Tilting to Corp. Bonds

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investorguy1
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Tilting to Corp. Bonds

Post by investorguy1 » Thu Jan 15, 2015 9:22 pm

I heard Bogle suggest tilting to corporate bonds. He said that the purpose of indexing is to "beat the guy next door" and most investors have more corporate bonds. He said the reason the index has more government bonds is because other governments buy them. Any thoughts?

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Re: Tilting to Corp. Bonds

Post by mosu » Thu Jan 15, 2015 9:33 pm

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Last edited by mosu on Thu Mar 12, 2015 9:12 pm, edited 1 time in total.

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Re: Tilting to Corp. Bonds

Post by columbia » Thu Jan 15, 2015 9:49 pm

If one is trying to squeeze out higher returns from their bonds (than provided by TBM), perhaps they should own more equities.

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Re: Tilting to Corp. Bonds

Post by YDNAL » Fri Jan 16, 2015 1:03 pm

Investerguy wrote:I heard Bogle suggest tilting to corporate bonds. He said that the purpose of indexing is to "beat the guy next door" and most investors have more corporate bonds. He said the reason the index has more government bonds is because other governments buy them. Any thoughts?
That's not necessarily what Bogle said (April 2013).
Benz: Let's talk about bond indexing, Jack. We've seen performance of [broad market] bond index funds relative to our intermediate-term bond category look a little [volatile] in recent years. So, in 2011 they did great. More recently they haven't looked as good. Active funds have actually done better. What do you think is the underpinning of that performance bifurcation?

Bogle: There is just no doubt about what the underpinning is, and that is the Barclays Capital U.S. Aggregate Bond Index is very heavily weighted around 70% in U.S. Treasuries and U.S. agencies, government instruments, if you will. And that 70% is working at a very low yield, and the other 30% probably much more resembles what the average bond fund is doing out there, the intermediate-term bond fund, which is the appropriate maturity.

Benz: So, the intermediate-term funds, the active funds, are generally heavily skewed toward corporate bonds?

Bogle: Very, very much so.
Regardless, the 70% Bogle mentions includes ~20% of Mortgage-backed bonds. That said, if an investor wishes to invest resembling the Total US Bond Mkt, market weights are what they are.
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Bonds are for safety. Stocks are for higher returns.

Post by Taylor Larimore » Fri Jan 16, 2015 1:39 pm

columbia wrote:If one is trying to squeeze out higher returns from their bonds (than provided by TBM), perhaps they should own more equities.
Bogleheads:

Bonds are for safety. Vanguard's Total Bond Market Index Fund does just that. The safety of bonds is needed most when stocks plunge in bear markets.

In 2008 Vanguard's Intermediate-Term Investment Grade Bond Fund fell -6.2%. Meanwhile Total Bond Market Fund gained +5.1%; (11.3% difference).

I agree with columbia: It is much more efficient to use bonds for safety and stocks for higher returns.

Best wishes.
Taylor
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Re: Tilting to Corp. Bonds

Post by investorguy1 » Fri Jan 16, 2015 1:56 pm

From a perspective of pure indexing I think it would makes sense to hold bonds in the same proportion as other investors. If you want to go the safety route why not just go with government bonds and forget the corporate all together? I guess the point here is that it seems the corporate allocation may be a little bit arbitrary.

regarding your point about adding equities to increase return instead of lowering bond quality. I had a similar thought regarding adding low volatility stocks maybe it would make more sense to just add more bonds.

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Re: Tilting to Corp. Bonds

Post by midareff » Fri Jan 16, 2015 2:36 pm

I think you have to look at and absorb the gain/decline numbers Taylor put forth. If you were fortunate enough to market-time (yes, market time) the bottom you would have had about 9% or so more to rebalance with. Not so lucky market timing not so great an amount. If you were going to hold pat a different result would have followed.

Assuming an equal $10K investment in VFIDX and VBMFX the Total Bond (VBMFX) was more valuable all the way from 7/4/2008 through 12/18/2009, when they NAV of the assets crossed, VFIDX becoming more valuable (higher $). At that point the original $10K was now roughly $11,160 for each. From 12/18/2009 until now the IT IG became $15,340 and the Total Bond became $13,384. Deduct the 12/18/2009 $11,160 and the gains since then are $4,180 for the IT IG and $2,224 for the Total Bond.

For the typical investor own the Total Bond and forgetaboutit. For the more sophisticated investor, who understands the risks associated with IT IG Bonds and can also assume some projections of interest rate increase impacts, and who can stay put with this investment, it's a bit like chicken soup and a cold ... a little can't hurt ya.

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Re: Tilting to Corp. Bonds

Post by itstoomuch » Fri Jan 16, 2015 2:43 pm

Bought my first bond funds this week. Long treasuries, intermediate corporate, and preferred stock funds.
I plan to make a bunch of money off of them. :greedy
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Re: Tilting to Corp. Bonds

Post by Munir » Fri Jan 16, 2015 2:49 pm

midareff wrote:I think you have to look at and absorb the gain/decline numbers Taylor put forth. If you were fortunate enough to market-time (yes, market time) the bottom you would have had about 9% or so more to rebalance with. Not so lucky market timing not so great an amount. If you were going to hold pat a different result would have followed.

Assuming an equal $10K investment in VFIDX and VBMFX the Total Bond (VBMFX) was more valuable all the way from 7/4/2008 through 12/18/2009, when they NAV of the assets crossed, VFIDX becoming more valuable (higher $). At that point the original $10K was now roughly $11,160 for each. From 12/18/2009 until now the IT IG became $15,340 and the Total Bond became $13,384. Deduct the 12/18/2009 $11,160 and the gains since then are $4,180 for the IT IG and $2,224 for the Total Bond.

For the typical investor own the Total Bond and forgetaboutit. For the more sophisticated investor, who understands the risks associated with IT IG Bonds and can also assume some projections of interest rate increase impacts, and who can stay put with this investment, it's a bit like chicken soup and a cold ... a little can't hurt ya.
+1.

Moreover, to imply that the risks of equities are the same as those of the Invesment Grade fund is ridiculous. There is a wide gap in risk between the two. As midareff stated above, if you cannot stay put for a year (as in 2008), then the Investment Grade fund is not for you. Maybe you should be all in treasuries or money under the mattress. Looking at results over one year, innoculating one's Total Bond Bond fund with some corporates is a fairly safe and wise move.

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Re: Bonds are for safety. Stocks are for higher returns.

Post by comeinvest » Sat Jan 17, 2015 3:49 am

Taylor Larimore wrote:
columbia wrote:If one is trying to squeeze out higher returns from their bonds (than provided by TBM), perhaps they should own more equities.
Bogleheads:

Bonds are for safety. Vanguard's Total Bond Market Index Fund does just that. The safety of bonds is needed most when stocks plunge in bear markets.

In 2008 Vanguard's Intermediate-Term Investment Grade Bond Fund fell -6.2%. Meanwhile Total Bond Market Fund gained +5.1%; (11.3% difference).

I agree with columbia: It is much more efficient to use bonds for safety and stocks for higher returns.

Best wishes.
Taylor
Do you have any quantitative evidence supporting your statement "It is much more efficient to use bonds for safety and stocks for higher returns"?
To be fair, a quantitative evaluation surely would not only depend on the investment constraints and utility fucntion of the individual investor, investment horizon and individual tail risk, but also on numerous macroeconomic, return, correlation, and portfolio-theoretic assumptions, that are too many to even mention here. Given that even "simple" questions as the stock/bond ratio or whether or not to leverage or use risk parity portfolios to optimize risk-adjusted returns are unresolved, heavily debated questions among quants and professionals, as well as on this forum, due to the the solutions depending on numerous assumptions about the future and unknown parameters, I have a hard time believing that an answer that simple can be substantiated, let alone generalized.
Intuitively, as discussed elsewhere in this forum, I find it highly questionable whether government bonds with approx. zero expected real returns for years if not decades at current rates, and practically "almost" guaranteed negative after-tax returns in many cases, can provide meaningful "safety" to a long-term investment portfolio.

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Re: Tilting to Corp. Bonds

Post by Taylor Larimore » Sat Jan 17, 2015 8:01 am

I wrote:
I agree with columbia: It is much more efficient to use bonds for safety and stocks for higher returns.
Comeinvest wrote:
Do you have any quantitative evidence supporting your statement "It is much more efficient to use bonds for safety and stocks for higher returns"?
I'm rushing out the door to go sailing, but read this:

Better returns: More stocks or riskier bonds?

Best wishes.
Taylor
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Re: Tilting to Corp. Bonds

Post by dkturner » Sat Jan 17, 2015 8:47 am

Does anyone have any thoughts about the unusual situation we have been in since 2009 with respect to the Federal Reserve Board's participation in the market for Treasury securities? Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds? Would an enterprising bond investor have been off base by reducing allocation to Treasury Bonds and increasing allocation to investment grade corporate bonds to compensate for the lower Treasury yields we have experienced over the last 6 years?

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Re: Tilting to Corp. Bonds

Post by midareff » Sat Jan 17, 2015 9:12 am

dkturner wrote:Does anyone have any thoughts about the unusual situation we have been in since 2009 with respect to the Federal Reserve Board's participation in the market for Treasury securities? Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds? Would an enterprising bond investor have been off base by reducing allocation to Treasury Bonds and increasing allocation to investment grade corporate bonds to compensate for the lower Treasury yields we have experienced over the last 6 years?
I would suggest you do a little mathematical modeling to see what the relationship is between distribution yields, duration, interest rate increases and the CPI-U over time. Use standard rule of thumb of interest rate rise X years of fund duration = loss of NAV. Add the interest rate rise to the NAV and see how long it takes to recover. Next take a hypothetical example.... say two, .25% interest rate rises a year for five years consecutively. To keep it simple you can use either 1.75% or 2% CPI-U to keep it real. Calculate your NAV recovery times to real dollars..... or do it within a time frame of say.. 5 or 10 years.

Total Bond distributing 2.35% duration 5.5 years.
Intermediate Term IG 3.04% duration 5.3 years.
Short Term Investment Grade 1.75% duration 2.4 years.
Intermediate Term Treasuries 1.72% duration 5.2 years.

You could also do this another way... Bengen used 2.1% real for IT Treasuries in his study. Rolling 12 month CPI-U is about 1.7% so figure you have to raise IT Treasuries distribution by 2.1%. see how that looks into the future.

Are things distorted? Pay the IRS 25% tax on Total Bonds 2.35% distribution and your left with zero real, and a fist full of interest rate risk. Good Luck.

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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 9:14 am

dkturner wrote:Does anyone have any thoughts about the unusual situation we have been in since 2009 with respect to the Federal Reserve Board's participation in the market for Treasury securities? Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds?
Did the government spend more money in an effort to stimulate the economy? Yes

Did the government have to issue more bonds to cover the added spending? Yes

Did the economy fail to recover at the expected/desired rate? Yes

Did businesses and individuals borrow less as a result of the economic slowdown? Yes

Did the Fed buy a lots (most?) of those extra Treasuries in order to boost the economy by lowering interest rates? Yes

Did investors shun non-agency MBS as a result of the Lehman collapse and new government banking restrictions? Yes

Did more Treasury bond issuance, less Corporate bond issuance, less non agency MBS issuance and therefore more agency MBS issuance distort the "traditional" government/credit mix of the BarCap Agg Index?


I'll leave the answer to the last as a group exercise.
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Re: Tilting to Corp. Bonds

Post by dkturner » Sat Jan 17, 2015 10:23 am

midareff wrote:
dkturner wrote:Does anyone have any thoughts about the unusual situation we have been in since 2009 with respect to the Federal Reserve Board's participation in the market for Treasury securities? Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds? Would an enterprising bond investor have been off base by reducing allocation to Treasury Bonds and increasing allocation to investment grade corporate bonds to compensate for the lower Treasury yields we have experienced over the last 6 years?
I would suggest you do a little mathematical modeling to see what the relationship is between distribution yields, duration, interest rate increases and the CPI-U over time. Use standard rule of thumb of interest rate rise X years of fund duration = loss of NAV. Add the interest rate rise to the NAV and see how long it takes to recover. Next take a hypothetical example.... say two, .25% interest rate rises a year for five years consecutively. To keep it simple you can use either 1.75% or 2% CPI-U to keep it real. Calculate your NAV recovery times to real dollars..... or do it within a time frame of say.. 5 or 10 years.

Total Bond distributing 2.35% duration 5.5 years.
Intermediate Term IG 3.04% duration 5.3 years.
Short Term Investment Grade 1.75% duration 2.4 years.
Intermediate Term Treasuries 1.72% duration 5.2 years.

You could also do this another way... Bengen used 2.1% real for IT Treasuries in his study. Rolling 12 month CPI-U is about 1.7% so figure you have to raise IT Treasuries distribution by 2.1%. see how that looks into the future.

Are things distorted? Pay the IRS 25% tax on Total Bonds 2.35% distribution and your left with zero real, and a fist full of interest rate risk. Good Luck.
Being a good Boglehead I pay more attention to the total return of asset classes. I took a look at the total return of the Barclays 5-10 Year Treasury and Credit indices to see what transpired over the period 2009-2014 when the Federal Reserve was, for lack of a better term, "repressing" Treasury interest rates. Treasuries returned an annualized 3.53% while corporates returned an annualized 8.87%. For an enterprising fixed income investor that translates into more than $53,000 per year in additional return on a $1 million bond portfolio. I found it amusing that the standard deviation of the corporate portfolio was 6.22 versus 6.65 for the Treasury portfolio.

Opportunities like this don't come along very often. Remember, I was inquiring about the propriety on an enterprising investor moving from Treasuries to investment grade corporates. I fully realize that an investor who believes that it's impossible to know anything about future asset returns and, accordingly, will never take any actions, other than a little rebalancing, to alter a portfolio based on what's going on in plain sight.

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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 10:57 am

dkturner wrote:Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds?
The credit spread doesn't look like it correlates with the Fed action as such except in the early part of the action. But that could have been recession related and not due to the Fed action itself.

Image

The spread went way up during the recession but then leveled out for the next five yeas at ~ 4% with corporate yields deceasing along with Treasuries. In the last year we have seen the yields stopped in their tracking with Treasuries moving up and corporates down (sort of) which dropped the spread to about 3%.

I have no idea what this all means as to cause and effect of any Fed action.

The five year nominal-real brake even chart is kind of similar if that means anything.

Image
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Re: Tilting to Corp. Bonds

Post by BlueEars » Sat Jan 17, 2015 11:16 am

Doc wrote:...
The spread went way up during the recession but then leveled out for the next five yeas at ~ 4% with corporate yields deceasing along with Treasuries. In the last year we have seen the yields stopped in their tracking with Treasuries moving up and corporates down (sort of) which dropped the spread to about 3%.
...
I wonder how that spread chart might change using the 30 year constant maturity? For the Moody's Baa Corporate the data's note says:
Moody's tries to include bonds with remaining maturities as close as possible to 30 years. Moody's drops bonds if the remaining life falls below 20 years, if the bond is susceptible to redemption, or if the rating changes.
BTW, is there a nice source for intermediate corporate bonds, i.e. around 5 years?

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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 11:29 am

BlueEars wrote:I wonder how that spread chart might change using the 30 year constant maturity?
The St Louis Fed charts (FRED) have lots of data but there are probably only a very few corporate 30's available so I don't know if there is any 30 year corporate indexes.

http://research.stlouisfed.org/fred2/categories/32991
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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 11:40 am

BlueEars wrote:BTW, is there a nice source for intermediate corporate bonds, i.e. around 5 years?
A few: VICSX,VCIT,VFIDX,VFICX,VBILX,BIV,CIU,ITR ... :D
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Re: Tilting to Corp. Bonds

Post by BlueEars » Sat Jan 17, 2015 11:53 am

Doc, I was thinking of maybe a combo of these since there are gaps in both series:
http://research.stlouisfed.org/fred2/series/GS30
http://research.stlouisfed.org/fred2/series/GS20

Using these would the spread graph above give the same conclusions or a different view?

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Re: Tilting to Corp. Bonds

Post by BlueEars » Sat Jan 17, 2015 11:56 am

Doc wrote:
BlueEars wrote:BTW, is there a nice source for intermediate corporate bonds, i.e. around 5 years?
A few: VICSX,VCIT,VFIDX,VFICX,VBILX,BIV,CIU,ITR ... :D
It's a bit OT, but I was hoping that there would be a long running source of monthly data similar to the Fed corporate data but with intermediate corporate bonds. I'm interested because I'd like to have monthly corporate bond data for the 1954 to 1989 period. After that I have DODIX data.

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Re: Tilting to Corp. Bonds

Post by midareff » Sat Jan 17, 2015 12:00 pm

BlueEars wrote:
Doc wrote:...
The spread went way up during the recession but then leveled out for the next five yeas at ~ 4% with corporate yields deceasing along with Treasuries. In the last year we have seen the yields stopped in their tracking with Treasuries moving up and corporates down (sort of) which dropped the spread to about 3%.
...
I wonder how that spread chart might change using the 30 year constant maturity? For the Moody's Baa Corporate the data's note says:
Moody's tries to include bonds with remaining maturities as close as possible to 30 years. Moody's drops bonds if the remaining life falls below 20 years, if the bond is susceptible to redemption, or if the rating changes.
BTW, is there a nice source for intermediate corporate bonds, i.e. around 5 years?

Of course there is... VFIDX 5.3 years duration, expense .10%

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Re: Tilting to Corp. Bonds

Post by BlueEars » Sat Jan 17, 2015 12:06 pm

midareff wrote:...
Of course there is... VFIDX 5.3 years duration, expense .10%
Unfortunately the Yahoo data only goes back to 1980 which meets a lot of purposes. For data analysis, I'm interested in rising rate period of 1954 to 1982 (especially 1954 - 1977 or so).

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Re: Tilting to Corp. Bonds

Post by midareff » Sat Jan 17, 2015 12:17 pm

BlueEars wrote:
midareff wrote:...
Of course there is... VFIDX 5.3 years duration, expense .10%
Unfortunately the Yahoo data only goes back to 1980 which meets a lot of purposes. For data analysis, I'm interested in rising rate period of 1954 to 1982 (especially 1954 - 1977 or so).

Interest rates back to 1971 can be had here. http://www.newyorkfed.org/markets/stati ... drate.html

June 30, 2004 forward to the end of 2006 may be of interest to you as the Fed increased interest rates .25%, 17 consecutive times. Run that scenario on any of the bond funds I cited in my post above and see what happens. Most interesting I think. Of course, past performance is not an indicator of anything other than you pay your money and take your chances, but numbers are numbers.

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Re: Tilting to Corp. Bonds

Post by nisiprius » Sat Jan 17, 2015 12:18 pm

My answer is that it's a completely personal risk/reward decisions.

OK, some spin: I think it is very important to evaluate one's risk tolerance and then stick to it. If you can't articulate some clear, specific reason why you are more risk tolerant than you used to be, I don't think it is rational to increase your portfolio risk. I think it is positively dangerous to convince yourself that you have gotten bolder merely because you don't like the return numbers from the portfolio you chose originally. If you are convinced your investments are going to earn less than you planned, the rational thing to do is revise your plans. (Ugh. I hate it when that happens.) Anyway, I as I say, I think it is personal, and it's easy to "fight the last war," but it's important at least to remember 2008-2009:

Source: Morningstar

Image

I like Total Bond, the blue line. A sane person could certainly prefer more risk, more reward, with corporate bonds, the orange line (Vanguard Intermediate-Term Investment Grade, not pure corporate but close). Another sane person could dislike the risk of Total Bond and opt to shorten up duration at the expense of return, the green line, Vanguard Short-Term Bond Index.

IMHO the only mistake is to think you can get more return without more risk--or that you can cut risk without also cutting return.

Starting with Barclay's Aggregate index, and then tilting to corporate bonds is increasing risk. Maybe not by a lot--that's a 10% notch on that chart compared to 20% for "high-yield" and 50% for stocks, but still 10%. That's fine as long as you know that and have looked carefully at it and can say exactly why you are willing to take more risk now in your bond holdings than you were willing to take before.
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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 1:09 pm

nisiprius wrote:I like Total Bond, the blue line.
I like the red line - iShares Interm Government/Credit Bd GVI

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

Image

For slightly more credit risk but less term risk. And who needs those stinking MBS anyway. :P
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Re: Tilting to Corp. Bonds

Post by dkturner » Sat Jan 17, 2015 2:11 pm

Doc wrote:
dkturner wrote:Does anyone think that Fed participation in the Treasury market may have been distorting the relationship between the relative yields of Treasury and investment grade corporate bonds?
The credit spread doesn't look like it correlates with the Fed action as such except in the early part of the action. But that could have been recession related and not due to the Fed action itself.

Image

The spread went way up during the recession but then leveled out for the next five yeas at ~ 4% with corporate yields deceasing along with Treasuries. In the last year we have seen the yields stopped in their tracking with Treasuries moving up and corporates down (sort of) which dropped the spread to about 3%.

I have no idea what this all means as to cause and effect of any Fed action.

The five year nominal-real brake even chart is kind of similar if that means anything.

Image
Doc,

In June of 2007 the spread between 5 year Treasuries and Baa corporates was only 167 basis points. Treasuries yielded 5.03% and corporates yielded 6.70%. The corporate yield was 33% higher than the treasury yield. Nothing to get excited about.

In December of 2014 the spread between the Treasuries and the corporates had only increased to 310 basis points. Treasuries yielded 1.64% and corporates yielded 4.74%. But at the end of 2014 the corporate yield was 189% higher than the Treasury yield. I submit that if you view yield differences in percentages, as opposed to basis points or percentage points, you get a much more accurate view of what is going on in the fixed income world.

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Re: Tilting to Corp. Bonds

Post by Doc » Sat Jan 17, 2015 6:21 pm

dkturner wrote:In June of 2007 the spread between 5 year Treasuries and Baa corporates was only 167 basis points. ... The corporate yield was 33% higher than the treasury yield. Nothing to get excited about.
dkturner wrote: I submit that if you view yield differences in percentages, as opposed to basis points or percentage points, you get a much more accurate view of what is going on in the fixed income world.
I don't understand. Are you saying that corporate yields are 33% higher than Treasuries is better than saying corporate yields are 167 bps (1.67%) higher than Treasuries?

If Treasury yields are 0.01% and corporate yields are 0.04% does that then make corporates 300% better? I don't' look at it that way.
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Re: Tilting to Corp. Bonds

Post by dkturner » Sun Jan 18, 2015 9:23 am

Doc wrote:
dkturner wrote:In June of 2007 the spread between 5 year Treasuries and Baa corporates was only 167 basis points. ... The corporate yield was 33% higher than the treasury yield. Nothing to get excited about.
dkturner wrote: I submit that if you view yield differences in percentages, as opposed to basis points or percentage points, you get a much more accurate view of what is going on in the fixed income world.
I don't understand. Are you saying that corporate yields are 33% higher than Treasuries is better than saying corporate yields are 167 bps (1.67%) higher than Treasuries?

If Treasury yields are 0.01% and corporate yields are 0.04% does that then make corporates 300% better? I don't' look at it that way.
Ok, let's go back to square one. The title of this thread is "Tilting to Corp. Bonds". Now, What would possess a rational, risk averse, investor to tilt his fixed income portfolio towards corporate bonds? In 2007 he would be collecting $50,300 per $1million of 5 year Treasuries. If he moved to seasoned Baa corporates he could increase his income to $67,000 per $1million. Nice bump up, but our investor is risk averse. Is the extra income really worth the extra risk?

Now it's 2015. Over the last 7 1/2 years our rational, risk averse, investor with the $1million portfolio of 5 year Treasuries has seen his income decline from $50,300 to $16,400. He notices that a $1million portfolio of seasoned Baa corporates would produce $47,400 of income. Is the extra income really worth the extra risk?

Obviously different individuals will answer differently. Jack Bogle has written extensively of late about the ills of holding too much of ones portfolio in government bonds. The point I was trying (unsuccessfully) to make is that we buy stuff with the $ of income we receive from our investments. When the $ decline precipitously we are more likely to consider taking greater risks to increase our income. We don't necessarily pay attention to the relative spread in Treasury vs corporate bond yields, but we do sit up and take notice if we have the opportunity to nearly triple our fixed income investment income by taking on added risk.

Investors are more likely to tilt to corporates when the percentage difference in yields is much greater, irrespective of the difference in spreads.

As an aside, I understand that in Germany the yield on 5 year Bunds is essentially zero. The spread between 5 year Bunds and seasoned U.S. Baa corporates is only 474 basis points. Ignoring the Dollar/Euro exchange rate issue, if my German cousins were to sell some of their 5 year Bunds and purchase seasoned U.S. Baa corporates how much would their income increase in percentage terms? Would this be adequate compensation for the increase in risk they would be taking?

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Re: Tilting to Corp. Bonds

Post by Doc » Sun Jan 18, 2015 9:42 am

dkturner wrote:Investors are more likely to tilt to corporates when the percentage difference in yields is much greater, irrespective of the difference in spreads.
That is a good argument but I don't think it is a good metric for defining the difference between two assets. I also don't know how widespread the argument might be. Based on all the threads in the last several years on the great benefit of CD's, corporates and their ilk I have not seen much discussion of "but it's only $x a year".

The thought process should be something like: The spread between corporates and Treasuries is a gazillion bps I really need to take a look at that. Oh gee whiz a gazillion bps only gives me an extra $100 a year, I think I'll pass.

Of course what I actually do is not what I necessarily argue. I tilt towards corporates from TBM but reduce the duration at the same time to actually come out with a lower expected return than TBM. I do this for two reasons. 1) Is yours, it's not that much money. 2) I think it makes for a better outcome for the portfolio as a whole not just the fixed income component.
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Re: Tilting to Corp. Bonds

Post by Bustoff » Sun Jan 18, 2015 10:38 am

Are there any allocation guides for the fixed income side? In other words, is there anything like an "age in bonds" equivalent rule of thumb for how to allocate the fixed-income side?
For instance, if someone is over 60 and retired with a 30/70 stock/bond allocation, how would one go about determining, in a reasonably intelligent manner, the proper way to allocate the 70% in fixed-income? Since risk tolerance is usually thought of in terms of equity losses, is it simply a guess or just defaulting to a total bond fund?
Last edited by Bustoff on Sun Jan 18, 2015 11:31 am, edited 1 time in total.

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Re: Tilting to Corp. Bonds

Post by tibbitts » Sun Jan 18, 2015 11:07 am

Investerguy wrote:I heard Bogle suggest tilting to corporate bonds. He said that the purpose of indexing is to "beat the guy next door" and most investors have more corporate bonds. He said the reason the index has more government bonds is because other governments buy them. Any thoughts?
I think the premise is a bit off-base (the sentiments attributed to Bogle aren't quite correct, or at least not fully in context), but clearly in recent years he's recommended a higher percentage of corporate bonds vs. a total bond index. You'll have to accept that there is a divergence of opinion here, and that many of the opinions have evolved in recent years.

You'll also have to accept that almost all the recommendations have a timing factor built into them. Within treasuries even, we've seen that with recommendations alternating between TIPS and traditional bonds. Even the issue of foreign ownership of treasuries implies timing - if a high amount of foreign ownership is part of the driver for a higher corporate allocation, then presumably there is some level at which if foreign ownership drops, the reverse would be true. So you need to determine that algorithm, or just look to your guru-of-choice for direction.

Even when you look at spreads, not everyone agrees on how to look at them. When real bond rates are 6%, maybe 3% over inflation, and you're looking at a 100bp difference between corporates and treasuries, a lot of people are going to yawn. When rates are 1-ish%, and below inflation, you're going to see more a little more excitement over that same 100bp spread.

Even regarding "bonds are for safety", you've still got your 100% treasury (or TIPS) crowd taking all their risk on the equity side, and then you've got your hybrid risk (corporates, high yield, international and - shudder - maybe even convertibles) crowd saying that you want to own some of everything that's out there - except the one or two pieces they don't personally like, of course.

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Re: Tilting to Corp. Bonds

Post by midareff » Sun Jan 18, 2015 11:26 am

All of this seems to miss a point or two IMHO. That downwards bump doesn't mean much to a disciplined investor UNLESS he has to sell IT IG during that period. I happen to hold an allocation to IT IG in my IRA. I'm 4 years out from the year I turn 70.5 so it means little now. As I get closer I will progressively move about 2 years of RMD to either Total Bond or IT Treasuries, depending on what the "cost" of that reduced distribution is then. If IT Treasuries were yielding 2.1% real, as they were when Bengen did his study, things would be way different for all of us.

With IT Treasuries distributing 1.72% and ST IG distributing 1.85% with half the interest rate risk, there is staying the course and there is adapting to the world around you, as the Fed has changed it. .. and there is heresy and there is Sam Walton's didn't lose anything, didn't sell anything theorem. Worse yet, whether it's the 1.72% or the 1.85% if it's in taxable you have to pay the IRS for it. Welcome to negative real.

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Re: Tilting to Corp. Bonds

Post by Quickfoot » Sun Jan 18, 2015 11:53 am

We don't tilt for performance, we tilt for diversification. Our core fixed income holding is the Intermediate Term Bond Index which is around 50% corporate bonds and 50% domestic government bonds, 30% of our fixed income is also in the international bond fund. I really like the corporate bond component but would not add more. 15% of the portfolio is REITS and 30% of our equities in international, 50% of our domestic equities are mid cap and the remaining 50% are large cap.

If you are constructing your portfolio to beat your neighbor you are chasing performance and that's dangerous. A well diversified portfolio will behave differently than any of the asset classes that comprise it but also should have much less risk than any of those asset classes as well.

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Re: Tilting to Corp. Bonds

Post by Doc » Sun Jan 18, 2015 2:25 pm

midareff wrote:That downwards bump doesn't mean much to a disciplined investor UNLESS he has to sell IT IG during that period. I happen to hold an allocation to IT IG in my IRA.
"That downwards bump doesn't mean much to a disciplined investor UNLESS he has wants to sell IT IG during that period." Wants as in rebalancing during a bear market.
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Re: Tilting to Corp. Bonds

Post by Dandy » Sun Jan 18, 2015 7:14 pm

I'm one of the few that favors fixed income diversity especially in this interest rate environment. Total Bond doesn't include TIPS or CDs so I've added them. I also have some legacy HH and EE bonds (4% is looking pretty good). Total Bond has about 45% Treasury bonds - I'm not sure how that compares with what it has held historically. Add short term bond index which has 67% Treasuries and I have a lot of government/gov. guarantee exposure.

While most of us support Jack's views on investing we often go our separate ways e.g. invest in international equities when he sees little value. I think he makes a decent case that Total bond could be better.

I think Jack makes a decent point that it is a bit heavy in government bonds and a bit light in corporate bonds. Certainly, corporate bonds have more default risk than Treasuries and in bad times will likely underperform Treasuries. But, any tilt is a trade off. Tilting a bit toward Corporate bonds isn't as risky as most equity tilts or likely to be as risky as adding a bit more equities to your allocation. A moderate tilt to Corporate bonds isn't likely to make a significant difference in your portfolio performance, which may be the best argument against tilting. With a large allocation to fixed income I also tilt a bit to corporate bonds. I'd rather do modest fixed income tilts then up my equity allocation.

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Re: Tilting to Corp. Bonds

Post by midareff » Sun Jan 18, 2015 11:12 pm

Doc wrote:
midareff wrote:That downwards bump doesn't mean much to a disciplined investor UNLESS he has to sell IT IG during that period. I happen to hold an allocation to IT IG in my IRA.
"That downwards bump doesn't mean much to a disciplined investor UNLESS he has wants to sell IT IG during that period." Wants as in rebalancing during a bear market.
Agreed Doc.... and once 20 to 25 years of liability matching in bonds has been established wanting to vacate that position to rebalance may look very differently.

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