Why Take Risk on Equity Side?

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Call_Me_Op
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Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 7:48 am

I have been an advocate of "taking your risk on the equity side." However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
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software
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Re: Why Take Risk on Equity Side?

Post by software » Thu Jul 19, 2018 7:56 am

Those results probably have a lot to do with your dataset. Not suggesting you purposefully cherrypicked dates, but those dates happen to include a 30 year bull run for bonds which is just recently coming to a close.

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Re: Why Take Risk on Equity Side?

Post by simplesimon » Thu Jul 19, 2018 7:58 am

Would you categorize your high-yield bond allocation under equity or bonds when looking at total stock and bond mix?

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Re: Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 7:59 am

software wrote:
Thu Jul 19, 2018 7:56 am
Those results probably have a lot to do with your dataset. Not suggesting you purposefully cherrypicked dates, but those dates happen to include a 30 year bull run for bonds which is just recently coming to a close.
Why would that affect risk-adjusted return? I can see that it would boost raw return.

By the way, that is the longest data set available on PV - so absolutely no cherry-picking.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 7:59 am

simplesimon wrote:
Thu Jul 19, 2018 7:58 am
Would you categorize your high-yield bond allocation under equity or bonds when looking at total stock and bond mix?
If you limit me to those two categories, I would split it 50-50. But more generally, I would simply place it in the "risky" category along with my stocks.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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simplesimon
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Re: Why Take Risk on Equity Side?

Post by simplesimon » Thu Jul 19, 2018 8:05 am

Call_Me_Op wrote:
Thu Jul 19, 2018 7:59 am
simplesimon wrote:
Thu Jul 19, 2018 7:58 am
Would you categorize your high-yield bond allocation under equity or bonds when looking at total stock and bond mix?
If you limit me to those two categories, I would split it 50-50. But more generally, I would simply place it in the "risky" category along with my stocks.
While you can make this distinction the general population would not be able to, which is the intended audience of the saying I think.

software
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Re: Why Take Risk on Equity Side?

Post by software » Thu Jul 19, 2018 8:06 am

Call_Me_Op wrote:
Thu Jul 19, 2018 7:59 am
software wrote:
Thu Jul 19, 2018 7:56 am
Those results probably have a lot to do with your dataset. Not suggesting you purposefully cherrypicked dates, but those dates happen to include a 30 year bull run for bonds which is just recently coming to a close.
Why would that affect risk-adjusted return? I can see that it would boost raw return.

By the way, that is the longest data set available on PV - so absolutely no cherry-picking.
Because sharpe ratio, which is what I assume you are using, depends on the standard deviation of the returns. If an asset class has mostly trended up during that time period then it will have lower standard deviation and less perceived risk.

This does not mean that it will have those same risk adjusted returns going forward, that’s why risk adjusted returns are not a single number, but is dependent on the time period analyzes, just like nominal returns.

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Re: Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 8:18 am

software wrote:
Thu Jul 19, 2018 8:06 am
Call_Me_Op wrote:
Thu Jul 19, 2018 7:59 am
software wrote:
Thu Jul 19, 2018 7:56 am
Those results probably have a lot to do with your dataset. Not suggesting you purposefully cherrypicked dates, but those dates happen to include a 30 year bull run for bonds which is just recently coming to a close.
Why would that affect risk-adjusted return? I can see that it would boost raw return.

By the way, that is the longest data set available on PV - so absolutely no cherry-picking.
Because sharpe ratio, which is what I assume you are using, depends on the standard deviation of the returns. If an asset class has mostly trended up during that time period then it will have lower standard deviation and less perceived risk.

This does not mean that it will have those same risk adjusted returns going forward, that’s why risk adjusted returns are not a single number, but is dependent on the time period analyzes, just like nominal returns.
My main question is where is the data that suggests that one should take their risk on the equity side? I used the longest data set I could find, and it does not support that premise.

And yes, I used Sharpe ratio as my measure. Can you think of a better one?
Last edited by Call_Me_Op on Thu Jul 19, 2018 8:19 am, edited 1 time in total.
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Re: Why Take Risk on Equity Side?

Post by SimpleGift » Thu Jul 19, 2018 8:18 am

Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
As a conservative investor, the greatest drawback of high yield bonds in my view is their equity-like risk during market meltdowns. For the 2007-2012 period, the chart below shows S&P 500 stocks in yellow, high-yield bonds in orange, and total bond market in the little green squiggles up at the top.
Granted, it's an extreme example, but many investors hold bonds in their portfolios to balance the risk of stocks during just such extreme crisis events. Personally, during 2008-09, when the stability and survival of the global financial system were in question, having a large allocation to high-quality bonds was our only real solace.
Last edited by SimpleGift on Thu Jul 19, 2018 8:23 am, edited 1 time in total.
Cordially, Todd

Call_Me_Op
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Re: Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 8:22 am

SimpleGift wrote:
Thu Jul 19, 2018 8:18 am
Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
As a conservative investor, the greatest drawback of high yield bonds in my view is their equity-like risk during market meltdowns. For the 2007-2012 period, the chart below shows S&P 500 stocks in yellow, high-yield bonds in orange, and total bond market in the little gray squiggles up at the top.
Granted, it's an extreme example, but many investors hold bonds in their portfolios to balance the risk of stocks during just such extreme crisis events. Personally, during 2008-09, when the stability and survival of the global financial system were in question, having a large allocation to high-quality bonds was our only real solace.
Yes, but equities went down much more the HY bonds. I am not suggesting that we view HY bonds as "safe" the way we would view treasury bonds. I am simply asking why not add some HY bonds in one's RISK portfolio as a diversifier? While all risk assets were highly correlated in 2008, that was a short-term phenomenon. Over time, it appears that HY bonds can provide a diversification benefit, since equity risk and credit risk correlation varies and is sometime low.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Why Take Risk on Equity Side?

Post by bigred77 » Thu Jul 19, 2018 8:29 am

Well, your looking at 2 asset classes in isolation. It would be better to take a portfolio wide look.

You know what has higher risk adjusted returns than 100% HY Corp Bonds? 60% US stocks and 40% HY Corp Bonds.

You know what has even higher risk adjusted returns? 60% Us stocks and 40% intermediate term treasuries.

The absolute returns also fall as one would expect along the risk/return spectrum (100% high yield -> 60/40 using treasuries -> 60/40 using high yield).

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SimpleGift
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Re: Why Take Risk on Equity Side?

Post by SimpleGift » Thu Jul 19, 2018 8:31 am

Call_Me_Op wrote:
Thu Jul 19, 2018 8:22 am
I am not suggesting that we view HY bonds as "safe" the way we would view treasury bonds. I am simply asking why not add some HY bonds in one's RISK portfolio as a diversifier?
Thanks, now I understand your point. In that case, wouldn't high-yield bonds be viewed as sort of "equity light"? If the purpose of one's risk portfolio is to maximize real (inflation-adjusted), after-tax returns, wouldn't other true stock asset classes offer higher expected long-term returns with just marginally less diversification benefits?
Cordially, Todd

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Re: Why Take Risk on Equity Side?

Post by AlohaJoe » Thu Jul 19, 2018 8:36 am

Another example of this is Emerging Markets Equities versus Emerging Markets Bonds. Or reinsurance :twisted:

I think the saying "take your risk on the equity side" doesn't really mean much and feels like a hold over from simplistic CAPM analysis where there are only two things to invest in.

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Re: Why Take Risk on Equity Side?

Post by Valuethinker » Thu Jul 19, 2018 9:09 am

AlohaJoe wrote:
Thu Jul 19, 2018 8:36 am
Another example of this is Emerging Markets Equities versus Emerging Markets Bonds. Or reinsurance :twisted:

I think the saying "take your risk on the equity side" doesn't really mean much and feels like a hold over from simplistic CAPM analysis where there are only two things to invest in.
The question is whether credit risk is a separate factor from equity and interest rate returns.

It's almost certainly separate from interest rates.

The real debate is whether Credit risk is genuinely a risk factor (alongside size, value, momentum) that is uncorrelated, or simply another form of equity risk.

That's the line of thinking that Larry Swedroe goes down. FWIW Rick Ferri thinks it is, and worth having. Larry Swedroe thinks that it is not.

I think it is pretty much established that adding junk bonds* to a bond-equity portfolio increases its correlation with equities.

* Investment Grade corporate bonds as well.

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9-5 Suited
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Re: Why Take Risk on Equity Side?

Post by 9-5 Suited » Thu Jul 19, 2018 9:33 am

Using Portfolio Visualizer, you can see (for the one dataset of returns from 1970 mind you) that there's an issue of the assets not mixing quite as well in terms of risk-adjusted return.

50% TSM/50% Int. Treasuries: 9.90% CAGR | 0.66 Sharpe Ratio | 21% Max Drawdown
50% TSM/50% HY Corp Bonds: 10.15% CAGR | 0.58 Sharpe Ratio | 36% Max Drawdown

Other posters have shown in previous threads that you are probably better off with a shade more equity and safer bonds for these reasons. The assets have a better relationship as part of a portfolio. With corporate bonds, your risks are likely to occur at the same time equities fall.

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Re: Why Take Risk on Equity Side?

Post by msk » Thu Jul 19, 2018 9:38 am

Before I discovered Portfolio Visualizer I did my own homework for 1966 to 2016. These are the results I got:

SP500 appreciation, compounded: 6.6%
Average Annual Dividend: 3.1% (NB do not forget tax on that!)
Inflation, compounded: 4%

My conclusion, and later confirmed by PV Monte Carlo simulations:
I can withdraw 5% of my portfolio annually, but never exceed 5%, and my remaining portfolio will keep its worth in real terms forever. The annual withdrawals will also keep pace with inflation, on average, forever. Hence I went for 100% stocks. Used to own a lot of RE, now all sold, but never owned a bond, and do not ever plan on buying any. To me it makes sense that bonds can never yield so much that companies cannot afford to borrow to invest. Occasional aberrations may happen...

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Re: Why Take Risk on Equity Side?

Post by aristotelian » Thu Jul 19, 2018 9:47 am

Seems to me that you are best off treating High Yield (junk) bonds as an "alternative" that are riskier than investment grade bonds and more highly correlated to stock than Treasuries, but with lower expected returns than stocks. They are not really a substitute for either stocks or bonds, but if you want to hold some as part of your portfolio I would not begrudge you.

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Re: Why Take Risk on Equity Side?

Post by Call_Me_Op » Thu Jul 19, 2018 10:04 am

SimpleGift wrote:
Thu Jul 19, 2018 8:31 am
Call_Me_Op wrote:
Thu Jul 19, 2018 8:22 am
I am not suggesting that we view HY bonds as "safe" the way we would view treasury bonds. I am simply asking why not add some HY bonds in one's RISK portfolio as a diversifier?
Thanks, now I understand your point. In that case, wouldn't high-yield bonds be viewed as sort of "equity light"? If the purpose of one's risk portfolio is to maximize real (inflation-adjusted), after-tax returns, wouldn't other true stock asset classes offer higher expected long-term returns with just marginally less diversification benefits?
Sure - that is certainly an argument that can be proposed. I am really just trying to understand the justification for the advice to "take risk on the equity side." Another potentially appealing asset class we could discuss in this context is emerging market bonds.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

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Re: Why Take Risk on Equity Side?

Post by AlohaJoe » Thu Jul 19, 2018 10:16 am

9-5 Suited wrote:
Thu Jul 19, 2018 9:33 am
Using Portfolio Visualizer, you can see (for the one dataset of returns from 1970 mind you) that there's an issue of the assets not mixing quite as well in terms of risk-adjusted return.

50% TSM/50% Int. Treasuries: 9.90% CAGR | 0.66 Sharpe Ratio | 21% Max Drawdown
50% TSM/50% HY Corp Bonds: 10.15% CAGR | 0.58 Sharpe Ratio | 36% Max Drawdown

Other posters have shown in previous threads that you are probably better off with a shade more equity and safer bonds for these reasons. The assets have a better relationship as part of a portfolio. With corporate bonds, your risks are likely to occur at the same time equities fall.
You have misunderstood the OP, in the same way that SimpleGift did. The OP re-explained himself to SimpleGift, so you should check out those posts.

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Re: Why Take Risk on Equity Side?

Post by nedsaid » Thu Jul 19, 2018 10:23 am

People has discussed High Dividend stocks as a surrogate bond and now we are considering High Yield Bonds as a Stock substitute. If I want bonds, I want real bonds. If I want stocks, I want real stocks. The real thing rather than the substitute. I take risk on the equity side because I want return, I own bonds for income and lower volatility. Having said all of that, experts disagree about High Yield or Junk Bonds. Rick Ferri believes High Yield Debt is worth owning as an asset class where Larry Swedroe distains them. My take is that High Yield might have a mild diversification benefit in a portfolio, there is a case for them but it is a relatively weak one.
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Re: Why Take Risk on Equity Side?

Post by azanon » Thu Jul 19, 2018 10:31 am

bigred77 wrote:
Thu Jul 19, 2018 8:29 am
Well, your looking at 2 asset classes in isolation. It would be better to take a portfolio wide look.

................

You know what has even higher risk adjusted returns? 60% Us stocks and 40% intermediate term treasuries.
And you know what has virtually the same Sharpe ratio, half the max drawdown, yet still a 4.52% real return over 39 years? 60% HY bonds and 40% IT Treasuries.

Are most people pretty happy if they can get 4% real long term? Looks like having stocks at all needs an argument.

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Re: Why Take Risk on Equity Side?

Post by MJW » Thu Jul 19, 2018 10:33 am

I remember a discussion on this topic a while back (can't seem to find it) and I believe the conclusion was that HY bonds historically haven't produced the diversification benefit you would want from including it as an "alternative" asset in addition to stocks and "safety" bonds.

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Re: Why Take Risk on Equity Side?

Post by azanon » Thu Jul 19, 2018 10:39 am

nedsaid wrote:
Thu Jul 19, 2018 10:23 am
People has discussed High Dividend stocks as a surrogate bond and now we are considering High Yield Bonds as a Stock substitute. If I want bonds, I want real bonds. If I want stocks, I want real stocks. The real thing rather than the substitute. I take risk on the equity side because I want return, I own bonds for income and lower volatility. Having said all of that, experts disagree about High Yield or Junk Bonds. Rick Ferri believes High Yield Debt is worth owning as an asset class where Larry Swedroe distains them. My take is that High Yield might have a mild diversification benefit in a portfolio, there is a case for them but it is a relatively weak one.
I'm not tracking. High Dividend stocks and high yield bonds are real stocks and bonds, respectively. Rick specifically recognizes HY bonds as real bonds, and intentionally adds them because Total Bond fund leaves them out.

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Re: Why Take Risk on Equity Side?

Post by azanon » Thu Jul 19, 2018 10:42 am

azanon wrote:
Thu Jul 19, 2018 10:31 am
bigred77 wrote:
Thu Jul 19, 2018 8:29 am
Well, your looking at 2 asset classes in isolation. It would be better to take a portfolio wide look.

................

You know what has even higher risk adjusted returns? 60% Us stocks and 40% intermediate term treasuries.
And you know what has virtually the same Sharpe ratio, half the max drawdown, yet still a 4.52% real return over 39 years? 60% HY bonds and 40% IT Treasuries.

Are most people pretty happy if they can get 4% real long term? Looks like having stocks at all needs an argument.
Let me add, that I do find the topic fascinating. Fascinating that one could have such a really odd portfolio, but statistically speaking, it appears to be quite rational. Now I wouldn't do it, but that math is hard to argue with.

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Re: Why Take Risk on Equity Side?

Post by jeffyscott » Thu Jul 19, 2018 2:40 pm

My understanding is that the true meaning of taking risk on equity side would mean investing only in equities and treasuries (maybe CDs also). This means excluding even investment grade corporate bonds.

This view comes from the concept that all corporate bonds are effectively some sort of hybrid of stock and treasuries. It also, IMO, comes from viewing all available investments as if the models of them are reality, instead of just being models/approximations based on past history.

I disagree with this shunning of risky bonds.
press on, regardless - John C. Bogle

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Re: Why Take Risk on Equity Side?

Post by azanon » Thu Jul 19, 2018 2:48 pm

Trying to exclude either "risky" bonds (anything not treasuries), or stocks is trying to be smarter than the global market portfolio. Both stocks, and investment-grade bonds are huge components of the global market portfolio. So excluding either one is definitely taking an active investing strategy given the sheer size of both asset classes. The sum total of investment grade debt worldwide is at least 20%, and I believe quite a bit more than that. Equities are at least 35%.

So I suggest always end up boglehead: own the market, don't leave huge pieces of that market out, and pay as little for owning it as possible.

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Re: Why Take Risk on Equity Side?

Post by willthrill81 » Thu Jul 19, 2018 3:43 pm

Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
I have been an advocate of "taking your risk on the equity side." However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
I don't think your question should be framed as whether high-yield bonds have a higher risk-adjusted return than stocks but whether high-yield bonds have a higher risk-adjusted return than a mix of stocks and safer bonds.

From 1979-2018, high-yield bonds had a Sharpe ratio of .53. A mix of 30% TSM and 70% ITT had a Sharpe ratio of .70. The latter also had higher returns, a smaller standard deviation, and a far smaller maximum drawdown (-9.96% vs. -28.90%). The latter provided higher returns and less risk.

I believe that this is what Larry is referring to. The risk-adjusted returns of each piece of a portfolio are not as important as that of the entire portfolio.

If all you wanted was to hold the one asset class that had the highest historical risk-adjusted returns, I believe that would be short-term Treasuries (Sharpe = .54 from 1979 to today).
Last edited by willthrill81 on Thu Jul 19, 2018 3:48 pm, edited 2 times in total.
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Re: Why Take Risk on Equity Side?

Post by vineviz » Thu Jul 19, 2018 3:48 pm

willthrill81 wrote:
Thu Jul 19, 2018 3:43 pm
Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
I have been an advocate of "taking your risk on the equity side." However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
I don't think your question should be framed as whether high-yield bonds have a higher risk-adjusted return than stocks but whether high-yield bonds have a higher risk-adjusted return than a mix of stocks and safer bonds.

From 1979-2018, high-yield bonds had a Sharpe ratio of .53. A mix of 30% TSM and 70% ITT had a Sharpe ratio of .70. The latter also had higher returns, a smaller standard deviation, and a far smaller maximum drawdown (-9.96% vs. -28.90%).

I believe that this is what Larry is referring to. The risk-adjusted returns of each piece of a portfolio are not as important as that of the entire portfolio.
Corporations with high-yield debt tend to be mid-cap stocks. Building a portfolio of midcap stocks and intermediate treasuries might have an even better match and a better Sharpe ratio.
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Re: Why Take Risk on Equity Side?

Post by columbia » Thu Jul 19, 2018 5:10 pm

Here’s a comparison since 1979:

1/3 stocks, 1/3 treasuries, 1/3 junk bonds

Vs.

1/2 stocks, 1/2 treasuries

https://www.portfoliovisualizer.com/bac ... hYield1=33

Pretty similar returns with 34% instead of 50% stocks. The question is, what would have someone “gained” with the former approach? The standard deviation was indeed lower, but certainly not that much lower and the Sharpe ratios were apart by .01.
Last edited by columbia on Thu Jul 19, 2018 5:13 pm, edited 1 time in total.

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Re: Why Take Risk on Equity Side?

Post by mptfan » Thu Jul 19, 2018 5:13 pm

Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
I have been an advocate of "taking your risk on the equity side." However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
Thank you. You have hit on a pet peeve of mine, where is it written that you should "take your risk on the equity side"? Says whom? What's wrong with taking risk on investments other than equities?

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Re: Why Take Risk on Equity Side?

Post by raven15 » Thu Jul 19, 2018 5:23 pm

https://www.portfoliovisualizer.com/eff ... tion3_1=25

It looks like the tangent portfolio was about 60% intermediate treasuries, 20% stocks, 20% junk bonds (limited to analyzing those three). The efficient frontier for higher return portfolios (50% stocks or more) was limited to stocks and treasuries only.

The minimum volatility portfolio was an azanon-like 60% treasuries 40% junk bonds.

Sharpe ratio is not edible. What allocation provided the maximum perpetual withdrawal rate?

I decided to take my credit risk on the municipal bond side, at least those are completely separate entities from corporations.
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Re: Why Take Risk on Equity Side?

Post by whomever » Thu Jul 19, 2018 5:34 pm

"By the way, that is the longest data set available on PV - so absolutely no cherry-picking."

A note of caution: 'cherry picking', which I would define as deliberately picking endpoints to get a desired result is obviously bad, but just looking at a single pair of endpoints can still be dangerous. If it's July and I want to understand the weather in Minnesota and find a database that has daily temps for the last 90 days, I'm going to be surprised next January even though I used all the available data. Any bond series data that mostly overlaps with the great bond bull market deserves a little side eye.

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Re: Why Take Risk on Equity Side?

Post by galeno » Thu Jul 19, 2018 5:37 pm

I would use one HY bond ETF as a diversifier if we ever decided to go below 40% equities.

E.g. 40% FTSE all world equity ETF would become 30% FTSE all world equity ETF + 10% HY bond ETF.

The perfect retirement portfolio: 30% FTSE all world equity ETF + 10% HY bond ETF + 40% TBM + 15% TIPS = 5% CASH.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Why Take Risk on Equity Side?

Post by MathWizard » Thu Jul 19, 2018 5:49 pm

simplesimon wrote:
Thu Jul 19, 2018 7:58 am
Would you categorize your high-yield bond allocation under equity or bonds when looking at total stock and bond mix?
I count them like stocks. I do have some, but I don't expect them to act like investment grade bonds.

I'm old enough to remember when high yield bonds were called junk bonds.

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permport
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Re: Why Take Risk on Equity Side?

Post by permport » Thu Jul 19, 2018 6:08 pm

I'm personally quite partial to the philosophy of risk parity.. that one should have equal risks coming from all portions of the portfolio -- whether they be stocks, bonds, or anything else. Just me though.
Buy right and hold tight.

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Re: Why Take Risk on Equity Side?

Post by azanon » Thu Jul 19, 2018 6:58 pm

permport wrote:
Thu Jul 19, 2018 6:08 pm
I'm personally quite partial to the philosophy of risk parity.. that one should have equal risks coming from all portions of the portfolio -- whether they be stocks, bonds, or anything else. Just me though.
I'm a fan of risk parity too and I'm glad you brought that up.

When I've heard Ray Dalio talk about asset classes, his view - or the risk parity view - is that most asset classes pay approximately the return they're supposed to pay, given their level of risks. So that strategy takes advantage of that fact by levering up the less risky asset classes to have "risk parity" with more risky ones. So thumbing through these posts here, it looks like the numbers are actually coming out so close that, more or less, Dalio's observation seems to be the case when comparing HY bonds vs. stocks.

So I think to answer the original question, for the most part, is that it really doesn't matter too much where you take your risk. If there were any sort of significant, risk-adjusted price disparities, the market collective would immediately adjust to eliminate that because million of eyes are constantly scanning for the optimal investment deal.

When it comes down to the math of it, what really usually has stocks winning out over many of these more exotic choices is costs. You can buy a stock fund for, what like 4 basis points, but you're going to pay a lot more for a HY bond fund, convertible fund, or something else more exotic. So costs end up being the deciding factor.

Another final thought, is that this is why you'll hear wise people say pick an investment strategy and stick with it. Mebane Faber found this to be true in his global asset allocation book I believe, and actually also verified that the one thing that can potentially cause a solid strategy to underperform many other equally viable solid strategies is if you pay too much to implement your specific one.

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Re: Why Take Risk on Equity Side?

Post by Theoretical » Thu Jul 19, 2018 7:17 pm

With high yields it’s also important to note that there are major differences in quality and viability between fallen angels and original issue junk.

The former category has the interesting characteristic of gaining company diversification in times of credit downgrades, with some nice recovery benefits as the economy turns around. The latter category is in some ways a lose lose because it’s already at or near par and has that much farther up to go.

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Re: Why Take Risk on Equity Side?

Post by stlutz » Thu Jul 19, 2018 8:18 pm

Here’s a comparison since 1979:

1/3 stocks, 1/3 treasuries, 1/3 junk bonds

Vs.

1/2 stocks, 1/2 treasuries

https://www.portfoliovisualizer.com/bac ... hYield1=33

Pretty similar returns with 34% instead of 50% stocks. The question is, what would have someone “gained” with the former approach? The standard deviation was indeed lower, but certainly not that much lower and the Sharpe ratios were apart by .01.
Interesting!

However, I tried the same exercise using the Simba/Siamond spreadsheet and the later portfolio ends up with a somewhat higher Sharpe ratio (.64 vs. .59). I think the difference actual arises from them using different series for T-Note returns (they are using the same VG fund for HY returns).

That's not to pick one dataset over another (I'm partial to Siamond just because the process was so transparent on how it was assembled), but is to note that seemingly insignificant changes (e.g. using "intermediate" treasuries with a somewhat different duration) can have a higher impact than you think.

My own view is that if you care more about portfolio efficiency than diversification, then stick with Treasuries. From a how-much-of-my-portfolio-could-theoretically-go-to-zero perspective, I prefer 50% Treasuries than 33%. If you care more about diversification, then include the HY bonds. Holding more assets increases the chances that you'll be appropriately compensated for the risks you are taking than if you just concentrate in one type of asset. Both approaches are legitimate; pick which you care more about (efficiency or diversification).

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Re: Why Take Risk on Equity Side?

Post by TVD » Thu Jul 19, 2018 8:37 pm

Great posts but 2 points:
1. HY bonds never saw a bond bear market and wont likely survive one.
2. Bridgewater will make Madoff look like childs play IMHO.

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Re: Why Take Risk on Equity Side?

Post by jeffyscott » Thu Jul 19, 2018 9:29 pm

stlutz wrote:
Thu Jul 19, 2018 8:18 pm
My own view is that if you care more about portfolio efficiency than diversification, then stick with Treasuries. From a how-much-of-my-portfolio-could-theoretically-go-to-zero perspective, I prefer 50% Treasuries than 33%. If you care more about diversification, then include the HY bonds. Holding more assets increases the chances that you'll be appropriately compensated for the risks you are taking than if you just concentrate in one type of asset. Both approaches are legitimate; pick which you care more about (efficiency or diversification).
But it is not just about HY, investment grade corporates are also to be shunned. As you noted for efficiency you would stick with only treasuries. Many here seem to think investment grade corporates meet the criterion of "take risk on equity side", they don't.

As Swedroe states it: "including credit risk in the bond portion of the portfolio is not an efficient way to construct it".
here: http://www.etf.com/sections/index-inves ... nopaging=1

Anyone using the total bond fund, such as in the 3 fund portfolio, is taking credit risk in the bond portion of the portfolio. Total bond fund contains corporate bonds and therefore includes credit risk.
press on, regardless - John C. Bogle

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Re: Why Take Risk on Equity Side?

Post by danielc » Thu Jul 19, 2018 9:41 pm

Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
I have been an advocate of "taking your risk on the equity side." However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds? I noticed also that the correlation with US stocks has been 0.58, which is not too high - so may be a decent diversifier.
Take those numbers with a huge grain of salt. For example, you'll notice that according Portfolio Visualizer, junk bonds always have better Sharpe ratios than investment grade-corporates, and investment-grade corporates always have better Sharpe raios than treasuries. What I think is happening is that the Sharpe ratio is mindlessly looking at just the standard deviation and ignoring other aspects of return, like the risk of default (credit risk) which mainly shows up when the market crashes, or the fact that corporate bonds (especially junk bonds) tend to crash precisely when the market crashes. A simple standard deviation doesn't capture those things.

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Re: Why Take Risk on Equity Side?

Post by danielc » Thu Jul 19, 2018 9:42 pm

Call_Me_Op wrote:
Thu Jul 19, 2018 7:59 am
software wrote:
Thu Jul 19, 2018 7:56 am
Those results probably have a lot to do with your dataset. Not suggesting you purposefully cherrypicked dates, but those dates happen to include a 30 year bull run for bonds which is just recently coming to a close.
Why would that affect risk-adjusted return? I can see that it would boost raw return.

By the way, that is the longest data set available on PV - so absolutely no cherry-picking.
If you boost returns without changing the volatility, you boost Sharpe ratios.

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Re: Why Take Risk on Equity Side?

Post by siamond » Thu Jul 19, 2018 9:43 pm

Call_Me_Op wrote:
Thu Jul 19, 2018 7:48 am
However, I noticed that from 1979-2018 (the maximum time period that Portfolio Visualizer has data) the risk-adjusted return for high-yield corporate bonds in actually slightly higher than the risk-adjusted return for the US stock market. Why then should one take their risk on the equity side? Why not also hold some high-yield bonds?
A puzzling thing is that, for the same time period, and similar data sources, the PortfolioVisualizer computation that you reported is wildly inconsistent with the (more intuitive) outcome of the Simba backtesting spreadsheet, where the Sharpe ratio for the 1979-2017 time period is squarely in favor of Total-Stock-Market.

I didn't take the time to truly get to the bottom of it, but I strongly suspect this is a consequence of making monthly computations (PV) as opposed to annual computations (Simba). I know that standard deviation numbers can't easily be compared between monthly math and annual math.

I am mentioning this arcane point because I think it shows well that using such metrics is a touchy business. Change a subtle underlying assumption and you might reach a very different conclusion. This could be the start/end date, it could be the periodicity of the samplings, etc. Personally, I really dislike those ratios (Sharpe, Sortino, whatever). They mix up units (e.g. divide an apple by an orange) and end up with an artificial number without any direct intuitive semantics. Better look at returns and standard deviation and other metrics as distinct quantities, over multiple time periods.

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Re: Why Take Risk on Equity Side?

Post by raven15 » Thu Jul 19, 2018 10:26 pm

siamond wrote:
Thu Jul 19, 2018 9:43 pm
Better look at returns and standard deviation and other metrics as distinct quantities.
The two that matter to me are:
accumulation stage - shortest and most reliable expected median time to meet saving objective at given saving rate
withdrawal stage - maximum expected safe withdrawal rate

The others can be interesting, but not useful to me personally. So, if junk bonds increase the Sharpe Ratio or some other "risk-adjusted return" metric, I personally find that rather useless.
It's Time. Adding Interest.

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Re: Why Take Risk on Equity Side?

Post by willthrill81 » Thu Jul 19, 2018 10:32 pm

raven15 wrote:
Thu Jul 19, 2018 10:26 pm
The two that matter to me are:
accumulation stage - shortest and most reliable expected median time to meet saving objective at given saving rate
Shortest = all stocks
Most reliable = likely a mix of some stocks and mostly bonds
raven15 wrote:
Thu Jul 19, 2018 10:26 pm
withdrawal stage - maximum expected safe withdrawal rate
Using which data and asset classes?

Depending on how strong of a believer you are in backtested performance, the Golden Butterfly portfolio might be appealing to you. Since 1970, it's 15 year rolling returns have all been between about 5.2% and 7.9%, remarkable consistency. It's longest drawdown was just two years. And with a 50% savings rate, you would have hit financial independence between 11 and 13 years every time. It's safe withdrawal rate over 30 years was an incredible 6.5%.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Why Take Risk on Equity Side?

Post by raven15 » Thu Jul 19, 2018 10:56 pm

willthrill81 wrote:
Thu Jul 19, 2018 10:32 pm
raven15 wrote:
Thu Jul 19, 2018 10:26 pm
The two that matter to me are:
accumulation stage - shortest and most reliable expected median time to meet saving objective at given saving rate
Shortest = all stocks
Most reliable = likely a mix of some stocks and mostly bonds
raven15 wrote:
Thu Jul 19, 2018 10:26 pm
withdrawal stage - maximum expected safe withdrawal rate
Depending on how strong of a believer you are in backtested performance, the Golden Butterfly portfolio might be appealing to you. Since 1970, it's 15 year rolling returns have all been between about 5.2% and 7.9%, remarkable consistency. It's longest drawdown was just two years. And with a 50% savings rate, you would have hit financial independence between 11 and 13 years every time. It's safe withdrawal rate over 30 years was an incredible 6.5%.
I'm familiar with it ;). It is too light on stocks for my taste and international stocks especially. I use the "perpetual withdrawal" option because I hope to have way more than 30 years, and that leads to a higher stock allocation being more optimal. Which agrees well with other sources.
Using which data and asset classes?
Whatever I can find!
It's Time. Adding Interest.

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Re: Why Take Risk on Equity Side?

Post by JBTX » Thu Jul 19, 2018 11:00 pm

I see countless threads in here where people take data, usually some subset of late 70's to now, and reach some conclusion on it. I am not sure how anyone can make generalized observations during a time when interest rates have dropped dramatically, inflation (and expectations) have dropped dramatically, and stocks have been on a 35 year tear.

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Re: Why Take Risk on Equity Side?

Post by willthrill81 » Thu Jul 19, 2018 11:07 pm

JBTX wrote:
Thu Jul 19, 2018 11:00 pm
I see countless threads in here where people take data, usually some subset of late 70's to now, and reach some conclusion on it. I am not sure how anyone can make generalized observations during a time when interest rates have dropped dramatically, inflation (and expectations) have dropped dramatically, and stocks have been on a 35 year tear.
I don't recall the authors, but I read an academic paper last year where they analyzed bond returns since the early 1980s and found that declining rates over the subsequent ~35 years boosted returns by about 1%. So even if that trajectory were reversed, and I don't think that many believe that it will, bonds would be facing about a 1% headwind, or 2% lower returns than prior.

But of course the bigger issue is that yields are coming up from a very low point, and yield is where bonds' returns mainly reside. For TBM, the current yield is likely about the best indicator we have of the next 10 years' returns. And if inflation holds steady, that means that TBM will probably have a real return of close to zero over the next decade. So I agree that bonds are unlikely to repeat the performance of the last ~35 years for the 'foreseeable' future.

Regarding stocks being on a 35 year tear, do you consider 2000-2009, a period with cumulative real losses, to be part of that? Returns from the early 1980s until 2000 were stellar, but 2000 - current has just been so-so (real annualized return of 3.5%).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Why Take Risk on Equity Side?

Post by HomerJ » Thu Jul 19, 2018 11:15 pm

azanon wrote:
Thu Jul 19, 2018 10:31 am
And you know what has virtually the same Sharpe ratio, half the max drawdown, yet still a 4.52% real return over 39 years? 60% HY bonds and 40% IT Treasuries.

Are most people pretty happy if they can get 4% real long term? Looks like having stocks at all needs an argument.
Are you stating that every 39-year period going forward will have the same results as 1979-2018?

You guys realize that bonds were paying like 10%-15% in the late 70s, early 80s, right? And then interest rates mostly went down over the next 39 years? Right?

Are we in a similar situation today?
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Re: Why Take Risk on Equity Side?

Post by nedsaid » Thu Jul 19, 2018 11:45 pm

azanon wrote:
Thu Jul 19, 2018 10:39 am
nedsaid wrote:
Thu Jul 19, 2018 10:23 am
People has discussed High Dividend stocks as a surrogate bond and now we are considering High Yield Bonds as a Stock substitute. If I want bonds, I want real bonds. If I want stocks, I want real stocks. The real thing rather than the substitute. I take risk on the equity side because I want return, I own bonds for income and lower volatility. Having said all of that, experts disagree about High Yield or Junk Bonds. Rick Ferri believes High Yield Debt is worth owning as an asset class where Larry Swedroe distains them. My take is that High Yield might have a mild diversification benefit in a portfolio, there is a case for them but it is a relatively weak one.
I'm not tracking. High Dividend stocks and high yield bonds are real stocks and bonds, respectively. Rick specifically recognizes HY bonds as real bonds, and intentionally adds them because Total Bond fund leaves them out.
You are not tracking because you didn't read what I wrote. High Dividend stocks were viewed by many people as a Bond surrogate, I have argued that High Dividend stocks are still stocks. Call_Me_Opp was suggesting that High Yield is sort of a stock surrogate, but I would say that High Yield bonds are still bonds though with some equity characteristics. To me, the discussion should be whether or not High Yield bonds add diversification to a portfolio. The opinion is split on this. My thoughts are that High Yield probably has mild diversification benefits. For the record, I have a small sliver of High Yield bonds in a quirky balanced fund that I own. Nearly all of my bonds are investment grade, probably 97% or so.
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