am assuming they auto-balance as they grow and shrink along with the market cap changes .. not sure if that assumption is valid).

I am still in doubt of bond strategy. The reason for holding bonds is to avoid temptation of switching strategy next stock market crash (because I can rebalance my bonds to equity or sell bonds and go all-in on equity until they recover). Therefore there should be little correlation between my equity and bonds (preferably negative).

For bonds there is credit risk, duration, and yield. I understand I should want to avoid corporate bonds (as they correlate with equity and if I would want to take more corporate risk I better allocate a larger percentage to equity). That leaves me with treasury. I should get a bond ETF with only AAA rated holdings in EUR (or hedged to) with 2 year maturity and 2% yield. That obviously does not exist today, so I need to compromise on any of these 3 items. I can accept (very) low yield, negative seems a bit hard psychologically. In general with the current artificial low yields (ECB), it's unclear to me if taking bond risk (credit or duration) is sufficiently rewarded at this moment.

To minimize credit risk, people here seem to recommend global bonds (EUR hedged) which would protect me against a default of e.g. Italy. As the global bond ETFs also include BBB rating, they should have a similar default risk though? Including BBB (e.g. Italy) would generally flip yield from negative to positive. Longer term, assuming Italy does not default before the bond duration expires, a lower credit rating for Italy should automatically move them out of the typical Eurozone bond ETF (as they would no longer be investment grade)?

On choosing duration is where I start to get lost. Quite some people here recommend people in my situation to go for a global EUR hedged bond (to avoid Eurozone credit risk). The available ETFs all have a duration of >=7 years, which seems long? I find it really hard to judge what duration I should go for as optimal long-term strategy. If interest rises (nobody knows when), this likely also negatively affects the stock market (hence more correlation with my bonds if I have a longer duration)? Based on available ETFs, I am also limited in choice here.

I've been reading many posts of Valuethinker, and although his recommendation is EUR hedged global bonds, his own portfolio has IGLS with a duration of 2 years. That's quite different from the 7-8 years of the available EUR hedged global bonds.

How to determine the optimal bond duration? As far as I can tell, these are some of my options:

Bloomberg Barclays Global Aggregate Bond (EUR Hedged):
E.g. iShares AGGH: Duration 6.90, <A rating 14%, treasury 57%, YTM 1.90%

AAA-AA Eurozone rating only:
E.g. Think TAT: Duration 3.19 (?), <A rating 0%, treasury 100%, YTM -0.33%

Bloomberg Barclays Euro Government Bond 1-3:
E.g. iShares IBGS: Duration 1.95, <A rating 32%, treasury 100%, YTM -0.01%

Bloomberg Barclays Euro Government Bond 3-5:
E.g. iShares IBGX: Duration 4.00, <A rating 24%, treasury 100%, YTM 0.29%

Bloomberg Barclays Euro Government Bond 3-7:
E.g. iShares CBE7: Duration 4.61, <A rating 29%, treasury 100%, YTM 0,52%

Bloomberg Barclays Euro Government Bond 5-7:
E.g. iShares IEGY: Duration 5.84, <A rating 28%, treasury 100%, YTM 0.80%

Bloomberg Barclays Euro Treasury Bond:
E.g. iShares IEGA: Duration 7.59, <A rating 25%, treasury 100%, YTM 0.81%

Generally I'd prefer a large physically replicated ETF (>1.000M). How to determine my optimal choice? Is there a specific reason why for Eurozone bond duration seems typical ~7-8 years that I should simply follow? Because of my long-term strategy, longer duration would generally seem fine so the key question would seem In how far the effect of bond duration (interest) is correlated with equity?

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oldcomputerguy
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Re: Looking for EUR holy grail bond strategy

Post by oldcomputerguy » Mon Jun 04, 2018 6:10 am

toine wrote:
Mon Jun 04, 2018 5:40 am
The reason for holding bonds is to avoid temptation of switching strategy next stock market crash (because I can rebalance my bonds to equity or sell bonds and go all-in on equity until they recover).
If you're changing your asset allocation based on what the market is currently doing, that is by definition market timing, not passive investing. You should re-think this plan.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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BeBH65
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Re: Looking for EUR holy grail bond strategy

Post by BeBH65 » Mon Jun 04, 2018 6:28 am

Hello Toine,

Welcome to this forum.
Some info below, based on your post you might already know a lot.
I am sure others will be along to also contribute.


1- For the equity portion of your portfolio:
VTI/VXUS split: If you follow the free-float-market-cap then you should be something like 60%/40%
This portion is focussed on growing your portfolio, knowing that there risks (volatility, drawdown, ... )


2- Bogleheads use the other portion of their portfolio for stability. The equity portion can vary a lot, this portion should dampen that.
If the equity market would crash hard, it could also give you money to buy additional stock at a low price.
While we often use the word "bonds" for this portion of the portfolio we really mean fixed income; that could include bonds, bond funds, savings accounts, CDs (whatever name they have in your country).

For your stable assets you want to avoid currency fluctuations; hence you should choose for assets in EUR or EURo hedged.


In Europe, Savings accounts have typically a government guarantee up to 100000 Euro. Hence the risk of lossing value is low. Depending on the intrest you can get un your country (maybe not a lot since you are in an AAA country).

For bond funds; Duration is an indication for the sensitivity of your fund to changes in the rate. It indicates how many % the fund would vary when the applicable rate changes, and also gives an indication after how many years it takes to get "even" again.
It is important to keep the duration a lot shorter dan your investment-horizon. Indeed on this forum Intermediate term is often mentioned. Which measnaa bit shorter then the 7-8 yrs of some of the funds you mention. You can shorten the duration by combining with an asset with shorter duration; like savings accounts?

Yes avoid corporate bonds; your are taking your risks on the equity side.

Which of the funds is best? difficult to predict; we will only know in 5-10 years.

If you mention your country, then the Bogleheads that live there might be able to identify some specific local opportunities.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

buylowbuyhigh
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Re: Looking for EUR holy grail bond strategy

Post by buylowbuyhigh » Mon Jun 04, 2018 6:45 am

Nice overview for EUR bond options. I think the YTM of AGGH is before the hedging, and in EUR it should be similar to EUR aggregate bonds with 0.7-0.8%. This is what I have my eyes on, but currently I use a savings account with 1.22% after tax interest until the yield makes sense. Obviously bank accounts may not be safe enough if the amount exceeds €100k.

Do you mean that you're not going to add to this portfolio when you mention that you bought VTI and VXUS just in time? What about rebalancing, are you sure you can add to an existing position? Are you familiar with the US estate taxation and withholding on dividends? A third country might tax a dividend before it gets to VXUS and then US again taxes the distribution when it is paid to you.

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 04, 2018 7:28 am

oldcomputerguy wrote:
Mon Jun 04, 2018 6:10 am
If you're changing your asset allocation based on what the market is currently doing, that is by definition market timing, not passive investing. You should re-think this plan.
You're right, so I should only periodically re-balance and stick to 75%/25%.
BeBH65 wrote:
Mon Jun 04, 2018 6:28 am
While we often use the word "bonds" for this portion of the portfolio we really mean fixed income; that could include bonds, bond funds, savings accounts, CDs (whatever name they have in your country).
I understand there are alternatives to bond (but for this post I'd like to stick to understanding bonds specifically).
buylowbuyhigh wrote:
Mon Jun 04, 2018 6:45 am
Do you mean that you're not going to add to this portfolio when you mention that you bought VTI and VXUS just in time? What about rebalancing, are you sure you can add to an existing position? Are you familiar with the US estate taxation and withholding on dividends? A third country might tax a dividend before it gets to VXUS and then US again taxes the distribution when it is paid to you.
I spent 75% on VTI/VXUS and have 25% left to spent on the optimal bond strategy. Good points about US estate taxation and withholding taxes on dividends, I am familiar and fortunate to be based in an EU country that has a treaty in place to resolve that.

buylowbuyhigh wrote:
Mon Jun 04, 2018 6:45 am
I think the YTM of AGGH is before the hedging, and in EUR it should be similar to EUR aggregate bonds with 0.7-0.8%.
Indeed AGGH YTM is likely before hedging, not sure how to get the actual EUR YTM (if that exists, as perhaps that cannot be calculated with currency changing over time?).
BeBH65 wrote:
Mon Jun 04, 2018 6:28 am
Which of the funds is best? difficult to predict; we will only know in 5-10 years.
True, but I'm trying to make an educated decision now on selected duration/credit risk/(yield).

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Mon Jun 04, 2018 11:13 am

toine wrote:
Mon Jun 04, 2018 5:40 am
My first post here after a lot of reading. I have a lumpsum investment. I live in an AAA rated EU country. My investment horizon is long, 30+ years. I chose for 75% equity and 25% bonds, and am looking for a strategy that does not tempt me to make changes to it based on market changes.

A good passive equity strategy seems straightforward (Global All Cap market-capitalisation weighted index). I was fortunate enough to buy VTI/VXUS before they became inaccessible to EU citizens (otherwise would have gone for e.g VWRL). To balance them correctly I took the USA percentage of VT for VTI (and am assuming they auto-balance as they grow and shrink along with the market cap changes .. not sure if that assumption is valid).

I am still in doubt of bond strategy. The reason for holding bonds is to avoid temptation of switching strategy next stock market crash (because I can rebalance my bonds to equity or sell bonds and go all-in on equity until they recover). Therefore there should be little correlation between my equity and bonds (preferably negative).

For bonds there is credit risk, duration, and yield. I understand I should want to avoid corporate bonds (as they correlate with equity and if I would want to take more corporate risk I better allocate a larger percentage to equity). That leaves me with treasury. I should get a bond ETF with only AAA rated holdings in EUR (or hedged to) with 2 year maturity and 2% yield. That obviously does not exist today, so I need to compromise on any of these 3 items. I can accept (very) low yield, negative seems a bit hard psychologically. In general with the current artificial low yields (ECB), it's unclear to me if taking bond risk (credit or duration) is sufficiently rewarded at this moment.

To minimize credit risk, people here seem to recommend global bonds (EUR hedged) which would protect me against a default of e.g. Italy. As the global bond ETFs also include BBB rating, they should have a similar default risk though? Including BBB (e.g. Italy) would generally flip yield from negative to positive. Longer term, assuming Italy does not default before the bond duration expires, a lower credit rating for Italy should automatically move them out of the typical Eurozone bond ETF (as they would no longer be investment grade)?
A bond with BBB should have a relatively small probability of default.

But here's the thing:

- countries don't default on one issue, they default on the whole lot
- Italy is the 4th (?) largest govt bond market in the world
- national defaults are driven by political events as well as company specific things - they carry political risk

So you cannot do a straight read across from Italy to BBB corporate bonds on probability of default, or for that matter to other countries that are BBB. We also have to be suspicious that the rating agencies (Italy is their client, not you and I as investors) will do anything they can to avoid downgrade below BBB-- the consequences in terms of some bondholders having to sell their bonds (thus making default more likely), triggering of other clauses, are just too great, and the pressure from the EU and national governments not to push through that downgrade too great.

If Italy goes, it will be largely a political thing, and it will be accompanied by some sort of restrictions on Italian bank deposits (Greece is just talking about reducing its restrictions on transfers and withdrawals out of Greek banks) and some sort of restructuring of the Euro. Really, a nightmare scenario.

Italy would be "a Black Swan" in other words. I really do not expect a default but one can imagine all kinds of messy horsetrading between an Italian coalition government and the EU/ IMF etc. on the way.

By holding the global govt bond fund, you are diluting but not totally avoiding that risk. Italy is the largest component of European govt bond funds, and Spain would not escape untouched, and add those 2 together and you are something like 45% of Eurozone govt bonds. Conversely, if Italy stabilizes, its bonds will go *up* by a lot.

The risk is so horrendous it is best to diversify.
On choosing duration is where I start to get lost. Quite some people here recommend people in my situation to go for a global EUR hedged bond (to avoid Eurozone credit risk). The available ETFs all have a duration of >=7 years, which seems long? I find it really hard to judge what duration I should go for as optimal long-term strategy. If interest rises (nobody knows when), this likely also negatively affects the stock market (hence more correlation with my bonds if I have a longer duration)? Based on available ETFs, I am also limited in choice here.
Bond markets basically reward you for longer holding periods, but there's a "kink", a flattening out, somewhere between 5 and 10 years maturity, on the yield curve. Above 10 years, you don't get much extra for your risk.
I've been reading many posts of Valuethinker, and although his recommendation is EUR hedged global bonds, his own portfolio has IGLS with a duration of 2 years. That's quite different from the 7-8 years of the available EUR hedged global bonds.
The gilt index has a duration of nearly 13 years-- it's unique in that. Inflation linked (Indexed linked gilts) is even worse. So devil you do, devil you do not. Given nominal gilt yields of around 1.6%, and significant political risk (Brexit/ Labour government of the most leftwing stripe since 1945) that did not seem worth the risk. So I have accepted essentially zero return for lower risk (but still full currency risk; I have limited choices). My alternative was gilt index funds and in some pensions, that's what I am holding (because that is all that is available).
How to determine the optimal bond duration? As far as I can tell, these are some of my options:

Bloomberg Barclays Global Aggregate Bond (EUR Hedged):
E.g. iShares AGGH: Duration 6.90, <A rating 14%, treasury 57%, YTM 1.90%

AAA-AA Eurozone rating only:
E.g. Think TAT: Duration 3.19 (?), <A rating 0%, treasury 100%, YTM -0.33%

Bloomberg Barclays Euro Government Bond 1-3:
E.g. iShares IBGS: Duration 1.95, <A rating 32%, treasury 100%, YTM -0.01%

Bloomberg Barclays Euro Government Bond 3-5:
E.g. iShares IBGX: Duration 4.00, <A rating 24%, treasury 100%, YTM 0.29%

Bloomberg Barclays Euro Government Bond 3-7:
E.g. iShares CBE7: Duration 4.61, <A rating 29%, treasury 100%, YTM 0,52%

Bloomberg Barclays Euro Government Bond 5-7:
E.g. iShares IEGY: Duration 5.84, <A rating 28%, treasury 100%, YTM 0.80%

Bloomberg Barclays Euro Treasury Bond:
E.g. iShares IEGA: Duration 7.59, <A rating 25%, treasury 100%, YTM 0.81%

Generally I'd prefer a large physically replicated ETF (>1.000M). How to determine my optimal choice? Is there a specific reason why for Eurozone bond duration seems typical ~7-8 years that I should simply follow? Because of my long-term strategy, longer duration would generally seem fine so the key question would seem In how far the effect of bond duration (interest) is correlated with equity?
I'd go for the aggregate global bond fund, and be done with it. If we have another financial crisis, you will take real pain on the corporate bonds (c. 43%, although I think a good proportion of those are govt guaranteed bonds, eg Agency bonds issued by FNMA FMAC in the USA).

The duration is long, but not horrifically so-- 7 years. You've avoided the currency risk. And if we do have an Italian govt bond crisis, you've diluted down that exposure (although the currency will hurt).

If you are still worried about interest rate risk, add the ST AAA-AA govt bonds, which will give you no yield (slightly negative) but avoid credit risk. Hold that fund and the global aggregate one and the average duration of the portfolio will be the weighted average of the 2 fund durations.

I think the risk has, for the moment, shifted onto govt bonds (Italy and whoever would follow suit) rather than corporate bonds.

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Fri Jun 08, 2018 2:45 am

Valuethinker wrote:
Mon Jun 04, 2018 11:13 am
The gilt index has a duration of nearly 13 years-- it's unique in that.
I understood from other posts you have IGLS which has a duration of 2.2 years, I assume I misunderstood your holdings then.
Valuethinker wrote:
Mon Jun 04, 2018 11:13 am
I'd go for the aggregate global bond fund, and be done with it.
There is a treasury-only global bond: Xtrackers Global Sovereign UCITS ETF 1C (EUR hedged) that has quite some history. Comparing it with a Germany-only treasury ETF with similar duration, Germany actually appears to outperform the global bond.

So that would suggest I should always prefer Germany (or Eurozone AAA) over global, as the product is more simple (no currency hedge) and the risk is lower (higher rating)? Or ignore your advice and go for Eurozone ~4 year duration to benefit from lower duration and accept the (Italy/Spain) country risk. :happy

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Fri Jun 08, 2018 3:38 am

toine wrote:
Fri Jun 08, 2018 2:45 am
Valuethinker wrote:
Mon Jun 04, 2018 11:13 am
The gilt index has a duration of nearly 13 years-- it's unique in that.
I understood from other posts you have IGLS which has a duration of 2.2 years, I assume I misunderstood your holdings then.
I do. And precisely for that reason. i.e. a gilt index fund will have a duration of 13 years. Also 10 year gilt pays c. 1.6% which I don't think is adequate compensation for the risk. Basically I would be holding a bond fund with a duration of 13 years and a yield below inflation?

For little duration risk, I am losing 1.6% p.a. (roughly) in yield. That seems an OK tradeoff.
Valuethinker wrote:
Mon Jun 04, 2018 11:13 am
I'd go for the aggregate global bond fund, and be done with it.
There is a treasury-only global bond: Xtrackers Global Sovereign UCITS ETF 1C (EUR hedged) that has quite some history. Comparing it with a Germany-only treasury ETF with similar duration, Germany actually appears to outperform the global bond.
OK past performance of bond funds is no guide to future performance. Excepting credit risk, the best guide to the performance of a bond fund is the current average yield of the bonds in the fund. Historically investors have not been rewarded for taking corporate credit risk (they got higher volatility with corporate bonds, but not higher long run returns).

Now if a bond fund is currency hedged back to Euros, the yield will be approximately that of the risk free Euro rate (i.e. the German one). Any yield above that is credit risk (there's also differences in real interest rate cycles between countries, so you might pick up/ lose a bit of yield on that one).
So that would suggest I should always prefer Germany (or Eurozone AAA) over global, as the product is more simple (no currency hedge) and the risk is lower (higher rating)? Or ignore your advice and go for Eurozone ~4 year duration to benefit from lower duration and accept the (Italy/Spain) country risk. :happy
I wouldn't go for a Eurozone government bond fund. Because half of your bonds will be Spain + Italy. The yield on those 2 countries tells you that the market thinks there is some risk of default/ restructuring/ Euro breakup. In the "Black Swan" event you would take real pain.

You could go for the German govt bond fund, your yield will be a bit above 0 per cent (quite close to 0, I should imagine, given bund yields across the yield curve).

Or you go for the global govt bond fund, you have a yield above 0 per cent, but probably c. 1.0% (I've not checked). You acquire credit risk exposure to the USA (which would only default for political reasons) and Japan (who knows - they have not defaulted yet, though and probably, since they borrow in their own currency, they won't). You dilute your event risk to an Italian restructuring.

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Fri Jun 08, 2018 7:04 am

Valuethinker wrote:
Fri Jun 08, 2018 3:38 am
Or you go for the global govt bond fund, you have a yield above 0 per cent, but probably c. 1.0% (I've not checked).
So based on my check the yield of global (treasury) bond EUR hedged is LOWER than going for similar duration Germany-only bond. Hence Germany-only seems a better option (higher yield, lower risk) than global. Except for losing diversification.

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Fri Jun 08, 2018 7:17 am

toine wrote:
Fri Jun 08, 2018 7:04 am
Valuethinker wrote:
Fri Jun 08, 2018 3:38 am
Or you go for the global govt bond fund, you have a yield above 0 per cent, but probably c. 1.0% (I've not checked).
So based on my check the yield of global (treasury) bond EUR hedged is LOWER than going for similar duration Germany-only bond. Hence Germany-only seems a better option (higher yield, lower risk) than global. Except for losing diversification.
Surprised that is true. In fact I cannot think why that is true?

Even hedged back into Euros, the global fund should have a (small) premium in yields.

What is your source?

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Fri Jun 08, 2018 7:44 am

Valuethinker wrote:
Fri Jun 08, 2018 7:17 am
What is your source?
I used JustETF to compare the results (graph) over various periods. Linked the 2 ETFs above (cannot provide a direct link for the comparison it seems).

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Fri Jun 08, 2018 10:51 am

toine wrote:
Fri Jun 08, 2018 7:44 am
Valuethinker wrote:
Fri Jun 08, 2018 7:17 am
What is your source?
I used JustETF to compare the results (graph) over various periods. Linked the 2 ETFs above (cannot provide a direct link for the comparison it seems).
A graph would not tell you the yield of the bonds in the fund?

What you want is the average Yield to Maturity of the bonds in the fund. That's a number, not something from a graph.

Does the fund factsheet print out the stats?

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Fri Jun 08, 2018 1:08 pm

The graph compares the development of an investment including all coupons over time. I checked different timeframes. This is an accurate comparison of (historic) results as far as I can tell.

The listed global YTM is much higher indeed, but I think it cannot be compared as the effect of the EUR hedging is not included.

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Fri Jun 08, 2018 4:33 pm

toine wrote:
Fri Jun 08, 2018 1:08 pm
The graph compares the development of an investment including all coupons over time. I checked different timeframes. This is an accurate comparison of (historic) results as far as I can tell.

The listed global YTM is much higher indeed, but I think it cannot be compared as the effect of the EUR hedging is not included.
But how then can you say the yield is significantly lower?

It seems as if you are confusing yield w historic performance?

RME
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Re: Looking for EUR holy grail bond strategy

Post by RME » Fri Jun 08, 2018 6:08 pm

Check the allocations proposed by my post here:
viewtopic.php?f=1&t=251280


Image

asset_chaos
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Re: Looking for EUR holy grail bond strategy

Post by asset_chaos » Fri Jun 08, 2018 9:24 pm

Valuethinker wrote:
Mon Jun 04, 2018 11:13 am
- Italy is the 4th (?) largest govt bond market in the world
I'll make this an excuse to post to post a nifty graphic from the 2018 DFA Matrix Book https://www.ifa.com/book-library/3720/D ... ook__2018/ depicting the relative size of the global (I think investment grade) bond market by country.

Image

As of the end of 2017, it looks like Italy was 5th largest.
Regards, | | Guy

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alpine_boglehead
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Re: Looking for EUR holy grail bond strategy

Post by alpine_boglehead » Fri Jun 08, 2018 11:46 pm

Here's my holy grail (greetings from Austria - AA+ rated):

For the bond portion of the portfolio there's a CD ladder (higher yield than government bonds), supplemented by a helping of non-EUR hedged global bonds (currently Xtrackers Global Sovereign UCITS ETF, but will probably switch to AGGG - iShares Global Aggregate Bond UCITS ETF, the unhedged sibling of AGGH). I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.

For the CDs I prefer to diversify across banks to stay well below the 100k insured limit (keeping to the 20k limit that was in place before the financial crisis). Of course, for CDs without withdrawal before they mature the downside is that you don't have the liquidity of a bond fund. But with a ladder, you have a slice maturing regularly.
It's a bit more effort, but I don't lose any sleep about potential EUR troubles.

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Sat Jun 09, 2018 12:02 am

Valuethinker wrote:
Fri Jun 08, 2018 4:33 pm
But how then can you say the yield is significantly lower?
I don't think I said that? In your posts here you explained "If a global bond fund hedges back into EUR then you will get returns = equivalent risk free bond in EUR (Germany) + credit spread". YTM of the global hedged bond is significantly higher, but that does not seem to take into account the effect of the currency hedging. My historical comparison shows that the return between global hedged and Germany-only is highly correlated (that was expected), and that Germany-only consistently performs slightly (!) better over a fairly long period (tested with different starting points, the graph I provided only shows one). That would suggest that the costs of EUR hedging are simply higher than the yield benefit? It seems incomplete to ignore the historic result comparison and just to trust on the theory.
alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.
I've had the same temptation to add a portion US$ but my understanding from various other posts here is that diversifying in currency like that is similar as going to a casino. :)

Valuethinker
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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Sat Jun 09, 2018 10:33 am

toine wrote:
Sat Jun 09, 2018 12:02 am
Valuethinker wrote:
Fri Jun 08, 2018 4:33 pm
But how then can you say the yield is significantly lower?
I don't think I said that? In your posts here you explained "If a global bond fund hedges back into EUR then you will get returns = equivalent risk free bond in EUR (Germany) + credit spread". YTM of the global hedged bond is significantly higher, but that does not seem to take into account the effect of the currency hedging. My historical comparison shows that the return between global hedged and Germany-only is highly correlated (that was expected), and that Germany-only consistently performs slightly (!) better over a fairly long period (tested with different starting points, the graph I provided only shows one). That would suggest that the costs of EUR hedging are simply higher than the yield benefit? It seems incomplete to ignore the historic result comparison and just to trust on the theory.
alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.
I've had the same temptation to add a portion US$ but my understanding from various other posts here is that diversifying in currency like that is similar as going to a casino. :)
Your misapprehension is that the factors which drove bond performance historically are repeated in the future. Of course the bund market outperformed everything else. Bund yields are now 0 or negative.

That is tautological.

Unless you think bund yields can now continue to drop by more or rise by less than all other bonds, bunds will underperform. And your yield on a bund fund will be quite close to zero. That's built into the yields of the bunds you are buying right now. If there is a European credit crisis, they probably will so outperform.

Historic cost of currency hedging is quite small. No reason to think that will change because the cost of fx futures and forwards remains very low.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Sat Jun 09, 2018 12:02 pm

Btw best way to estimate yield of a bond fund in absence of data on underlying bonds is to take last 12 months distributions and divide by current share price.

The problem is if there were significant capital gains on the bonds or losses. But assuming interest rates did not move too much and the coupons are close to current yields to maturity it should not be a bad estimate.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Sat Jun 09, 2018 1:02 pm

Valuethinker wrote:
Sat Jun 09, 2018 10:33 am
Your misapprehension is that the factors which drove bond performance historically are repeated in the future.
True, although it does put my mind at ease if I at least understand the difference in historical performance. I ran another comparison and that confirms my earlier check probably was not very meaningful.

Would you go for aggregate or treasury-only hedged global bond though? The Vanguard paper recommending a global bond strategy only discusses aggregate, however as hedge against equity risk going for treasury-only would seem more logical to me.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Sat Jun 09, 2018 4:53 pm

toine wrote:
Sat Jun 09, 2018 1:02 pm
Valuethinker wrote:
Sat Jun 09, 2018 10:33 am
Your misapprehension is that the factors which drove bond performance historically are repeated in the future.
True, although it does put my mind at ease if I at least understand the difference in historical performance. I ran another comparison and that confirms my earlier check probably was not very meaningful.

Would you go for aggregate or treasury-only hedged global bond though? The Vanguard paper recommending a global bond strategy only discusses aggregate, however as hedge against equity risk going for treasury-only would seem more logical to me.
If there is an investment grade government only global bond fund? I think you had posted an Aggregate one as a choice, only?

Yes, in principle you should avoid equity risk as much as possible in bonds-- thus from a portfolio view avoiding correlation between the 2 asset classes.

(from memory, looking at US data, investment grade corporate bonds have a Beta = 0.3 (correlation with equities); US Treasury bonds it is around 0 (but fluctuates a bit depending on period used, I think I have seen numbers as high as 0.2)).

The credit quality of such a fund is not quite as high as Germany alone. You do have Italy and Spain in there. Yield, hedged back into EUR, should therefore be a little above the comparable German govt bond fund. Not sure what (modified) duration is, but around 8 years I believe.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Sun Jun 10, 2018 2:31 am

Valuethinker wrote:
Sat Jun 09, 2018 4:53 pm
If there is an investment grade government only global bond fund?
There is Xtrackers Global Sovereign UCITS ETF 1C (EUR hedged). The extra diversification and yield on aggregate does make it tempting (assuming that is not just due to including corporate).

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Re: Looking for EUR holy grail bond strategy

Post by TM90 » Sun Jun 10, 2018 3:27 am

alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
Here's my holy grail (greetings from Austria - AA+ rated):

For the bond portion of the portfolio there's a CD ladder (higher yield than government bonds), supplemented by a helping of non-EUR hedged global bonds (currently Xtrackers Global Sovereign UCITS ETF, but will probably switch to AGGG - iShares Global Aggregate Bond UCITS ETF, the unhedged sibling of AGGH). I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.

For the CDs I prefer to diversify across banks to stay well below the 100k insured limit (keeping to the 20k limit that was in place before the financial crisis). Of course, for CDs without withdrawal before they mature the downside is that you don't have the liquidity of a bond fund. But with a ladder, you have a slice maturing regularly.
It's a bit more effort, but I don't lose any sleep about potential EUR troubles.
I also considered buying a non hedged global bond fund, but when I compared a hedged fund with a non hedged fund, the results were similar except the non hedged bond fund had higher volatility, which is why I chose the xtrackers global government bond fund eur hedged. I also recommend other investors from europe to do the same.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Sun Jun 10, 2018 3:56 am

TM90 wrote:
Sun Jun 10, 2018 3:27 am
I chose the xtrackers global government bond fund eur hedged
Why not aggregate? That seems to align better with the BND recommendation for US investors.

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Re: Looking for EUR holy grail bond strategy

Post by BeBH65 » Sun Jun 10, 2018 4:22 am

TM90 wrote:
Sun Jun 10, 2018 3:27 am
I also considered buying a non hedged global bond fund, but when I compared a hedged fund with a non hedged fund, the results were similar except the non hedged bond fund had higher volatility, which is why I chose the xtrackers global government bond fund eur hedged. I also recommend other investors from europe to do the same.
I have been looking at the same for my investments. I found that the total return between Hedged (blue) and Non-hedged versions (yellow) is different.
For comparison I also added a Euro bond fund in Euro.


Image

Edit: oops the Euro bond fund shown is an aggregate fund; maybe less applicable for comparison with the global sovereign bonds.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

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Re: Looking for EUR holy grail bond strategy

Post by TM90 » Sun Jun 10, 2018 5:46 am

Depending on the time frame indeed returns can be different.. I wanted to look for the graph i made back then but I still get the error message on Morningstar. But just look at the difference in volatility in for example the start of 2017, or 2018 is that what you expect from a bond fund? As I said I was also looking into this because it seems rational for an investor to spread bond holdings over multiple currencies. Choosing Hedged or unhedged is just a matter of willing to take the currency risk for some more return or loss. A risk which I'm not willing to take with my stable portion of my portfolio in this stage of my life and at my current 75/25 AA which is risky enough.

Maybe a 50/50 combination between Hedged and unhedged is a good solution to even out volatility but that adds complexity and transaction costs which might diminish returns.


Why not Aggregate? Because corporates bonds are also linked to stocks and i want my bond portion to be as little correlated with stocks as possible.

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Re: Looking for EUR holy grail bond strategy

Post by TM90 » Sun Jun 10, 2018 6:15 am

Image

The difference in return is mostly because of the USD/EUR rate of the last couple of years. But the USD is getting stronger again so we might see a reversion to the mean.

For risk adjusted returns, I think EUR Hedged is better.

Note: obligaties wereldwijd means global bonds

Pretty strange though that Morningstar can go back to 1989 for EUR Hedged bonds because the euro didn't exist back then.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Sun Jun 10, 2018 7:31 am

toine wrote:
Sun Jun 10, 2018 2:31 am
Valuethinker wrote:
Sat Jun 09, 2018 4:53 pm
If there is an investment grade government only global bond fund?
There is Xtrackers Global Sovereign UCITS ETF 1C (EUR hedged). The extra diversification and yield on aggregate does make it tempting (assuming that is not just due to including corporate).
The extra yield will be mostly because it is holding corporate bonds. That will be OK unless we have another really bad bear market or financial crash. That's the problem, it will cut your safety just when you need it most.

It's shrug time. You pay your money and you makes your choice ;-). At the end of the day, you cannot get higher return without taking on higher risk and higher volatility.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Sun Jun 10, 2018 9:29 am

Valuethinker wrote:
Sun Jun 10, 2018 7:31 am
It's shrug time.
Except that apparently for US investors the "Bogle way" is aggregate (BND), why would that be different for Europeans?

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Re: Looking for EUR holy grail bond strategy

Post by TM90 » Sun Jun 10, 2018 9:37 am

Because it adheres to the philosophy of buying the haystack. Choosing between the Aggregate or government bonds is a personal choice and one must know the good and bad for each choice.

The Bogleheads principles are what is most important everyones portfolio is different.

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Re: Looking for EUR holy grail bond strategy

Post by TM90 » Sun Jun 10, 2018 9:40 am

Valuethinker wrote:
Sun Jun 10, 2018 7:31 am
At the end of the day, you cannot get higher return without taking on higher risk and higher volatility.
That's what's most important and I highly recommend taking more risk by adjusting your AA instead of making your less risky assets more risky.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Sun Jun 10, 2018 10:15 am

toine wrote:
Sun Jun 10, 2018 9:29 am
Valuethinker wrote:
Sun Jun 10, 2018 7:31 am
It's shrug time.
Except that apparently for US investors the "Bogle way" is aggregate (BND), why would that be different for Europeans?
c. 75% of the bonds in that fund are US government guaranteed if we include the Agency securities. Thus no credit risk.

It is also an actively managed fund, and can thus avoid callable corporate bonds-- a major issue with corporate bonds is that many of them embed call provisions.

Vanguard defines the universe of the fund so that it can cap exposure to certain bond sectors, eg US Agency securities below "market cap" weight.

There is an issue with US Mortgage Backed Securities (Agency), regarding negative convexity, but that risk has not hurt performance to date. We argue back and forth here whether investors should worry about that, because it might show up in the future. The argument is never resolved, but boils down to the CFA/ Finance types "the risk is intrinsic to the nature bonds*" vs. the "it's never shown up" empirical types.

Also worth noting:

- it's a very low cost bond fund

- Larry Swedroe, among other authors, does not recommend this fund for precisely the reasons I outline above 1). it has credit risk, which correlates w equity risk in the portfolio 2). Mortgage Backed Securities have the property of negative convexity, and thus the response to interest rates is not as one would desire

- I think that the fact that it calls itself "Total Bond Market" sounds like "Total Stock Market" and I suspect a lot of people simply go with that, without understanding anything more about the fundamentals of the fund. It wouldn't be obvious that "Intermediate Term Treasury Bond fund" is your logical alternative, would it?

* technically the US home mortgage market. AFAIK other mortgage markets don't have the characteristic of 30 year fixed rate w repayment possible, thus the MBS don't have prepayment/ extension risk.

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Re: Looking for EUR holy grail bond strategy

Post by alpine_boglehead » Sun Jun 10, 2018 10:51 pm

toine wrote:
Sat Jun 09, 2018 12:02 am
Valuethinker wrote:
Fri Jun 08, 2018 4:33 pm
But how then can you say the yield is significantly lower?
I don't think I said that? In your posts here you explained "If a global bond fund hedges back into EUR then you will get returns = equivalent risk free bond in EUR (Germany) + credit spread". YTM of the global hedged bond is significantly higher, but that does not seem to take into account the effect of the currency hedging. My historical comparison shows that the return between global hedged and Germany-only is highly correlated (that was expected), and that Germany-only consistently performs slightly (!) better over a fairly long period (tested with different starting points, the graph I provided only shows one). That would suggest that the costs of EUR hedging are simply higher than the yield benefit? It seems incomplete to ignore the historic result comparison and just to trust on the theory.
alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.
I've had the same temptation to add a portion US$ but my understanding from various other posts here is that diversifying in currency like that is similar as going to a casino. :)
Shouldn't spreading your bond holdings (not all, but a minor portion like 20% of your bonds) over multiple currencies lower your risk?

From a Euro perspective, non-hedged funds sure have higher fluctuations. But that's (partly) because of the volatility of the Euro itself. Which you don't see in everyday prices (e.g. when shopping) because these are somewhat buffered (with some delay) from currency fluctuations. But as most goods are imported, should the Euro have a strong decline, the price of smartphones, clothes etc. (and equities) etc. will go up. The most obviously exposed everyday variable is probably the price of fuel, which will directly fluctuate with the EUR/USD exchange rate. So filling up at the gas station is similar to going to a casino. :twisted:

The argument for holding bonds only in your home currency is because you consume in your home currency. But obviously that's only partly true.

Of course you can argue that with an equity-heavy portfolio you already have lots of exposure to other currencies.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Mon Jun 11, 2018 3:19 am

alpine_boglehead wrote:
Sun Jun 10, 2018 10:51 pm
toine wrote:
Sat Jun 09, 2018 12:02 am
Valuethinker wrote:
Fri Jun 08, 2018 4:33 pm
But how then can you say the yield is significantly lower?
I don't think I said that? In your posts here you explained "If a global bond fund hedges back into EUR then you will get returns = equivalent risk free bond in EUR (Germany) + credit spread". YTM of the global hedged bond is significantly higher, but that does not seem to take into account the effect of the currency hedging. My historical comparison shows that the return between global hedged and Germany-only is highly correlated (that was expected), and that Germany-only consistently performs slightly (!) better over a fairly long period (tested with different starting points, the graph I provided only shows one). That would suggest that the costs of EUR hedging are simply higher than the yield benefit? It seems incomplete to ignore the historic result comparison and just to trust on the theory.
alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.
I've had the same temptation to add a portion US$ but my understanding from various other posts here is that diversifying in currency like that is similar as going to a casino. :)
Shouldn't spreading your bond holdings (not all, but a minor portion like 20% of your bonds) over multiple currencies lower your risk?
If that number is less than 10% of your total assets, it is irrelevant from the perspective of final portfolio value/ total wealth. It depends upon what your home currency is, but for the Euro & USD that would certainly be true, also probably the main G7 currencies (AUD, CAD etc.).
From a Euro perspective, non-hedged funds sure have higher fluctuations. But that's (partly) because of the volatility of the Euro itself. Which you don't see in everyday prices (e.g. when shopping) because these are somewhat buffered (with some delay) from currency fluctuations. But as most goods are imported, should the Euro have a strong decline, the price of smartphones, clothes etc. (and equities) etc. will go up. The most obviously exposed everyday variable is probably the price of fuel, which will directly fluctuate with the EUR/USD exchange rate. So filling up at the gas station is similar to going to a casino. :twisted:

The argument for holding bonds only in your home currency is because you consume in your home currency. But obviously that's only partly true.
The other argument is that holding foreign currency subjects your portfolio to volatility for which you are paid no additional return. In the end, you can't "win" at the foreign currency game - you can only add volatility to your returns.

On the import question, if you are US-based then your consumption outside USD is quite small because commodities are also priced in USD.

The EUR price of oil can fall whilst the USD price is rising, btw.

The big costs for most of us are not goods-- the things directly affected by currency movements. And, as you say, manufacturers and retailers dampen the effects of currency swings on retail prices.

Rather we buy services: housing, transport, utilities, healthcare, restaurants etc. Those tend to be pretty much in domestic currencies, reacting only slowly (if at all) to movements in exchange rates. Wages of service sector staff (the biggest cost) don't tend to move much as a result of exchange rate moves. House prices and rents are in your local currency, not in USD.

To the extent that you hold inflation linked domestic bonds, you are hedged against these moves (assuming that CPI inflation roughly tracks your personal inflation rate). Just to help things along, UK Indexed LInked Gilts (inflation linked bonds) are trading at real yields of minus 1.5%-- a guaranteed loss of capital in real terms in the long run, unless inflation exceeds 4.5% p.a. :?

The main exception is foreign travel. As someone who lives in GBP, that exchange rate volatility is one I feel ;-).

Of course you can argue that with an equity-heavy portfolio you already have lots of exposure to other currencies.
The actual standard case is 100% home currency -- Bond and Equity portfolios. We then get into economic arguments about your marginal propensity to consume in foreign currency.

The usual rule of thumb is that FX volatility in equity evens out in the end (Purchasing Power Parity on traded goods and services aka Law of One Price) and equities are a long term and highly volatile investment, so it does not matter.

In a 75/25 equity/ bond portfolio, as long as the domestic government bond market is risk free, it's best to not hedge the equities (probably) but to hedge the bonds (almost certainly). Otherwise you could be in an equity bear market *and* have your currency devaluing, which is a tough place to sit.

It's also worth remembering that "more money has been lost reaching for yield, than just about any other way". The Global Financial Crisis was, in the end, about reaching for yield (AAA govt debt didn't pay a "high enough" yield, so investors bought A, AA & AAA tranches of CDOs, which fed the CDO creation machine in the USA, which in the end led to the GFC...).

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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 11, 2018 4:01 am

I very much appreciate everyone's input. I'm back to my (final) selection process. There seems to be only 1 (!) ETF that's EUR hedged global treasury-only, so that would limit me to:
Xtrackers II Global Government Bond UCITS ETF 1C - EUR Hedged EUR (LU0378818131): TER 0.25%, YTM 1.41%, effective duration 7.89 (31 May 2018)

I cannot find any good fund alternatives either.

There are more and lower cost choices when going for an aggregate bond, e.g.:
iShares Global Aggregate Bond UCITS ETF (IE00BDBRDM35): TER 0.10%, YTM 1.90%, effective duration 6.90 (7 May 2018)

The benchmark AGGH follows has:
Treasuries - 54.25%
Agency Fixed Rate - 11.08
Local Authority - 3.00
Supranational - 2.21
Sovereign - 1.25
Government Guaranteed - 2.33

Total: 74.12% (excluding Banking, Consumer Non-Cyclical, Mortgage Collateralized, Owned No Guarantee).

If I switch my AA from 75/25 to 70/30 to compensate aggregate versus treasury-only, is that a valid reasoning? What should I prefer?

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Mon Jun 11, 2018 4:16 am

toine wrote:
Mon Jun 11, 2018 4:01 am
I very much appreciate everyone's input. I'm back to my (final) selection process. There seems to be only 1 (!) ETF that's EUR hedged global treasury-only, so that would limit me to:
Xtrackers II Global Government Bond UCITS ETF 1C - EUR Hedged EUR (LU0378818131): TER 0.25%, YTM 1.41%, effective duration 7.89 (31 May 2018)

I cannot find any good fund alternatives either.

There are more and lower cost choices when going for an aggregate bond, e.g.:
iShares Global Aggregate Bond UCITS ETF (IE00BDBRDM35): TER 0.10%, YTM 1.90%, effective duration 6.90 (7 May 2018)

The benchmark AGGH follows has:
Treasuries - 54.25%
Agency Fixed Rate - 11.08
Local Authority - 3.00
Supranational - 2.21
Sovereign - 1.25
Government Guaranteed - 2.33

Total: 74.12% (excluding Banking, Consumer Non-Cyclical, Mortgage Collateralized, Owned No Guarantee).

If I switch my AA from 75/25 to 70/30 to compensate aggregate versus treasury-only, is that a valid reasoning? What should I prefer?
It starts to be splitting hairs to move the bond/ equity weightings around. The volatility of the equities will very much dominate the volatility of the bonds (when equities are greater than 50% of the total portfolio, at least).

My preference would be either to split it 50/50 OR go for 25% in the first fund because it is a purer play. However if you go 25% in the second fund it's not going to have a noticeable difference EXCEPT in the event of another financial crash. Conversely in a Eurozone crisis the second fund might do better due to less exposure to the weaker tier of Eurozone govt bonds.

Shrug ... you pays your money and you takes your choice ;-). At 25% of portfolio I would not get too worked up about it, because the equity volatility will far, far dominate.

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Re: Looking for EUR holy grail bond strategy

Post by aristotelian » Mon Jun 11, 2018 5:05 am

toine wrote:
Mon Jun 11, 2018 4:01 am
I very much appreciate everyone's input. I'm back to my (final) selection process. There seems to be only 1 (!) ETF that's EUR hedged global treasury-only, so that would limit me to:
Xtrackers II Global Government Bond UCITS ETF 1C - EUR Hedged EUR (LU0378818131): TER 0.25%, YTM 1.41%, effective duration 7.89 (31 May 2018)

I cannot find any good fund alternatives either.

There are more and lower cost choices when going for an aggregate bond, e.g.:
iShares Global Aggregate Bond UCITS ETF (IE00BDBRDM35): TER 0.10%, YTM 1.90%, effective duration 6.90 (7 May 2018)

The benchmark AGGH follows has:
Treasuries - 54.25%
Agency Fixed Rate - 11.08
Local Authority - 3.00
Supranational - 2.21
Sovereign - 1.25
Government Guaranteed - 2.33

Total: 74.12% (excluding Banking, Consumer Non-Cyclical, Mortgage Collateralized, Owned No Guarantee).

If I switch my AA from 75/25 to 70/30 to compensate aggregate versus treasury-only, is that a valid reasoning? What should I prefer?
I would keep it at 75/25 for the reason you stated in your original post. Aggregate includes corporates which have more market risk than Treasury. The reason to go for aggregate would be higher return.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 11, 2018 6:01 am

aristotelian wrote:
Mon Jun 11, 2018 5:05 am
I would keep it at 75/25 for the reason you stated in your original post. Aggregate includes corporates which have more market risk than Treasury. The reason to go for aggregate would be higher return.
So by moving 5% from my equity allocation to bond when choosing aggregate over treasury (to compensate the 25% corporate in aggregate), I should offset that (and increase my diversity). Probably splitting hairs, but I rather do that now than next crash feeling bad on my original strategy.

The advantage of aggregate would be more diversity and lower TER, the risk and yield should be the same if I adjust my AA accordingly. The modified duration is 1 year shorter which is also appealing. I somehow like iShares better than XTrackers which also plays a role (no good explanation why). The psychological effect of my bonds going negative when an equity crash occurs are not solved though.

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Re: Looking for EUR holy grail bond strategy

Post by Valuethinker » Mon Jun 11, 2018 7:09 am

toine wrote:
Mon Jun 11, 2018 6:01 am
aristotelian wrote:
Mon Jun 11, 2018 5:05 am
I would keep it at 75/25 for the reason you stated in your original post. Aggregate includes corporates which have more market risk than Treasury. The reason to go for aggregate would be higher return.
So by moving 5% from my equity allocation to bond when choosing aggregate over treasury (to compensate the 25% corporate in aggregate), I should offset that (and increase my diversity). Probably splitting hairs, but I rather do that now than next crash feeling bad on my original strategy.

The advantage of aggregate would be more diversity and lower TER, the risk and yield should be the same if I adjust my AA accordingly. The modified duration is 1 year shorter which is also appealing. I somehow like iShares better than XTrackers which also plays a role (no good explanation why). The psychological effect of my bonds going negative when an equity crash occurs are not solved though.
Even if correlation long run is near 0, as it is with US Treasury bonds and US equity markets (AFAIK), they can still go down together.

Think for example an interest rate rise a la 1994. The bond market was badly caught out, and 30 year US Treasury dropped over 20%. Stock markets also dropped.

Or some kind of political crisis around solvency of a major govt bond market. Equities and bonds could both drop.

2008-09 was the perfect storm, in the sense that pretty much *all* bonds, *except* the Treasury bonds of AAA and AA rated countries, went down. But those bonds went up-- it really was "flight to safety". A future bear market might not repeat that pattern.

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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 11, 2018 9:28 am

The JustETF historic return graph comparing "Global Gov Hedged to EUR" with "Germany-only" is very different from the Google Finance graph (the colors are inverse). I think that started my confusion. Not sure what is correct here, Yahoo agrees with Google so I assume JustETF is off (asked them via email).

Then my only remaining mystery is why Xtrackers iBoxx Sovereigns Eurozone AAA UCITS ETF 1C would perform better than Xtrackers Global Sovereign UCITS ETF 1C (EUR hedged) when I compare them via Google.
Last edited by toine on Mon Jun 11, 2018 10:01 am, edited 2 times in total.

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Re: Looking for EUR holy grail bond strategy

Post by galeno » Mon Jun 11, 2018 9:56 am

Splitting hairs. KISS. The only useful thing a back test on bonds is good for is to determine past volatility. Period.

Use one investment grade bond ETF. Use CASH to shorten the duration of FI allocation to whatever you prefer. I like intermediate term.

You hold bonds for ballast. Lower yield = higher credit rating = more "bounce". Higher yield = lower credit rating = less "bounce".

Bounce means an increase in value when equities crash. Junk bonds don't bounce when equities crash. They crash too.

With 75% equities your best choice is Vanguard's VETY. It does everything you need from bonds.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.4%. Port Yield = 2.0%. Term = 35 yr. FI Duration = 6.2 yr. Portfolio survival probability = 100%.

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Re: Looking for EUR holy grail bond strategy

Post by alpine_boglehead » Mon Jun 11, 2018 12:35 pm

Valuethinker wrote:
Mon Jun 11, 2018 3:19 am
alpine_boglehead wrote:
Sun Jun 10, 2018 10:51 pm
toine wrote:
Sat Jun 09, 2018 12:02 am
Valuethinker wrote:
Fri Jun 08, 2018 4:33 pm
But how then can you say the yield is significantly lower?
I don't think I said that? In your posts here you explained "If a global bond fund hedges back into EUR then you will get returns = equivalent risk free bond in EUR (Germany) + credit spread". YTM of the global hedged bond is significantly higher, but that does not seem to take into account the effect of the currency hedging. My historical comparison shows that the return between global hedged and Germany-only is highly correlated (that was expected), and that Germany-only consistently performs slightly (!) better over a fairly long period (tested with different starting points, the graph I provided only shows one). That would suggest that the costs of EUR hedging are simply higher than the yield benefit? It seems incomplete to ignore the historic result comparison and just to trust on the theory.
alpine_boglehead wrote:
Fri Jun 08, 2018 11:46 pm
I don't see why I should put all my fixed-income eggs into the EUR basket. Just for diversification, just in case.
I've had the same temptation to add a portion US$ but my understanding from various other posts here is that diversifying in currency like that is similar as going to a casino. :)
Shouldn't spreading your bond holdings (not all, but a minor portion like 20% of your bonds) over multiple currencies lower your risk?
If that number is less than 10% of your total assets, it is irrelevant from the perspective of final portfolio value/ total wealth. It depends upon what your home currency is, but for the Euro & USD that would certainly be true, also probably the main G7 currencies (AUD, CAD etc.).
From a Euro perspective, non-hedged funds sure have higher fluctuations. But that's (partly) because of the volatility of the Euro itself. Which you don't see in everyday prices (e.g. when shopping) because these are somewhat buffered (with some delay) from currency fluctuations. But as most goods are imported, should the Euro have a strong decline, the price of smartphones, clothes etc. (and equities) etc. will go up. The most obviously exposed everyday variable is probably the price of fuel, which will directly fluctuate with the EUR/USD exchange rate. So filling up at the gas station is similar to going to a casino. :twisted:

The argument for holding bonds only in your home currency is because you consume in your home currency. But obviously that's only partly true.
The other argument is that holding foreign currency subjects your portfolio to volatility for which you are paid no additional return. In the end, you can't "win" at the foreign currency game - you can only add volatility to your returns.

On the import question, if you are US-based then your consumption outside USD is quite small because commodities are also priced in USD.

The EUR price of oil can fall whilst the USD price is rising, btw.

The big costs for most of us are not goods-- the things directly affected by currency movements. And, as you say, manufacturers and retailers dampen the effects of currency swings on retail prices.

Rather we buy services: housing, transport, utilities, healthcare, restaurants etc. Those tend to be pretty much in domestic currencies, reacting only slowly (if at all) to movements in exchange rates. Wages of service sector staff (the biggest cost) don't tend to move much as a result of exchange rate moves. House prices and rents are in your local currency, not in USD.

To the extent that you hold inflation linked domestic bonds, you are hedged against these moves (assuming that CPI inflation roughly tracks your personal inflation rate). Just to help things along, UK Indexed LInked Gilts (inflation linked bonds) are trading at real yields of minus 1.5%-- a guaranteed loss of capital in real terms in the long run, unless inflation exceeds 4.5% p.a. :?

There's not much you can do about that. When the risk-free rate is -1.5%, we probably just have to swallow that. With 10 year Geman Bunds yielding 0.5% and the ECB inflation target of 2%, it's the same for Euro holdings.
Valuethinker wrote:
Mon Jun 11, 2018 3:19 am
The main exception is foreign travel. As someone who lives in GBP, that exchange rate volatility is one I feel ;-).

Of course you can argue that with an equity-heavy portfolio you already have lots of exposure to other currencies.
The actual standard case is 100% home currency -- Bond and Equity portfolios. We then get into economic arguments about your marginal propensity to consume in foreign currency.

The usual rule of thumb is that FX volatility in equity evens out in the end (Purchasing Power Parity on traded goods and services aka Law of One Price) and equities are a long term and highly volatile investment, so it does not matter.

In a 75/25 equity/ bond portfolio, as long as the domestic government bond market is risk free, it's best to not hedge the equities (probably) but to hedge the bonds (almost certainly). Otherwise you could be in an equity bear market *and* have your currency devaluing, which is a tough place to sit.
Valuethinker, thanks for your explanation - it's very much appreciated. At this point I realize maybe I'm just rationalizing some fear that the Euro might go down (there's quite some skepticism regarding the Euro in the populace I am part of), and am merely looking for other points to justify holding non-Euro bonds.
Valuethinker wrote:
Mon Jun 11, 2018 3:19 am

It's also worth remembering that "more money has been lost reaching for yield, than just about any other way". The Global Financial Crisis was, in the end, about reaching for yield (AAA govt debt didn't pay a "high enough" yield, so investors bought A, AA & AAA tranches of CDOs, which fed the CDO creation machine in the USA, which in the end led to the GFC...).
Yes, greed is probably the worst behavioral mistake. Or as another quote goes, take your risk with equities, stay safe on the bond side.

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ekoli
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Re: Looking for EUR holy grail bond strategy

Post by ekoli » Mon Jun 11, 2018 1:01 pm

Splitting hairs. KISS. The only useful thing a back test on bonds is good for is to determine past volatility. Period.

Use one investment grade bond ETF. Use CASH to shorten the duration of FI allocation to whatever you prefer. I like intermediate term.

You hold bonds for ballast. Lower yield = higher credit rating = more "bounce". Higher yield = lower credit rating = less "bounce".

Bounce means an increase in value when equities crash. Junk bonds don't bounce when equities crash. They crash too.

With 75% equities your best choice is Vanguard's VETY. It does everything you need from bonds.
I also think in a portfolio of stocks and bonds, especially where stocks make up the majority of one's total portfolio, intermediate-term bonds is a good option. At list US goberment bonds have historically provided the best risk-adjusted return . I think EUR Eurozone Government Bond UCITS ETF is an excellent choice however going global with bonds I think you are minimizing the probability of default of some european bonds (i.e Italy, Portugal, Spain) ...

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 11, 2018 1:11 pm

Reading this article cured me from considering aggregate as cheaper ETF to access treasury, apparently in 2007 only 35% of aggregate was government related (I wrongly assumed it would stay ~75%).

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BeBH65
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Re: Looking for EUR holy grail bond strategy

Post by BeBH65 » Mon Jun 11, 2018 2:23 pm

Toine, Isn't the situation for US Aggregate satisfactory since Sept 2008?
link above wrote: Fannie Mae and Freddie Mac were put into conservatorship in September 2008, and ever since then have been wards of the government. The placing of Fannie Mae and Freddie Mac in government conservatorship effectively turned their debt into government debt and immediately transformed the U.S. Aggregate into predominantly a “government bond index.” The index was roughly 35 percent government-affiliated bonds at the end of 2007, as shown in Figure 1 (Treasury debt + government-related debt). With that mortgage debt added in at the end of 2010, that number was closer to 80 percent.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

toine
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Re: Looking for EUR holy grail bond strategy

Post by toine » Mon Jun 11, 2018 2:44 pm

BeBH65 wrote:
Mon Jun 11, 2018 2:23 pm
Toine, Isn't the situation for US Aggregate satisfactory since Sept 2008?
It is, but can change again next 30 years of course.

buylowbuyhigh
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Re: Looking for EUR holy grail bond strategy

Post by buylowbuyhigh » Tue Jun 12, 2018 1:42 am

toine wrote:
Mon Jun 11, 2018 2:44 pm
BeBH65 wrote:
Mon Jun 11, 2018 2:23 pm
Toine, Isn't the situation for US Aggregate satisfactory since Sept 2008?
It is, but can change again next 30 years of course.
This seems to answer your question. If you're not comfortable with the aggregate index shifting away from treasuries, you should invest directly in treasuries and then possibly add corporate bonds/MBS for a fixed percentage or not.

Also the difference of 0.1% and 0.25% ER should not matter when the assets are not the same; paying 2.5x the fee sounds like a lot, but it's likely not very much in absolute € terms. AGGH is a brand new ETF, and someone might offer a global EUR hedged government bond ETF with <0.1% ER relatively soon as well.

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BeBH65
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Re: Looking for EUR holy grail bond strategy

Post by BeBH65 » Tue Jun 12, 2018 4:10 am

Attention:
This thread is intertwining posts on the different Barclays bond Aggregate indexes and funds, each of them holds different assets: US-Aggregate , Global-Aggregate and earlier Euro-Aggregate
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

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galeno
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Re: Looking for EUR holy grail bond strategy

Post by galeno » Tue Jun 12, 2018 8:54 am

"If you're not comfortable with the aggregate index shifting away from treasuries, you should invest directly in treasuries and then possibly add corporate bonds/MBS for a fixed percentage or not."

Last year we swapped SUAG (Barclay USA bond index. ER = 0.25%) for two new cheaper Ireland Vanguard bond ETFs: VDTY (int term USA treas. ER = 0.12%) and VDCP (USA corps. ER = 0.12%).

I broke my "simplicity rule" to get cheaper and cleaner (no MBS) bonds. But I had to use 2 ETFs to do it.

The new ishares bond ETF: AGGU (Barclay Global bond index. ER = 0.10%) looks promising. It's cheaper. I get to simplify. And it contains non-USD bonds so it's more diversified and those non-USD bonds are hedged to USD which significantly lowers the volatility.

My only minor pause on this new bond ETF is that it's accumulating and not distributing. I prefer our dividend and interest income to go into CASH. But it's not a deal breaker. My drive for simplicity is stronger than my preference for distributing ETFs over accumultating ETFs.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.4%. Port Yield = 2.0%. Term = 35 yr. FI Duration = 6.2 yr. Portfolio survival probability = 100%.

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