Does tilting towards shorter-term bonds make sense?

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fsh71
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Does tilting towards shorter-term bonds make sense?

Post by fsh71 » Wed Jul 11, 2018 5:11 pm

The host of an investing podcast I frequently listen to mentioned he is steering clear of medium-to-long duration bonds, given the likelihood of a continued rising interest rate environment. He also mentioned that given the flattening yield curve, you don't sacrifice much upside but mitigate a lot of downside risk by shifting to short-term bonds.

This may be borderline anti-boglehead philosophy, but has anyone here similarly adjusted their bond duration? And if you don't, what's the rationale for maintaining longer duration bonds when, as I understand it, you're getting less risk-adjusted-return compared to short-term bonds as the yield curve flattens.
Last edited by fsh71 on Wed Jul 11, 2018 5:17 pm, edited 1 time in total.

jebmke
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Re: Does tilting towards shorter-term bonds make sense?

Post by jebmke » Wed Jul 11, 2018 5:14 pm

My nominal bond holdings have always been short. The only long position I ever hold is individual Tips.

Looking at the treasury yield curve the sweet spot seems to be around 2 years +/-
When you discover that you are riding a dead horse, the best strategy is to dismount.

fsh71
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Re: Does tilting towards shorter-term bonds make sense?

Post by fsh71 » Wed Jul 11, 2018 5:22 pm

jebmke wrote:
Wed Jul 11, 2018 5:14 pm
My nominal bond holdings have always been short. The only long position I ever hold is individual Tips.

Looking at the treasury yield curve the sweet spot seems to be around 2 years +/-
So do you occassionally (say during rebalancing), look at the yield curve and adjust your average bond duration? This seems to make the portfolio less hands-off, but I will admit I think I may have been underestimating the downside risk in these medium duration bonds. I think my average duration is around 6-6.5 years.

jebmke
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Re: Does tilting towards shorter-term bonds make sense?

Post by jebmke » Wed Jul 11, 2018 5:26 pm

I only adjust the average duration based on real yields on Tips. If Tips start to get north of 2% again I will probably shift some from nominal funds (short term investment grade) and buy some more Tips.
When you discover that you are riding a dead horse, the best strategy is to dismount.

venkman
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Re: Does tilting towards shorter-term bonds make sense?

Post by venkman » Wed Jul 11, 2018 10:16 pm

fsh71 wrote:
Wed Jul 11, 2018 5:11 pm
This may be borderline anti-boglehead philosophy, but has anyone here similarly adjusted their bond duration? And if you don't, what's the rationale for maintaining longer duration bonds when, as I understand it, you're getting less risk-adjusted-return compared to short-term bonds as the yield curve flattens.
The rationale for longer-term bonds is that the bond market is pricing in fears of an economic downturn. If the economy tanks, the 2.35% rate on a one-year Treasury will plummet and you won't be able to reinvest it in a year at anywhere near the current yield. If you buy a 10-year Treasury today, you're guaranteed 2.8% on it for 10 years. Essentially, investors are willing to take on more duration risk right now as a hedge against a possible faltering economy.

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danielc
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Re: Does tilting towards shorter-term bonds make sense?

Post by danielc » Thu Jul 12, 2018 1:51 am

fsh71 wrote:
Wed Jul 11, 2018 5:11 pm
The host of an investing podcast I frequently listen to mentioned he is steering clear of medium-to-long duration bonds, given the likelihood of a continued rising interest rate environment. He also mentioned that given the flattening yield curve, you don't sacrifice much upside but mitigate a lot of downside risk by shifting to short-term bonds.

This may be borderline anti-boglehead philosophy, but has anyone here similarly adjusted their bond duration? And if you don't, what's the rationale for maintaining longer duration bonds when, as I understand it, you're getting less risk-adjusted-return compared to short-term bonds as the yield curve flattens.
I don't pay attention to investing podcasts but my bond allocation is 100% short bonds, and specifically Treasury Bills, but for entirely different reasons. Treasury Bills are the safest instrument available; the truly risk-free asset. So I have decided to take the rule of taking the risk on the equity side to its extreme logical conclusion: 100% of my risky assets are in equities, and 100% of my non-equity assets are risk-free. My risk-free assets are a combination of T-Bills, CDs, and money market. I am currently building ladder of T-Bills bought at the auction. When I'm done, I will have a simple "two asset" portfolio: risky equities and risk-free T-Bills.

A typical bond fund will include corporate bonds. I don't like corporate bonds because historically the return you receive from them has not been a fair compensation for the risk you take with them. I have no problem with risk; I just want to be well-compensated for them. Municipals are ok, but they are not free of credit risk and they do tend to drop in price when the market crashes, just like corporate bonds do. So munis and corporate bonds fail at doing the main thing that I want out of my bond allocation: providing peace of mind when the market crashes.

This leaves just treasuries for the bond allocation. In principle I might be OK with longer term treasuries, but I like the idea of not having interest rate risk on my risk-free asset. I admit that the shape of the yield curve right now is also influencing my decision.

Dandy
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Re: Does tilting towards shorter-term bonds make sense?

Post by Dandy » Fri Jul 13, 2018 7:40 am

While I think a good intermediate bond fund will usually do the job fine almost all the time over time i like some diversity in my fixed income allocations, especially in retirement. Many often say that the purpose of their fixed income is for stability so and they take the risk on the equity side. Yet, short term bonds and other "safer" fixed income options are dismissed usually with the comment about "drag" on growth. All fixed income is a drag to some extent but their role in a portfolio isn't growth. So to me that is like saying a dump truck isn't a good race car.

Since the risk and reward are overwhelmingly tied to the equities there is a natural focus on their diversity. That and a long term decline in interest rates has, to some extent, made looking at other fixed income options somewhat unnecessary.

For those who have a large allocation to fixed income having say 60% of their portfolio, they may not want all of that "exposed" to the mild headwind of rising rates. Also, other options such as inflation protected funds, CD ladders, Prime at 2+%, muni bonds, etc. have their own stand along features from inflation protection, government guarantees, rising with rising rates, tax savings, etc.

So tilting toward short term bonds and other fixed income products can make sense. There is a concern about making a portfolio overly complex by having too many moving parts but most of these options are easy to understand and not often subject to major risks.

gmaynardkrebs
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Re: Does tilting towards shorter-term bonds make sense?

Post by gmaynardkrebs » Fri Jul 13, 2018 8:00 am

danielc wrote:
Thu Jul 12, 2018 1:51 am
fsh71 wrote:
Wed Jul 11, 2018 5:11 pm
The host of an investing podcast I frequently listen to mentioned he is steering clear of medium-to-long duration bonds, given the likelihood of a continued rising interest rate environment. He also mentioned that given the flattening yield curve, you don't sacrifice much upside but mitigate a lot of downside risk by shifting to short-term bonds.

This may be borderline anti-boglehead philosophy, but has anyone here similarly adjusted their bond duration? And if you don't, what's the rationale for maintaining longer duration bonds when, as I understand it, you're getting less risk-adjusted-return compared to short-term bonds as the yield curve flattens.
I don't pay attention to investing podcasts but my bond allocation is 100% short bonds, and specifically Treasury Bills, but for entirely different reasons. Treasury Bills are the safest instrument available; the truly risk-free asset. So I have decided to take the rule of taking the risk on the equity side to its extreme logical conclusion: 100% of my risky assets are in equities, and 100% of my non-equity assets are risk-free. My risk-free assets are a combination of T-Bills, CDs, and money market. I am currently building ladder of T-Bills bought at the auction. When I'm done, I will have a simple "two asset" portfolio: risky equities and risk-free T-Bills.

A typical bond fund will include corporate bonds. I don't like corporate bonds because historically the return you receive from them has not been a fair compensation for the risk you take with them. I have no problem with risk; I just want to be well-compensated for them. Municipals are ok, but they are not free of credit risk and they do tend to drop in price when the market crashes, just like corporate bonds do. So munis and corporate bonds fail at doing the main thing that I want out of my bond allocation: providing peace of mind when the market crashes.

This leaves just treasuries for the bond allocation. In principle I might be OK with longer term treasuries, but I like the idea of not having interest rate risk on my risk-free asset. I admit that the shape of the yield curve right now is also influencing my decision.
Have you back tested this or done a Monte Carlo? It's sort of a barbell strategy I guess. Might work out, but I'm wondering about whether you can be on the efficient frontier with such a strategy.

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patrick013
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Re: Does tilting towards shorter-term bonds make sense?

Post by patrick013 » Fri Jul 13, 2018 12:11 pm

Here's what the boss has been doing, no LT at all.
Bogle says 50-50 short/intermediate bonds
Exactly what I would do. If or when rates peak the shorter
durations would look good as the longest durations. If the
economy collapses for a year rates would drop some then,
except corporates which may rise a bit. A little chaos then.
age in bonds, buy-and-hold, 10 year business cycle

garlandwhizzer
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Re: Does tilting towards shorter-term bonds make sense?

Post by garlandwhizzer » Fri Jul 13, 2018 2:05 pm

I shortened the average duration of my bond portfolio considerably a bit more than a year ago. At the time both rates and inflation were rising slowly but steadily and expected to continue doing so, a situation that penalizes longer duration. That was anticipated but you're never sure it's going to happen. Fortunately it did. Shifting from TBM and ITIG into ST TIPS, ST Treasuries, and Prime MMF turned out to net my bond portfolio between 2% - 3% over the last year.

I personally believe it's probably late in the game to shorten duration at the present time. The FED projects another 2 rate increases this year and 2 - 3 next year but I don't believe that will happen. My suspicion is that economic growth will slow down over the next year or two for a number of reasons and that the FED, being data dependent, will adjust their rising rate schedule downward. Remember the rising rate hysteria some years ago when bonds took a hit because of fears that rates were expected to take off? The imminent bond bear market turned out to be a fake-out because the economy stubbornly refused to grow quickly and needed continue support in the form of lower rates. I suspect a similar but less severe replay going forward. The FED for years has rather consistently overestimated the pace and degree of future rises in rates. I don't believe our economy will be strong enough in a year to handle interest rates of about 3.5% without negative effects on economic growth. As before, I could be wrong about that. When future rates and future inflation stabilize and stop rising, duration will be rewarded. Deciding when this change happens is difficult and can be prone to error. So far I've been fortunate. I'll wait in the safety of short duration until it's clear in my mind that inflation and rates have stopped rising, at which point I'll increase duration to intermediate term which is my default position. To make market timing work you have to be right twice, not once.

Garland Whizzer

aristotelian
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Re: Does tilting towards shorter-term bonds make sense?

Post by aristotelian » Fri Jul 13, 2018 2:10 pm

Intuitively, it doesn't make sense to me to get locked into 10 or 20 years for essentially zero premium. I just bought some ST Treasury.

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patrick013
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Re: Does tilting towards shorter-term bonds make sense?

Post by patrick013 » Fri Jul 13, 2018 2:58 pm

"......gradual increases in the target range for the federal funds rate
will be consistent with a sustained expansion of economic activity,
strong labor market conditions, and inflation...near 2%......"


So last reports indicate a surprising 10% increase in 2nd quarter
earnings, and unemployment very low around 4%. I'd thank the
new corporate tax rates. Higher rates should actually help the
economy as corporate balance sheets are already full of low interest
rate debt from prior years.
age in bonds, buy-and-hold, 10 year business cycle

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danielc
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Re: Does tilting towards shorter-term bonds make sense?

Post by danielc » Fri Jul 13, 2018 3:11 pm

gmaynardkrebs wrote:
Fri Jul 13, 2018 8:00 am
danielc wrote:
Thu Jul 12, 2018 1:51 am
This leaves just treasuries for the bond allocation. In principle I might be OK with longer term treasuries, but I like the idea of not having interest rate risk on my risk-free asset. I admit that the shape of the yield curve right now is also influencing my decision.
Have you back tested this or done a Monte Carlo? It's sort of a barbell strategy I guess. Might work out, but I'm wondering about whether you can be on the efficient frontier with such a strategy.
I don't know whether ignoring corporate bonds is theoretically efficient, but various authors (e.g. Bernstein) have argued that they give you poor compensation for the risk you are taking. So they don't look optimal. I also feel I understand treasuries and stocks better. Corporates are also correlated with stocks; especially when the market crashes. So they don't achieve one of the main goals of the bond allocation.

Hank Moody
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Re: Does tilting towards shorter-term bonds make sense?

Post by Hank Moody » Fri Jul 13, 2018 3:12 pm

I shoot for a duration of 4-5. Granted the yield curve has flattened, but that's a relatively recent development. I wouldn't recalibrate my duration everytime the shape of the curve changes.
-HM

DetroitRick
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Re: Does tilting towards shorter-term bonds make sense?

Post by DetroitRick » Fri Jul 13, 2018 3:37 pm

It does to me, given my overall portfolio construction and my short-term withdrawal needs:

1)The yield curve is relatively flat, and and I don't consider the current government or corporate yields to be providing adequate compensation for fixed income risks beyond 3 years or so. That's pure opinion and personal risk assessment only, of course. Example from several days ago - 3 yr Treasuries yielding 2.67%, 10 year 2.84%. 3 yr AA corporates average yield 2.90%, 10 yr 3.77%. Pretty small, and for me it makes shortening up an easy choice right now.
2)I am currently taking withdrawals, part of which will likely come from my fixed income positions. While I don't really forecast interest rates (I'd be a billionaire if I could), I also don't expect them to come down in the next few years. So, I do tilt that piece towards shorter-terms because there is little opportunity to come out ahead if I do otherwise.

But all-in-all this is still just a "tilt" for me. I still keep decent positions in intermediate bonds as well. Plus I'm willing to take on more risk on the equity side anyway, with my shorter-term needs covered by shorter-term fixed income positions.

bondsr4me
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Re: Does tilting towards shorter-term bonds make sense?

Post by bondsr4me » Fri Jul 13, 2018 4:12 pm

danielc wrote:
Thu Jul 12, 2018 1:51 am
fsh71 wrote:
Wed Jul 11, 2018 5:11 pm
The host of an investing podcast I frequently listen to mentioned he is steering clear of medium-to-long duration bonds, given the likelihood of a continued rising interest rate environment. He also mentioned that given the flattening yield curve, you don't sacrifice much upside but mitigate a lot of downside risk by shifting to short-term bonds.

This may be borderline anti-boglehead philosophy, but has anyone here similarly adjusted their bond duration? And if you don't, what's the rationale for maintaining longer duration bonds when, as I understand it, you're getting less risk-adjusted-return compared to short-term bonds as the yield curve flattens.
I don't pay attention to investing podcasts but my bond allocation is 100% short bonds, and specifically Treasury Bills, but for entirely different reasons. Treasury Bills are the safest instrument available; the truly risk-free asset. So I have decided to take the rule of taking the risk on the equity side to its extreme logical conclusion: 100% of my risky assets are in equities, and 100% of my non-equity assets are risk-free. My risk-free assets are a combination of T-Bills, CDs, and money market. I am currently building ladder of T-Bills bought at the auction. When I'm done, I will have a simple "two asset" portfolio: risky equities and risk-free T-Bills.

A typical bond fund will include corporate bonds. I don't like corporate bonds because historically the return you receive from them has not been a fair compensation for the risk you take with them. I have no problem with risk; I just want to be well-compensated for them. Municipals are ok, but they are not free of credit risk and they do tend to drop in price when the market crashes, just like corporate bonds do. So munis and corporate bonds fail at doing the main thing that I want out of my bond allocation: providing peace of mind when the market crashes.

This leaves just treasuries for the bond allocation. In principle I might be OK with longer term treasuries, but I like the idea of not having interest rate risk on my risk-free asset. I admit that the shape of the yield curve right now is also influencing my decision.
+1

I like your above post.

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