Bond Investing when Yield Curve is Flat

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Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 05, 2019 2:31 pm

While doing some research on Treasury yield calculations I came upon this recent article from schwab.

Barbells and Bond Ladders: How to Invest When the Yield Curve is Flat
https://www.schwab.com/resource-center/ ... ve-is-flat

"Key Points
Although the yields offered on longer-term bonds are only modestly higher than those with short maturities, investors should still consider extending the average maturities of their bond holdings.

A bond barbell is a tactical strategy that focuses on bonds with two different types of maturities—some short-term bonds and some longer-term bonds.

A bond ladder is a type of “all-weather” strategy that is meant to help provide predictable income with the flexibility to reinvest bonds as they mature."

Previously I had a 7-3 rolling Treasury ladder to capture the roll down yield effect with the additional of a 1-3 fund/etf as a contingency reserve. As the yield curve has flattened I have been replacing the ladder rungs at 3 years with T-bills instead of buying a new 7. The article suggests that this may not be the best approach.

Any thoughts.

(For those not familiar with the Roll Down yield look here for a quick description: https://www.investopedia.com/terms/r/rolldownreturn.asp )
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Re: Bond Investing when Yield Curve is Flat

Post by Northern Flicker » Sat Oct 05, 2019 5:09 pm

Treasury and TIPS fund ERs are so low that you probably have higher cost managing a ladder with retail instead of wholesale transaction costs.

The ladder gives you liquidity at par at fixed points in time, but also means you have higher reinvestment risk by concentrating reinvestment at specific points in time. A bond fund diversified the reinvestment points over time.

I don’t think you can time the yield curve.
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Re: Bond Investing when Yield Curve is Flat

Post by dual » Sat Oct 05, 2019 5:31 pm

Northern Flicker wrote:
Sat Oct 05, 2019 5:09 pm
Treasury and TIPS fund ERs are so low that you probably have higher cost managing a ladder with retail instead of wholesale transaction costs.
Why not buy the Treasuries at auction? Most brokers do not charge commission-Vanguard, Fidelity, Schwab, TDAmeritrade, Etrade do not charge but notably MerrillEdge does charge.

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Re: Bond Investing when Yield Curve is Flat

Post by jebmke » Sat Oct 05, 2019 5:46 pm

Treasuries are easy to buy and sell and there is no commission.
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Re: Bond Investing when Yield Curve is Flat

Post by Northern Flicker » Sat Oct 05, 2019 6:04 pm

You still don’t get to diversify the portfolio turnover days and reinvestment interest rate across many days of the year without taking on a major management headache of frequent ladder maturities.
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Re: Bond Investing when Yield Curve is Flat

Post by Call_Me_Op » Sun Oct 06, 2019 6:48 am

Right now, I am staying mostly short (Pascal's Wager).
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sun Oct 06, 2019 7:23 am

Northern Flicker wrote:
Sat Oct 05, 2019 6:04 pm
You still don’t get to diversify the portfolio turnover days and reinvestment interest rate across many days of the year without taking on a major management headache of frequent ladder maturities.
A rolling return ladder over the "fat" part of the yield curve only needs 4 or 5 rungs to be effective. And there is no reinvestment risk because unlike a fund, you do not have to sell when your rung reaches the original sell point if the yield curve moves adversely.

We are talking Treasuries. You don't need to diversify credit risks.

The rolling ladder (notes not held maturity) is a well accepted procedure under normal yield curve conditions. What the Schwab paper is addressing is it's application in flat conditions. AKA now.
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Re: Bond Investing when Yield Curve is Flat

Post by Horton » Sun Oct 06, 2019 7:37 am

Since when did bonds with maturities between 7 and 10 years become classified as long term? :mrgreen:

I don’t think this article delves appropriately enough into an interesting debate. In essence, the author is advocating a blend of short and intermediate bond funds. Total Bond or an intermediate Treasury fund are going to perform similarly to such strategy.

The more interesting topic would be whether investors should blend a short term fund with a true long term fund (duration of 15+ years) to match their investment horizon, to borrow a term that vineviz repeats often.
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Re: Bond Investing when Yield Curve is Flat

Post by Mountain Doc » Sun Oct 06, 2019 7:53 am

Doc wrote:
Sun Oct 06, 2019 7:23 am
The rolling ladder (notes not held maturity) is a well accepted procedure under normal yield curve conditions.
I probably don't fully understand a rolling ladder, but it doesn't seem like there is any free lunch there even under normal yield curve conditions. Yes, after four years your 7-year bonds become kind of like 3-year bonds. But your bond is not like other 3-year bonds on the market, because it has the higher 7-year bond coupon payments. Isn't the price appreciation just compensation for giving up those remaining coupons, which are larger than you will get by buying a different 3-year bond? Selling them seems like a wash compared with just holding to maturity, assuming you do want some bonds maturing in 1-3 years (which it sounds like you do).

I suspect Doc is much more knowledgable about bonds than me, so I will look forward to being corrected :happy

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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Sun Oct 06, 2019 8:30 am

Assuming you maintain a ladder for TRSY's in a normal market isn't it a better time to sell this year ? There's cap gains to be had and spent. In a screwy bond market like today when all rates are low what advise can be given ? TRSY's can still rise when the market deflates.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sun Oct 06, 2019 8:34 am

Mountain Doc wrote:
Sun Oct 06, 2019 7:53 am
Yes, after four years your 7-year bonds become kind of like 3-year bonds. But your bond is not like other 3-year bonds on the market, because it has the higher 7-year bond coupon payments. Isn't the price appreciation just compensation for giving up those remaining coupons, which are larger than you will get by buying a different 3-year bond? Selling them seems like a wash compared with just holding ...
What you are missing is that you get that the compensation for those remaining coupons now, not spread over the next three years. It is not that you get more money that counts, you just get that money sooner. Moreover depending on your tax situation that money may be LTCG not ordinary income.

Also it is not "timing the market" as some have implied because if the curve has moved adversely just don't sell. So if anything that "market timing" is after the fact.

Now if we decided today that given the current yield curve we should let out ladder roll off that might be considered market timing which is what the the linked paper is all about.
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Re: Bond Investing when Yield Curve is Flat

Post by Mountain Doc » Sun Oct 06, 2019 8:41 am

Doc wrote:
Sun Oct 06, 2019 8:34 am
What you are missing is that you get that the compensation for those remaining coupons now, not spread over the next three years. It is not that you get more money that counts, you just get that money sooner. Moreover depending on your tax situation that money may be LTCG not ordinary income.

Also it is not "timing the market" as some have implied because if the curve has moved adversely just don't sell. So if anything that "market timing" is after the fact.

Now if we decided today that given the current yield curve we should let out ladder roll off that might be considered market timing which is what the the linked paper is all about.
So do you think the treasury market is mispricing the time value of money between a 7-year bond with 3 years to go, and a new 3-year bond? I would be highly skeptical that the treasury market is pricing that inefficiently.

Converting income to LTCG could have some value, though.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sun Oct 06, 2019 9:11 am

Mountain Doc wrote:
Sun Oct 06, 2019 8:41 am
So do you think the treasury market is mispricing the time value of money between a 7-year bond with 3 years to go, and a new 3-year bond? I would be highly skeptical that the treasury market is pricing that inefficiently.
No not inefficiency. The point of the "Roll Down Return" ladder is just to get the return from your fixed income portfolio sooner than waiting until it matures.

With today's yield curve I don't see much benefit other than the tax aspects but the Schwab paper seems to imply otherwise.
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Re: Bond Investing when Yield Curve is Flat

Post by ofckrupke » Sun Oct 06, 2019 11:06 am

Mountain Doc wrote:
Sun Oct 06, 2019 8:41 am
Converting income to LTCG could have some value, though.
yahbut I pay 28.1% on LTCG vs. 27.8% on treasury interest...

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sun Oct 06, 2019 11:59 am

ofckrupke wrote:
Sun Oct 06, 2019 11:06 am
Mountain Doc wrote:
Sun Oct 06, 2019 8:41 am
Converting income to LTCG could have some value, though.
yahbut I pay 28.1% on LTCG vs. 27.8% on treasury interest...
Think about moving to another state. :D
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Re: Bond Investing when Yield Curve is Flat

Post by Northern Flicker » Sun Oct 06, 2019 5:25 pm

Doc wrote:
Sun Oct 06, 2019 7:23 am
Northern Flicker wrote:
Sat Oct 05, 2019 6:04 pm
You still don’t get to diversify the portfolio turnover days and reinvestment interest rate across many days of the year without taking on a major management headache of frequent ladder maturities.
A rolling return ladder over the "fat" part of the yield curve only needs 4 or 5 rungs to be effective. And there is no reinvestment risk because unlike a fund, you do not have to sell when your rung reaches the original sell point if the yield curve moves adversely.

We are talking Treasuries. You don't need to diversify credit risks.

The rolling ladder (notes not held maturity) is a well accepted procedure under normal yield curve conditions. What the Schwab paper is addressing is it's application in flat conditions. AKA now.
You have no control over prevailing rates at the time a bond matures, but you can average over many maturity points with bonds maturing all through the year.

There actually has been research showing that professionally managed treasury bond funds have outperformed treasury bond ladders slightly in return if the duration is the same.
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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Sun Oct 06, 2019 7:21 pm

Northern Flicker wrote:
Sun Oct 06, 2019 5:25 pm
Doc wrote:
Sun Oct 06, 2019 7:23 am
Northern Flicker wrote:
Sat Oct 05, 2019 6:04 pm
You still don’t get to diversify the portfolio turnover days and reinvestment interest rate across many days of the year without taking on a major management headache of frequent ladder maturities.
A rolling return ladder over the "fat" part of the yield curve only needs 4 or 5 rungs to be effective. And there is no reinvestment risk because unlike a fund, you do not have to sell when your rung reaches the original sell point if the yield curve moves adversely.

We are talking Treasuries. You don't need to diversify credit risks.

The rolling ladder (notes not held maturity) is a well accepted procedure under normal yield curve conditions. What the Schwab paper is addressing is it's application in flat conditions. AKA now.
You have no control over prevailing rates at the time a bond matures, but you can average over many maturity points with bonds maturing all through the year.

There actually has been research showing that professionally managed treasury bond funds have outperformed treasury bond ladders slightly in return if the duration is the same.
If there is a normal yield curve where spreads hover around average waiting a month or 2 till spreads become average or greater again is very likely to occur with normal market volatility. Today the curve is inverted so what to buy is a harder decision. Luckily there is an uncooperating yield curve only about 10% of the time. Buying below the average spread is never good but the last few years low spreads were common due to high demand for TRSY's. Knowing that buying below the average spread would still be a good investment.
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Re: Bond Investing when Yield Curve is Flat

Post by jeffyscott » Mon Oct 07, 2019 10:04 am

Doc wrote:
Sat Oct 05, 2019 2:31 pm
While doing some research on Treasury yield calculations I came upon this recent article from schwab.

Barbells and Bond Ladders: How to Invest When the Yield Curve is Flat
There seems to be little difference between the two options (barbell or ladder) as presented there. If I understand correctly, Schwab's barbell would own 0-3 and 7-10, while the ladder also includes the maturities in-between. Is there really much difference if I own an equal amount of each of, say, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 year bonds vs. skipping the 4, 5, 6 year ones?

Seems like a pretty short barbell, I would've thought a barbell would mean owning something like at least 20 year bonds on the long end? My understanding of a barbell would be that you own long and short but skip intermediate so maybe something like owning 1-3 year and 20-30 year bonds, but not the in-between maturities...like what you would get by owning Vg short term and long term treasury index.

Regarding your former ladder, I understand the bonus you would normally get from the roll down yield. And now it would be negative, due to shorter term yields exceeding the 3 year, right? But do you gain anything by selling the 3 year ones and moving to T-bills vs. just keeping the 3 year bonds until the mature (or the yield curve changes)?

The Schwab article says you are missing the opportunity to lock in about a 1.4% yield by not buying the 7 year. I must be wrong, but it is very hard for me to see locking in 1.4% for 7 years as an advantage. I can't even bring myself to lock in ~2% or less via brokered CDs. Instead I guess I am moving these decisions to bond fund managers, and adding credit risk, as my existing 3%+ CDs mature (though most of them have some time to run before I need to reinvest anything other than the interest payments).
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Mon Oct 07, 2019 10:36 am

jeffyscott wrote:
Mon Oct 07, 2019 10:04 am
Is there really much difference if I own an equal amount of each of, say, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 year bonds vs. skipping the 4, 5, 6 year ones?
Schwab's rational for that type of ladder FWIW:
Schwab wrote:1. Reducing risk. By staggering maturity dates, investors avoid getting locked into a single interest rate.
2. Managing cash flow. A bond ladder also helps to manage cash flows for particular needs.
jeffyscott wrote:
Mon Oct 07, 2019 10:04 am
But do you gain anything by selling the 3 year ones and moving to T-bills vs. just keeping the 3 year bonds until the mature (or the yield curve changes)?
Not much. I converted the rungs in taxable to T-Bills to change the gain from ordinary income to LTCG. (Because of special circumstances our LTCG rate is zero this year. Our effective LTCG is usually 10.2%.) The rungs in tax advantaged I left alone.
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Re: Bond Investing when Yield Curve is Flat

Post by jeffyscott » Mon Oct 07, 2019 11:09 am

Doc wrote:
Mon Oct 07, 2019 10:36 am
Schwab's rational for that type of ladder FWIW:
Schwab wrote:1. Reducing risk. By staggering maturity dates, investors avoid getting locked into a single interest rate.
But if I were establishing a 1-10 year ladder today, the range of rates I would get is just 1.34-1.58% based on the treasury yield curve site. I assume the author would say something like "you will likely get a wider variety rates when you reinvest as the ladder rungs mature, since the yield curve is unlikely to remain flat/inverted".

I know the purists would say to not accept the market is timing, but I look at it as: "I am not willing to lend money for 2-10 years at the interest rates currently being offered on treasuries".
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Mon Oct 07, 2019 12:13 pm

seems like it says you loose by not locking in current rate for long term.
You go as long as 7 years. 7 year yield is at 1.43%. How much are you going to loose compare to holding treasury bills? Even if you loose, its not going to be much.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Mon Oct 07, 2019 12:27 pm

jeffyscott wrote:
Mon Oct 07, 2019 11:09 am
But if I were establishing a 1-10 year ladder today, the range of rates I would get is just 1.34-1.58% based on the treasury yield curve site. I assume the author would say something like "you will likely get a wider variety rates when you reinvest as the ladder rungs mature, since the yield curve is unlikely to remain flat/inverted".
But I don't think he did say that.

The reasons for the ladder were: Reducing Risks and Managing Cash Flow.

The barbell arguments were: Locking in yields and Diversification benefits. The current low yields were acknowledged and he went further out on the curve to get past the "belly". The diversification was based on diversifying equities.
Schwab wrote:Intermediate-term Treasuries generally have outperformed Treasury bills when stocks have fallen sharply.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Mon Oct 07, 2019 1:05 pm

Does that mean if stocks don't fall sharply and yield stay where they are, bills should outperform intermediate bonds?

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Mon Oct 07, 2019 3:33 pm

Hector wrote:
Mon Oct 07, 2019 1:05 pm
Does that mean if stocks don't fall sharply and yield stay where they are, bills should outperform intermediate bonds?
No. The intermediate Treasury out performing T-Bills in stock market corrections/crashes is the result of "flight to quality" events. Many people bail out of stocks in such a situation and buy Treasuries making the Treasury price go up sharply.

In the absence of stock market crashes intermediate bonds will outperform short bonds usually. Currently we have a somewhat inverted yield curve up to about 7 year maturity. So longer term notes still have higher yields than T-bills but if the yield curve becomes more normal the price of these intermediate notes is going to go down and they will underperform T-Bills.

So we have two competing situations which might occur because of the flat yield curve. The whole point of the article is how we should react to this situation. If we have a stock market crash we would be better off with the longer term issue but if there is no crash the shorter issues will outperform as the yield curve becomes more like normal. Catch 22.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Mon Oct 07, 2019 4:31 pm

Doc wrote:
Mon Oct 07, 2019 3:33 pm
Hector wrote:
Mon Oct 07, 2019 1:05 pm
Does that mean if stocks don't fall sharply and yield stay where they are, bills should outperform intermediate bonds?
No. The intermediate Treasury out performing T-Bills in stock market corrections/crashes is the result of "flight to quality" events. Many people bail out of stocks in such a situation and buy Treasuries making the Treasury price go up sharply.

In the absence of stock market crashes intermediate bonds will outperform short bonds usually. Currently we have a somewhat inverted yield curve up to about 7 year maturity. So longer term notes still have higher yields than T-bills but if the yield curve becomes more normal the price of these intermediate notes is going to go down and they will underperform T-Bills.

So we have two competing situations which might occur because of the flat yield curve. The whole point of the article is how we should react to this situation. If we have a stock market crash we would be better off with the longer term issue but if there is no crash the shorter issues will outperform as the yield curve becomes more like normal. Catch 22.
Thanks!
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Re: Bond Investing when Yield Curve is Flat

Post by stlutz » Mon Oct 07, 2019 7:12 pm

Northern Flicker wrote:
Sun Oct 06, 2019 5:25 pm

There actually has been research showing that professionally managed treasury bond funds have outperformed treasury bond ladders slightly in return if the duration is the same.
Do you have any links or titles or author names that you recall? Would be interested in reading them!

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Re: Bond Investing when Yield Curve is Flat

Post by stlutz » Mon Oct 07, 2019 7:16 pm

Doc wrote:
Sat Oct 05, 2019 2:31 pm


Previously I had a 7-3 rolling Treasury ladder to capture the roll down yield effect with the additional of a 1-3 fund/etf as a contingency reserve. As the yield curve has flattened I have been replacing the ladder rungs at 3 years with T-bills instead of buying a new 7. The article suggests that this may not be the best approach.

Any thoughts.
What is your view on the economy? The bond market reflects the weighted average view of all participants, but it seems you are thinking that we are in fact not heading into a recession and that the Fed will be able to maintain 2% inflation. If those are your thoughts, then shortening up your maturities makes sense.

Conversely, if you think we are going to head into a deep recession (e.g. a "Trump recession" becomes a "Warren depression"), the long-term bonds are what you want.

If you have no view on the economy, then I don't know why you would change your strategy given that you have no idea what will happen at the longer end of the curve.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 8:16 am

stlutz wrote:
Mon Oct 07, 2019 7:16 pm
What is your view on the economy? The bond market reflects the weighted average view of all participants, but it seems you are thinking that we are in fact not heading into a recession and that the Fed will be able to maintain 2% inflation. If those are your thoughts, then shortening up your maturities makes sense.
I'm an engineer not an economist. I have no view on the economy.

I didn't make a conscious decision to shorten my Treasury duration. When ladder rungs reached their normal sell points I just sold to convert the income to LTCG. Since the yield curve had no obvious reinvest maturity I just put the money into six month bills. After reading the Schwab paper I am considering moving a few positions to maybe 7 years but as market crash protection not as the usual maximize income reason for a ladder
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Tue Oct 08, 2019 10:24 am

Doc wrote:
Tue Oct 08, 2019 8:16 am
stlutz wrote:
Mon Oct 07, 2019 7:16 pm
What is your view on the economy? The bond market reflects the weighted average view of all participants, but it seems you are thinking that we are in fact not heading into a recession and that the Fed will be able to maintain 2% inflation. If those are your thoughts, then shortening up your maturities makes sense.
I'm an engineer not an economist. I have no view on the economy.

I didn't make a conscious decision to shorten my Treasury duration. When ladder rungs reached their normal sell points I just sold to convert the income to LTCG. Since the yield curve had no obvious reinvest maturity I just put the money into six month bills. After reading the Schwab paper I am considering moving a few positions to maybe 7 years but as market crash protection not as the usual maximize income reason for a ladder
When you sold 7 years at sell points, yield curve was inverted.
Lets say, sell point was at 1 year remaining maturity. What is the downside of not letting it mature and then buy 6 months bill? Was LTCG more than what you could have earned from last one year of interest?

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 10:53 am

Hector wrote:
Tue Oct 08, 2019 10:24 am
When you sold 7 years at sell points, yield curve was inverted.
Lets say, sell point was at 1 year remaining maturity. What is the downside of not letting it mature and then buy 6 months bill? Was LTCG more than what you could have earned from last one year of interest?
It's not one year. The sell point is often in the 3-4 year range. Say three. So without compounding, the amount earned is 3 times the difference between the coupon of the intermediate note and then current return for a new three year note. You are not getting anymore total money. You are just getting it three years earlier and it is LTCG not ordinary income.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Tue Oct 08, 2019 12:10 pm

Doc wrote:
Tue Oct 08, 2019 10:53 am
Hector wrote:
Tue Oct 08, 2019 10:24 am
When you sold 7 years at sell points, yield curve was inverted.
Lets say, sell point was at 1 year remaining maturity. What is the downside of not letting it mature and then buy 6 months bill? Was LTCG more than what you could have earned from last one year of interest?
It's not one year. The sell point is often in the 3-4 year range. Say three. So without compounding, the amount earned is 3 times the difference between the coupon of the intermediate note and then current return for a new three year note. You are not getting anymore total money. You are just getting it three years earlier and it is LTCG not ordinary income.
So there are two advantages of selling it earlier:
1. LTCG over ordinary income.
2. You get money earlier and re-invest it.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 1:23 pm

Hector wrote:
Tue Oct 08, 2019 12:10 pm
So there are two advantages of selling it earlier:
1. LTCG over ordinary income.
2. You get money earlier and re-invest it.
Right but it is not a freebie. By going longer you take on more risk. In the past a rule of thumb number like 15 to 20 basis points a year was needed for extending duration. This is for a typical yield curve. And the whole point of the Schwab paper is what to do when the yield curve is flat like now. Which is not typical.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Tue Oct 08, 2019 2:09 pm

Doc wrote:
Tue Oct 08, 2019 1:23 pm
Hector wrote:
Tue Oct 08, 2019 12:10 pm
So there are two advantages of selling it earlier:
1. LTCG over ordinary income.
2. You get money earlier and re-invest it.
Right but it is not a freebie. By going longer you take on more risk. In the past a rule of thumb number like 15 to 20 basis points a year was needed for extending duration. This is for a typical yield curve. And the whole point of the Schwab paper is what to do when the yield curve is flat like now. Which is not typical.
Keep in mind that the "rule of thumb" approaches that you refer to are a form of market timing and, more dangerously, are based on a completely backwards understanding of the nature of bond risk.

Many people think that "(b)y going longer you take on more risk" but this isn't true.
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Re: Bond Investing when Yield Curve is Flat

Post by cheezit » Tue Oct 08, 2019 2:22 pm

vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
To be clear, you are talking about portfolio risk here, correct? It seems obvious that by extending duration you are taking on more term risk - the reason to do it is because some term risk is a good thing for a portfolio with a large (dominant, probably) exposure to market risk.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 2:31 pm

vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
If going longer is not taking on more risk than why do long term Treasuries generally have higher yields than T-Bills?

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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Tue Oct 08, 2019 2:35 pm

Doc wrote:
Tue Oct 08, 2019 1:23 pm
Hector wrote:
Tue Oct 08, 2019 12:10 pm
So there are two advantages of selling it earlier:
1. LTCG over ordinary income.
2. You get money earlier and re-invest it.
Right but it is not a freebie. By going longer you take on more risk. In the past a rule of thumb number like 15 to 20 basis points a year was needed for extending duration. This is for a typical yield curve. And the whole point of the Schwab paper is what to do when the yield curve is flat like now. Which is not typical.
I understand that we are not talking about typical yield curve.
In typical yield curve, you might buy 7 years note to keep desired average maturity of your total fixed income holdings.

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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Tue Oct 08, 2019 2:45 pm

cheezit wrote:
Tue Oct 08, 2019 2:22 pm
vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
To be clear, you are talking about portfolio risk here, correct? It seems obvious that by extending duration you are taking on more term risk - the reason to do it is because some term risk is a good thing for a portfolio with a large (dominant, probably) exposure to market risk.
Term (or duration) exposure is, indeed, an excellent diversifier for the risks associated with equity investing.

But I was referring to the fact that interest rate risk isn't an inherent characteristic of the bond itself, but rather is a function of the match between the duration of portfolio's assets and the duration (or time horizon) of the investor's liabilities. If your investment horizon is long-term, you are taking on more interest rate risk with short-term bonds than with long-term bonds.

This is one of the basic concepts of portfolio management that, in my experience, individual investors tend to misunderstand most frequently.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Tue Oct 08, 2019 2:58 pm

Lets say I am holding only bills and yield curve becomes normal tomorrow.
How do I go about buying notes then?

Lets say, my target maturity is 3 year. So I can buy few 5 years notes and few 4 weeks notes to keep average maturity to 3 years. Every few weeks/months, instead of renewing 4 week bill, I exchange some with 5 year notes. By doing this, I can maintain average maturity to 3 years. This is going to take few years before I hold only notes. Then I can start selling my notes before maturity to buy new 5 year note and to keep average duration of 3 years.

So while I am waiting to have all notes, I am not selling any notes. Which means I am leaving riding the yield curve bonus(capital gain) on the table. How can I avoid it? By buying mix maturity notes (similar to some bond index fund)? If I do that, I also need to wait for a while before selling as I need to hold my notes at least for some time to see its value rises. And while I am waiting, my average maturity is declining. Which means I am leaving some interest money on the table.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 3:17 pm

vineviz wrote:
Tue Oct 08, 2019 2:45 pm
Term (or duration) exposure is, indeed, an excellent diversifier for the risks associated with equity investing.
Agreed, at least in normal times. This thread started out with a discussion about flat yield curves. The interaction of Treasuries with equities is a side issue but it was raised in the Schwab paper.
Schwab wrote:Intermediate-term Treasuries generally have outperformed Treasury bills when stocks have fallen sharply
We got sidetracked on the roll down yield concept of a rolling ladder instead of a ladder held to maturity as was discussed in the article.

We probably have very little data on how longer term Treasuries behave in a stock market sharp fall when the yield curve is flat. I don't consider a flat yield curve as being "generally".
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 3:22 pm

Hector wrote:
Tue Oct 08, 2019 2:58 pm
Every few weeks/months, instead of renewing 4 week bill, I exchange some with 5 year notes. By doing this, I can maintain average maturity to 3 years. This is going to take few years before I hold only notes.
You can do the whole thing tomorrow morning after 10:00 Eastern. Just sell the T-Bills and buy your 1, 2, 3 ,4 and 5 year notes in the open market. No need to wait for the T-Bills to mature.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Tue Oct 08, 2019 3:56 pm

Doc wrote:
Tue Oct 08, 2019 3:17 pm
vineviz wrote:
Tue Oct 08, 2019 2:45 pm
Term (or duration) exposure is, indeed, an excellent diversifier for the risks associated with equity investing.
Agreed, at least in normal times. This thread started out with a discussion about flat yield curves. The interaction of Treasuries with equities is a side issue but it was raised in the Schwab paper.
The diversification benefit is going to be there all the time, "normal" and otherwise.
Schwab wrote:Intermediate-term Treasuries generally have outperformed Treasury bills when stocks have fallen sharply
Doc wrote:
Tue Oct 08, 2019 3:17 pm
We probably have very little data on how longer term Treasuries behave in a stock market sharp fall when the yield curve is flat. I don't consider a flat yield curve as being "generally".
There's no theoretical reason I can think of that would suggest the behavior of long-term Treasuries relative to equities would be different in flat yield curve environments. Nonetheless, I took a quick look: the correlation of long-term Treasuries with stocks is the same regardless of the slope of the yield curve. And going back to the 1950s, if you isolate months in which the yield curve was relatively flat AND US stocks dropped by more than 3% you see the average return of long-term Treasuries during those same months was positive 0.9% which is precisely what you'd expect and the same as when the yield curve was "normal".
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Tue Oct 08, 2019 5:16 pm

vineviz wrote:
Tue Oct 08, 2019 3:56 pm
And going back to the 1950s, if you isolate months in which the yield curve was relatively flat AND US stocks dropped by more than 3% you see the average return of long-term Treasuries during those same months was positive 0.9% which is precisely what you'd expect and the same as when the yield curve was "normal".
That's find but it is not what I am concerned with. I'm interested in what the different Treasury segments do when the stock market crashes not when is't down by only 3%.

Going back to the Schwab chart:

Image

If the stock market is down a couple of percent I probably won't rebalance but if I wanted to I have lots of different FI assets to use. According to the chart in the last three market crashes the intermediate term T's were up an average of some 10% and the Bills only 2 or 3 percent. In none of these instances was the yield curve flat as far as I can tell. The ten - one spread was 2.3 in '01, 2.7 in '03 and 2.2 in '09. That's not flat.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Tue Oct 08, 2019 6:44 pm

Doc wrote:
Tue Oct 08, 2019 3:22 pm
Hector wrote:
Tue Oct 08, 2019 2:58 pm
Every few weeks/months, instead of renewing 4 week bill, I exchange some with 5 year notes. By doing this, I can maintain average maturity to 3 years. This is going to take few years before I hold only notes.
You can do the whole thing tomorrow morning after 10:00 Eastern. Just sell the T-Bills and buy your 1, 2, 3 ,4 and 5 year notes in the open market. No need to wait for the T-Bills to mature.
Seems like I am hijacking this thread. I will start the new one with this question.

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Re: Bond Investing when Yield Curve is Flat

Post by politely » Wed Oct 09, 2019 12:37 am

This is an interesting topic, and I think that bonds are sufficiently different from equities that they should be viewed differently for certain purposes.

In the context of market timing, I don't think it's always "bad" to market time - for example, I would not invest in negative yields and wouldn't consider a decision to suspend bond buying at that point to be an irrational or emotional decision.

With respect to return, I'm not sure I would look at it in the way presented by Schwab, at least for my individual bond portfolio. In that portfolio, I plan to hold to maturity - so, the performance numbers are sort of emphemeral, because prices will go back to par at maturity (assuming no default). I care more about yield to maturity at the time of purchase. In this portfolio, I'm trying to reach a certain level of income to cover certain basic expenses, rather than trying to achieve an optimal return. So, I don't mind having long maturities, and I'm not too concerned about achieving a particular ladder while still in the earning & investment phase. Important to me is that I can predict my income from this portfolio for a given period of time. Consequently, given a specific return, specific life and specific rating, I don't mind picking and choosing individual bonds, maturies and yields/returns - or choosing to stop buying when conditions don't meet my criteria. I think bond funds are different because I don't have the same level of control or transparency.

In respect of allocation, I think it's worth considering that while bonds and bond funds may perform better when the equity market declines, the theory is to sell bonds to buy equities to rebalance, and the timing and significance of the rebalancing will interfere with reaching "full" bond returns for the entire position. Also true when selling equities to buy bonds.

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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Wed Oct 09, 2019 6:21 am

Doc wrote:
Tue Oct 08, 2019 5:16 pm
That's find but it is not what I am concerned with. I'm interested in what the different Treasury segments do when the stock market crashes not when is't down by only 3%.
You pretty much don't get "stock market crashes" (whatever you mean by that) without months which have returns of less than -3%.

Anyway, my post answered your question: long-term Treasuries will do the same thing they typically do. If you want to diversify an equity portfolios, long-term Treasuries are the best way to do that no matter what the yield curve looks like.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Wed Oct 09, 2019 6:24 am

politely wrote:
Wed Oct 09, 2019 12:37 am
In the context of market timing, I don't think it's always "bad" to market time - for example, I would not invest in negative yields and wouldn't consider a decision to suspend bond buying at that point to be an irrational or emotional decision.
"Bad" is obviously a subjective evaluation, but making investment decisions predicated on an assumption that your forecasts of future market behavior are better than everyone else's always has a low probability of making you better off.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Wed Oct 09, 2019 6:50 am

vineviz wrote:
Wed Oct 09, 2019 6:21 am
Anyway, my post answered your question: long-term Treasuries will do the same thing they typically do. If you want to diversify an equity portfolios, long-term Treasuries are the best way to do that no matter what the yield curve looks like.
We agree on that. But your original response was
vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
You were apparently addressing a bond/equity portfolio. That wasn't clear since the discussion at that point was concentrated on FI.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Wed Oct 09, 2019 7:00 am

Doc wrote:
Wed Oct 09, 2019 6:50 am
vineviz wrote:
Wed Oct 09, 2019 6:21 am
Anyway, my post answered your question: long-term Treasuries will do the same thing they typically do. If you want to diversify an equity portfolios, long-term Treasuries are the best way to do that no matter what the yield curve looks like.
We agree on that. But your original response was
vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
You were apparently addressing a bond/equity portfolio. That wasn't clear since the discussion at that point was concentrated on FI.
No, my comment was not limited exclusively to a bond/equity portfolio. It would be true even for a 0% equity portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by daffyd » Wed Oct 09, 2019 8:38 am

Ordinarily I like anything between 3-7 year and 7-10 year intermediate funds, having read plenty on them and stress tested them as a defensive component of a diversified portfolio.

Right now, I like using short term government backed banking plus much longer term bonds to get a similar intermediate level of duration. In an extreme situation I expect broadly similar levels of defensiveness but the starting yield is more attractive. In the short term, for example, if the belly of the curve drops in yield more quickly there could be an opportunity cost: it's not risk-free money.

E.g. in the US I'd look at savings accounts like Marcus or short term CDs combined with long term treasuries (say 20 year or longer). Due to bank regulation, individuals can often get better cash rates than institutions (money market). Obviously your tax situation may make this more or less attractive. And average duration of your cash+bonds isn't everything but it's definitely the biggest driver of risk in a conventional fixed income portfolio.

Note I've only done modest back-testing of this (with Australian cash and bonds) but have limited choices at reasonable cost in tax advantaged space and a desire for liquidity in taxable, so it suits my present situation. YMMV

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Wed Oct 09, 2019 4:44 pm

vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
vineviz wrote:
Wed Oct 09, 2019 7:00 am
No, my comment was not limited exclusively to a bond/equity portfolio. It would be true even for a 0% equity portfolio.
I don't understand. If going long does not mean you are taking on more risk but you get higher return why would anyone buy short term bonds?

If you are limiting yourself to special circumstances like say a liability matching portfolio then maybe. In that case you are defining "risk" in a specific way not as a generality.

Can you please give us some reasoning or a reference.
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