Burton Malkiel de-emphasizes bonds

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Berean
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Burton Malkiel de-emphasizes bonds

Post by Berean »

This is an excerpt from MarketWatch's recent interview with Burton Malkiel, author of the seminal text "A Random Walk Down Wall Street" and one of the original proponents of indexing:

MarketWatch: What does that mean for the traditional 60/40 portfolio of stocks and bonds?

Malkiel: I don’t think there ought to be a 60/40 portfolio. I think there ought to be a broad diversification. What I have recommended in the new edition of my book is, maybe for retired people, the bond allocation might be a lot less. Not that you don’t need some safe assets or some income-producing assets, but there may be a better way to get them than through bonds. Basically, safe bonds now do not provide income and in the long run may have some real risk, because if we do get some inflation in the future, yields will rise and their prices will go down.

What can you do? Let me suggest a couple of strategies that I talk about in the book. One is preferred stock. You can buy a very good quality preferred stock, say, in a company like JPMorgan Chase JPM, -1.85% or AT&T T, -0.46% . You’ll get a return of 5% and under current tax laws, the tax is less than the tax on bond interest (because of the dividend credit.) You can buy a preferred stock ETF and get a 5.5% dividend return. You could even think about buying high quality dividend-producing (common) stocks. Let’s say IBM IBM, +0.88% . It’s very well covered by cash flow, dividend yield is about 5.5%. Verizon VZ, +0.93% is 5%. The company had been in trouble but is coming back.

Anybody recommend adjusting investments in response to his concern? For example, my 401(k) and IRA are in 2030 target-retirement funds. Should I switch them to 2040 funds to decrease the percentage invested in bonds? All my taxable investments are in Vanguard Balanced Index Fund, which is 40% bonds. I could reduce my exposure to bonds by moving money out of Vanguard Balanced Index and putting 60% into Vanguard Total Stock Market Index, 20% into a Vanguard dividend fund, and 20% in the Total Bond Market Index fund.
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Re: Burton Malkiel de-emphasizes bonds

Post by Call_Me_Op »

Berean wrote: Sun Jul 19, 2020 7:37 am Anybody recommend adjusting investments in response to his concern?
Not me. Stocks (preferred or otherwise) are never a good substitute for bonds. He is ignoring the all-important behavioral aspect of investing. In response to ultra-low interest rates and a flat yield curve, I just stick with high-quality and short duration (fixed income) - and then hold my nose. By the way, this includes cash - which is essentially a zero-duration bond. If rates rise in the future, your yield will ride-up with the rising rates and you will not see much if any loss of value.

If you like being 60/40, I would stay where you are. The 60% in stocks is likely to be far more volatile than the 40% in bonds. And one thing you need to understand about high-quality bonds is that they are essentially guaranteed to recover over a time period less than the duration. Remember that bonds are IOUs. They are totally different from stocks.
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Re: Burton Malkiel de-emphasizes bonds

Post by Valuethinker »

Berean wrote: Sun Jul 19, 2020 7:37 am This is an excerpt from MarketWatch's recent interview with Burton Malkiel, author of the seminal text "A Random Walk Down Wall Street" and one of the original proponents of indexing:

MarketWatch: What does that mean for the traditional 60/40 portfolio of stocks and bonds?

Malkiel: I don’t think there ought to be a 60/40 portfolio. I think there ought to be a broad diversification. What I have recommended in the new edition of my book is, maybe for retired people, the bond allocation might be a lot less. Not that you don’t need some safe assets or some income-producing assets, but there may be a better way to get them than through bonds. Basically, safe bonds now do not provide income and in the long run may have some real risk, because if we do get some inflation in the future, yields will rise and their prices will go down.

What can you do? Let me suggest a couple of strategies that I talk about in the book. One is preferred stock. You can buy a very good quality preferred stock, say, in a company like JPMorgan Chase JPM, -1.85% or AT&T T, -0.46% . You’ll get a return of 5% and under current tax laws, the tax is less than the tax on bond interest (because of the dividend credit.) You can buy a preferred stock ETF and get a 5.5% dividend return. You could even think about buying high quality dividend-producing (common) stocks. Let’s say IBM IBM, +0.88% . It’s very well covered by cash flow, dividend yield is about 5.5%. Verizon VZ, +0.93% is 5%. The company had been in trouble but is coming back.

Anybody recommend adjusting investments in response to his concern? For example, my 401(k) and IRA are in 2030 target-retirement funds. Should I switch them to 2040 funds to decrease the percentage invested in bonds? All my taxable investments are in Vanguard Balanced Index Fund, which is 40% bonds. I could reduce my exposure to bonds by moving money out of Vanguard Balanced Index and putting 60% into Vanguard Total Stock Market Index, 20% into a Vanguard dividend fund, and 20% in the Total Bond Market Index fund.
The charts of preferred stock in 2008 09 will show you these are nothing like bonds. They are stocks with equity risk.

In another financial crisis global banking regulators have made it abundantly clear that holders of shadow equity like preferred stock or contingent convertible bonds will take equity pain. There will be no bailouts of equity.

This is awful advice by Malkiel. All the studies show it is better for investors to realise capital by selling bonds or shares rather than trying to increase equity income. Investors should focus on total return not yield in other words.

If you move money out of bonds you are increasing your risk profile. Just as if you moved money to a HIgh Yield/ junk bond fund. You are taking on equity risk. And many former high yielding companies such as Royal Dutch Shell, the world's second largest oil company by value, have slashed their dividends. RDS by over two thirds, the first such cut since the 1930s.

Again look at the charts of these funds in 2008 9 and 2020 (March). These are stocks with stock risk not bond risk. 30%+ falls in value.

If you do decide to do this you should consider Minimum Volatility equity funds. Because historically these have given equity returns but not as much risk as the market as a whole. However since this relationship has been discovered it may not be as strong in the future.

Generally on dividend income other stock markets, like the UK, yield much more than the S and P 500. So international stocks are one way to increase your portfolio dividend yield.
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Re: Burton Malkiel de-emphasizes bonds

Post by Call_Me_Op »

Here is a link to iSHARES US Minimum Volatility Fund: https://screener.fidelity.com/ftgw/etf/ ... =sq-NavBar

Compare to S&P 500 and you will see that they tanked equally, and the MV fund went on to under-perform. Not to excited about this idea.
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Re: Burton Malkiel de-emphasizes bonds

Post by reln »

Berean wrote: Sun Jul 19, 2020 7:37 am This is an excerpt from MarketWatch's recent interview with Burton Malkiel, author of the seminal text "A Random Walk Down Wall Street" and one of the original proponents of indexing:

MarketWatch: What does that mean for the traditional 60/40 portfolio of stocks and bonds?

Malkiel: I don’t think there ought to be a 60/40 portfolio. I think there ought to be a broad diversification. What I have recommended in the new edition of my book is, maybe for retired people, the bond allocation might be a lot less. Not that you don’t need some safe assets or some income-producing assets, but there may be a better way to get them than through bonds. Basically, safe bonds now do not provide income and in the long run may have some real risk, because if we do get some inflation in the future, yields will rise and their prices will go down.

What can you do? Let me suggest a couple of strategies that I talk about in the book. One is preferred stock. You can buy a very good quality preferred stock, say, in a company like JPMorgan Chase JPM, -1.85% or AT&T T, -0.46% . You’ll get a return of 5% and under current tax laws, the tax is less than the tax on bond interest (because of the dividend credit.) You can buy a preferred stock ETF and get a 5.5% dividend return. You could even think about buying high quality dividend-producing (common) stocks. Let’s say IBM IBM, +0.88% . It’s very well covered by cash flow, dividend yield is about 5.5%. Verizon VZ, +0.93% is 5%. The company had been in trouble but is coming back.

Anybody recommend adjusting investments in response to his concern? For example, my 401(k) and IRA are in 2030 target-retirement funds. Should I switch them to 2040 funds to decrease the percentage invested in bonds? All my taxable investments are in Vanguard Balanced Index Fund, which is 40% bonds. I could reduce my exposure to bonds by moving money out of Vanguard Balanced Index and putting 60% into Vanguard Total Stock Market Index, 20% into a Vanguard dividend fund, and 20% in the Total Bond Market Index fund.
I understand the desire to act on this new information you have.

I am curious about the criteria you're using for making asset allocation changes.

Is it always based on Burton's recommendation? If so, what will you do when he passes?

If not, what's the criteria?
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Re: Burton Malkiel de-emphasizes bonds

Post by nisiprius »

1) I think one should completely ignore anyone who warns against "bonds" because of inflation concerns without even mentioning TIPS. I am not saying that TIPS are the answer to everything or that everyone should have them or that they have no issues. I am saying that anyone does not even mention them might be telling the truth and nothing but the truth, but is not telling the whole truth. Why not? I've been railing about TIPS blindness for years, and I still cannot come up with any explanation except a desire to grind an axe and an unwillingness to complicate a pitch by including a detail that doesn't fit the main storyline.

2) Burton Malkiel has been de-emphasizing bonds at least since 2013. In 2010 he co-authored a book with Charles Ellis entitled The Elements of Investing in which they presented, basically, the three-fund portfolio and described it as fitting "timeless wisdom." Just three years later, they co-authored a revision in which they suggested replacing Total Bond with an allocation of half dividend stocks and half emerging markets bonds.
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Re: Burton Malkiel de-emphasizes bonds

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Seems strange for the author of 'A Random Walk Down Wall Street' talking about his favorite dividend stocks and making judgements like 'they had some troubles but they're coming back'...
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Re: Burton Malkiel de-emphasizes bonds

Post by coingaroo »

nisiprius wrote: Sun Jul 19, 2020 8:42 am 1) I think one should completely ignore anyone who warns against "bonds" because of inflation concerns without even mentioning TIPS. I am not saying that TIPS are the answer to everything or that everyone should have them or that they have no issues. I am saying that anyone does not even mention them might be telling the truth and nothing but the truth, but is not telling the whole truth. Why not? I've been railing about TIPS blindness for years, and I still cannot come up with any explanation except a desire to grind an axe and an unwillingness to complicate a pitch by including a detail that doesn't fit the main storyline.
TIPS don't work. In times of high inflation, bond yields rise as the Fed raises interest rates. This rise in yields will cause a decline in value of your TIPS. Your inflation-indexed interest payments will cover this somewhat, but the ability of TIPS to counter inflation historically have been disappointing. Source: Asset Management, TIPS chapter.

TIPS are fundamentally equivalent to standard bonds, with an inflation call option overlaid on top of it.

You know the asset class that actually protects against inflation? Cash. In periods of high inflation, interest rates rise and your balance will rise; without losing value due to interest rates going up.
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Re: Burton Malkiel de-emphasizes bonds

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Re: Burton Malkiel de-emphasizes bonds

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nisiprius wrote: Sun Jul 19, 2020 8:42 am 1) I think one should completely ignore anyone who warns against "bonds" because of inflation concerns without even mentioning TIPS. I am not saying that TIPS are the answer to everything or that everyone should have them or that they have no issues. I am saying that anyone does not even mention them might be telling the truth and nothing but the truth, but is not telling the whole truth. Why not? I've been railing about TIPS blindness for years, and I still cannot come up with any explanation except a desire to grind an axe and an unwillingness to complicate a pitch by including a detail that doesn't fit the main storyline.

2) Burton Malkiel has been de-emphasizing bonds at least since 2013. In 2010 he co-authored a book with Charles Ellis entitled The Elements of Investing in which they presented, basically, the three-fund portfolio and described it as fitting "timeless wisdom." Just three years later, they co-authored a revision in which they suggested replacing Total Bond with an allocation of half dividend stocks and half emerging markets bonds.
Malkiel's timeless wisdom seems be a random walk.

The press is saying 10-year TIPs have negative real yield. Maybe that's why he is not there at the present time.

https://www.metro.us/dollar-falls-on-rising/

But I don't think that exclusively owning only assets have an expected positive real return at every point in time should be the goal of diversification anyway.
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Re: Burton Malkiel de-emphasizes bonds

Post by midareff »

Berean wrote: Sun Jul 19, 2020 7:37 am
Anybody recommend adjusting investments in response to his concern?
I try not to make recommendations in general. Personally, I have adjusted a bit of my AA to respond to the continually falling bond SEC percentages. As an example in January 2019 my portfolio SEC was 3.01%..... today it is 1.55%. When I look at the rolling 12 month inflation average of 1.57% and the tax due on that SEC yield it is hard to fathom a large portion of my portfolio at a negative real return before any NAV price adjustments.

Dividend yields of bonds keep falling making stock dividends look more and more appealing BUT, there is no avoiding the equity side volatility risk. I drive down the street and see all these businesses closed.. many I suppose to not open in the foreseeable future and I try and follow the ramifications of the loss of employment, rents, unsold merchandise on hand, unpaid property tax, and more for the now unemployed and their families and wonder what's supporting the equities markets other than huge Fed monies sloshing around.

At 72 and into year 9 of retirement with a pension and SS that can pay all our bills.. portfolio for world travel and the finer things, none of which are going on now and our WR has dropped to whatever taxable account dividends are and they go to the bank as an additional cash reserve, already > 4% of total. RMD from May to end of year got rolled to my Roth. I did increase equities exposure from 48% to 52% with a corresponding decrease in bonds, now 44%. I also increased my rather conservative average duration to 5.5 years overall looking for some additional basis points where I could get >25 bps per year of duration at the same credit quality.

I did nothing in response to his concerns... only my concerns watching the numbers migrate.
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Re: Burton Malkiel de-emphasizes bonds

Post by Nowizard »

One concern would be whether the investments were in tax deferred, retirement investments or taxable ones. For some in retirement, the combination of SS, perhaps a pension and RMD's result in substantial income. Additional, taxable income from interest/dividends can readily result in a higher income tax bracket and substantial IRMAA increases. Convert to Roth-IRA's when possible before retirement and RMD ages.

Tim
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Re: Burton Malkiel de-emphasizes bonds

Post by livesoft »

coingaroo wrote: Sun Jul 19, 2020 8:44 am Seems strange for the author of 'A Random Walk Down Wall Street' talking about his favorite dividend stocks and making judgements like 'they had some troubles but they're coming back'...
In another thread from yesterday, Rick Ferri posted a link to his 1-hour long discussion with Dr. Burton Malkiel where much of this is discussed. If one listens to it, then I think one will get a better idea of what Malkiel is thinking and why.
Rick Ferri wrote: Sat Jul 18, 2020 6:03 pm
livesoft wrote: Sat Jul 18, 2020 5:56 pm This might drive people into higher yielding bonds thus increasing the prices of those bonds.
It's also driving people into high-yielding stocks. Listen to my podcast with Burton Malkiel. It's what he advocates.

Episode 023: Dr. Burton Malkiel, host Rick Ferri

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Re: Burton Malkiel de-emphasizes bonds

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nisiprius wrote: Sun Jul 19, 2020 8:42 am 1) I think one should completely ignore anyone who warns against "bonds" because of inflation concerns without even mentioning TIPS. I am not saying that TIPS are the answer to everything or that everyone should have them or that they have no issues. I am saying that anyone does not even mention them might be telling the truth and nothing but the truth, but is not telling the whole truth. Why not? I've been railing about TIPS blindness for years, and I still cannot come up with any explanation except a desire to grind an axe and an unwillingness to complicate a pitch by including a detail that doesn't fit the main storyline.

2) Burton Malkiel has been de-emphasizing bonds at least since 2013. In 2010 he co-authored a book with Charles Ellis entitled The Elements of Investing in which they presented, basically, the three-fund portfolio and described it as fitting "timeless wisdom." Just three years later, they co-authored a revision in which they suggested replacing Total Bond with an allocation of half dividend stocks and half emerging markets bonds.
I for one believed that the 30 year plus bull market in bonds ended with the "Taper tantrum" in July 2013. I believed that interest rates would "normalize" from there. I prayed for, I hoped for, wished for higher interest rates. My prayers were answered for a while and then the Covid-19 pandemic hit. Here we sit in July 2020, seven years later and bond yields have fallen even father. The Mighty and Powerful Nedsaid wasn't so mighty and powerful after all, the markets blissfully ignored my impeccable logic and reason and interest rates went even lower.

Also, the inflation beast refuses to rise up again. I thought we would see a rip roaring economy but the best we could do was to briefly touch 3% GDP growth and fall back into the twos.

Like Linus Van Pelt, I await the Great Swedroe to appear at Halloween in the Pumpkin patch and give gifts to the good little boys and girls that believed in the Value premium. My prediction for the resurgence of Value has fallen flat as well. So not only is my reputation as an Economic forecaster in utter tatters, so is my record as a Market forecaster. My buy recommendation for Value, made in jest, hasn't panned out.

Like Nisiprius, I have a fondness for TIPS but only have 12% of my bonds in them. I am suspicious that my forecast of higher inflation due to all the recent money printing will fall flat as well. There are countervailing deflationary trends in place as well.
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Re: Burton Malkiel de-emphasizes bonds

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nisiprius wrote: Sun Jul 19, 2020 8:42 am 2) Burton Malkiel has been de-emphasizing bonds at least since 2013. In 2010 he co-authored a book with Charles Ellis entitled The Elements of Investing in which they presented, basically, the three-fund portfolio and described it as fitting "timeless wisdom." Just three years later, they co-authored a revision in which they suggested replacing Total Bond with an allocation of half dividend stocks and half emerging markets bonds.
It is very disappointing to see giants like these abandoning their own wisdom. Fortunately, Jack Bogle always stuck to his guns on the value of bonds in an investment portfolio. Jack called bonds "an anchor to windward." Even if they are just an anchor in the sand, there is great value in that (when everything else is going to hell).
Last edited by Call_Me_Op on Sun Jul 19, 2020 1:10 pm, edited 1 time in total.
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Re: Burton Malkiel de-emphasizes bonds

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Call_Me_Op wrote: Sun Jul 19, 2020 1:05 pmIt is very disappointing to see giants like these abandoning their own wisdom. Fortunately, ....
Your statements are presuming a future that is not yet the past. It will be interesting to see what happens. :)
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Re: Burton Malkiel de-emphasizes bonds

Post by Call_Me_Op »

livesoft wrote: Sun Jul 19, 2020 1:10 pm
Call_Me_Op wrote: Sun Jul 19, 2020 1:05 pmIt is very disappointing to see giants like these abandoning their own wisdom. Fortunately, ...l
Your statements are presuming a future that is not yet the past. It will be interesting to see what happens. :)
No - I am making no such presumption. I am espousing a strategy, which should not be confused with an outcome. :wink:
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Re: Burton Malkiel de-emphasizes bonds

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I like him but it doesn’t make any sense to me to buy dividend/preferred stocks because bonds yields are low. Are we going to do a change to a portfolio every time bond yields change?

For OP

You have one of the best funds out there - VNG balanced index fund, i would not do any change to holding that fund.
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Re: Burton Malkiel de-emphasizes bonds

Post by whodidntante »

Here are my 2 cents, which is approximately the same as a US aggregate bond fund yields right now. :D

I agree with Dr. Malkiel and in principle with other experts who are recommending higher stock allocations in this environment.

But I disagree with buying high dividend stocks. One should still prefer a total return approach. Dividends are not a factor, and you should not prefer stocks with a higher dividend as a long-term investment strategy. Owning high dividend stocks doesn't protect you from losses in any way. And if you want to do factor investing, do so, but don't use a dubious value measurement like dividend yield. Buy a fund that targets the factors you want exposure to.

With a total return approach, if one needs income and their investments didn't distribute enough income, one sells assets.
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Re: Burton Malkiel de-emphasizes bonds

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coingaroo wrote: Sun Jul 19, 2020 8:50 am
nisiprius wrote: Sun Jul 19, 2020 8:42 am 1) I think one should completely ignore anyone who warns against "bonds" because of inflation concerns without even mentioning TIPS. I am not saying that TIPS are the answer to everything or that everyone should have them or that they have no issues. I am saying that anyone does not even mention them might be telling the truth and nothing but the truth, but is not telling the whole truth. Why not? I've been railing about TIPS blindness for years, and I still cannot come up with any explanation except a desire to grind an axe and an unwillingness to complicate a pitch by including a detail that doesn't fit the main storyline.
TIPS don't work. In times of high inflation, bond yields rise as the Fed raises interest rates. This rise in yields will cause a decline in value of your TIPS. Your inflation-indexed interest payments will cover this somewhat, but the ability of TIPS to counter inflation historically have been disappointing. Source: Asset Management, TIPS chapter.
1) We have not had any ¨times of high inflation¨ since TIPS arrived on the scene a little over 20 years ago. Declaring that TIPS don´t work when we have not yet had high inflation is like saying auto insurance does not work when you have not experienced a collision with damage more than your deductible.

2) When we *did* have high inflation (in the 70s and early 80s), *nominal* yields rose but real yields did not rise, if anything they fell, because nominal rates did not increase as fast as inflation did. The yield on TIPS is specified in real not nominal terms.

Edited to add: The above said, I want to be clear that like nisiprius, ¨I am not saying that they are the answer to everything or that everyone should have them or that they have no issues.¨ I just think that Burton Malkiel should have acknowledged their existence and explain his position on them and his rationale behind not considering them as at least *part* of the solution.
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Re: Burton Malkiel de-emphasizes bonds

Post by Vanguard Fan 1367 »

I can't get excited about the low interest that bond funds pay. I took Burt's advice and made about 10% of my AA VYM, Vanguard's High Dividend Yield ETF.
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Re: Burton Malkiel de-emphasizes bonds

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coingaroo wrote: Sun Jul 19, 2020 8:50 am TIPS don't work. In times of high inflation, bond yields rise as the Fed raises interest rates. This rise in yields will cause a decline in value of your TIPS. Your inflation-indexed interest payments will cover this somewhat, but the ability of TIPS to counter inflation historically have been disappointing. Source: Asset Management, TIPS chapter.
Where does Andrew claim that a rise in Fed funds rate (which is nominal), causes a rise in real yields?

Also, you butchered part of that chapter in your last sentence. Here's what Andrew really said:
"Almost all investors investing in TIPS hold a portfolio of TIPS, and the composition of that portfolio changes over time (unlike a perfectly immunized bond portfolio). Investors often hold a fixed proportion of their portfolio in TIPS, treating TIPS as an asset class, or as part of an overall bond portfolio. Investing in TIPS this way, as opposed to using individual TIPS bonds to immunize (usually partially unknown) future cash flows, results in TIPS being a poor inflation hedge. Real bonds, unfortunately, are not so real."

Emphasis is mine.
Andrew's point is that rolling ladders of TIPs, or just 5/10/15Y TIP returns are not very correlated to inflation. The reason is NOT because the Fed raises rates. It's because real rates themselves are very volatile (a similar problem with using equities as an inflation hedge).

The solution is that TIPs should be duration-matched and the TIPs portfolio immunized. This greatly eliminates the problem with the volatility of TIPs and leads to very good inflation protection. He says it in the section before:

"If the TIPS bond is held to payoff a liability coming due at the maturity of the bond, the investor purchasing the TIPS has eradicated inflation risk. (This is an example of immunization; see chap- ter 4.) If a retired person can purchase a series of TIPS maturing in different years, then she has locked in a stream of payments that are constant in real terms. This allows her to meet her living expenses in the future, impervious to the effects of inflation."

Now, he does concede some issues (sovereign risk, cash flows aren't always perfectly known, negative rates, etc) but he definitely believes they do a great job against inflation if properly used.
coingaroo wrote: Sun Jul 19, 2020 8:50 am You know the asset class that actually protects against inflation? Cash. In periods of high inflation, interest rates rise and your balance will rise; without losing value due to interest rates going up.
I don't think cash does well against inflation, especially in a world where the Fed has specifically said they will not raise rates, even in the face of moderate inflation that goes past 2%. But that's just me.
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Re: Burton Malkiel de-emphasizes bonds

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dodecahedron wrote: Sun Jul 19, 2020 1:25 pm 1) We have not had any ¨times of high inflation¨ since TIPS arrived on the scene a little over 20 years ago. Declaring that TIPS don´t work when we have not yet had high inflation is like saying auto insurance does not work when you have not experienced a collision with damage more than your deductible.
The problem is that Andrew Ang didn't claim they didn't work. He calls them a "lousy inflation hedge" because the returns of TIPs have not been strongly correlated to inflation. This happens to all sorts of real assets that are very volatile (like stocks).

Unlike stocks though, TIPs do have known and predetermined cash flows so you can duration-match the portfolio, greatly diminishing the issue of volatile real rates, and have bonds that do protect against inflation just fine.
dodecahedron wrote: Sun Jul 19, 2020 1:25 pm 2) When we *did* have high inflation (in the 70s and early 80s), *nominal* yields rose but real yields did not rise, if anything they fell, because nominal rates did not increase as fast as inflation did. The yield on TIPS is specified in real not nominal terms.
This is absolutely correct and Andrew Ang in the book actually claims it too. He developed real bond yield data out of term structures and time-varying inflation risk premium. And he found that during the late 70's/early 80s, as the Fed reserve raised rates and inflation ticked up, real rates actually dropped and became negative.

I honestly don't know where coingaroo got that idea that as the Fed raises rates, real rates also go up. I can't find it in the book but hopefully he'll chime in. I might've missed it.
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Re: Burton Malkiel de-emphasizes bonds

Post by BJJ_GUY »

Steve Reading wrote: Fri Oct 09, 2020 2:42 pm
coingaroo wrote: Sun Jul 19, 2020 8:50 am TIPS don't work. In times of high inflation, bond yields rise as the Fed raises interest rates. This rise in yields will cause a decline in value of your TIPS. Your inflation-indexed interest payments will cover this somewhat, but the ability of TIPS to counter inflation historically have been disappointing. Source: Asset Management, TIPS chapter.
Where does Andrew claim that a rise in Fed funds rate (which is nominal), causes a rise in real yields?

Also, you butchered part of that chapter in your last sentence. Here's what Andrew really said:
"Almost all investors investing in TIPS hold a portfolio of TIPS, and the composition of that portfolio changes over time (unlike a perfectly immunized bond portfolio). Investors often hold a fixed proportion of their portfolio in TIPS, treating TIPS as an asset class, or as part of an overall bond portfolio. Investing in TIPS this way, as opposed to using individual TIPS bonds to immunize (usually partially unknown) future cash flows, results in TIPS being a poor inflation hedge. Real bonds, unfortunately, are not so real."

Emphasis is mine.
Andrew's point is that rolling ladders of TIPs, or just 5/10/15Y TIP returns are not very correlated to inflation. The reason is NOT because the Fed raises rates. It's because real rates themselves are very volatile (a similar problem with using equities as an inflation hedge).

The solution is that TIPs should be duration-matched and the TIPs portfolio immunized. This greatly eliminates the problem with the volatility of TIPs and leads to very good inflation protection. He says it in the section before:

"If the TIPS bond is held to payoff a liability coming due at the maturity of the bond, the investor purchasing the TIPS has eradicated inflation risk. (This is an example of immunization; see chap- ter 4.) If a retired person can purchase a series of TIPS maturing in different years, then she has locked in a stream of payments that are constant in real terms. This allows her to meet her living expenses in the future, impervious to the effects of inflation."

Now, he does concede some issues (sovereign risk, cash flows aren't always perfectly known, negative rates, etc) but he definitely believes they do a great job against inflation if properly used.
coingaroo wrote: Sun Jul 19, 2020 8:50 am You know the asset class that actually protects against inflation? Cash. In periods of high inflation, interest rates rise and your balance will rise; without losing value due to interest rates going up.
I don't think cash does well against inflation, especially in a world where the Fed has specifically said they will not raise rates, even in the face of moderate inflation that goes past 2%. But that's just me.
Good information, Steve.

I don't know the book you guys are citing, however, depending on the date, I can say that there has been a shift on TIPS in the institutional community (i.e., endowments etc.). Initially, when institutionalizations first bought into the utility and efficacy of TIPS, it was largely the reasons outlined by Steve above.

As long as you own a direct portfolio of TIPS (no funds), you can hold to maturity you benefit from:
- Real return (inflation protection)
- Deflation protection. This was one was critical to the initial reason for TIPS use for endowments and foundations (and again, this only works if you own directly so you can hold to maturity)

The reason many, and probably most, have largely abandoned the use of TIPS is because:
- Lack of liquidity compared to the nominal market
- But the big reason is loss of confidence in CPI-U as an accurate gauge of inflation (and thus, a faulty multiplier for the bonds).
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coingaroo
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Re: Burton Malkiel de-emphasizes bonds

Post by coingaroo »

Steve Reading wrote: Fri Oct 09, 2020 2:51 pm I honestly don't know where coingaroo got that idea that as the Fed raises rates, real rates also go up. I can't find it in the book but hopefully he'll chime in. I might've missed it.
I have reread the section (in Andrew Ang's "Asset Management: A Systematic Approach to Factor Investing"), and I cannot find any support for the ideas I posted.

I apologise and would like to retract the statements I've made in this thread. I misinterpreted and/or mis-remembered the book. Thanks for correcting me.
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