Dalio - bonds don't provide a diversification benefit when interest rates are near zero

[JBTX]

Dahlio is a guy who has convictions, but can make fairly significant moves in a short period of time that would impossible for individual investors to replicate.

I am also about 60% stocks and just a few years behind you. The other 40% is a fairly unruly composition of approximately:

5% cash (includes emergency / liquidity fund)
4% ibonds
5% gold/silver
4% REITS
10% TIPS
12% conventional bonds

None of that includes our home.

You started out expressing a concern that I have had about hedge funds and those trying to copy the strategies of the relative few that have been successful. That is you really have to know what you are doing, you are up against the world's smartest people with resources and contacts for research that few can access. They also have the best IT in the world. Hard to fathom that retail investors can compete with that, perhaps Vanguard, Blackrock, and Fidelity could compete in the hedge fund space but they are for the most part playing a different game: sort of an investing vs. a trading strategies type of mindset. Whenever you employ shorting and leverage, you take on all kinds of additional risks that aren't always well understood.

As much as I loved Larry Swedroe's contributions to this forum, I wondered if AQR and Stone Ridge were just in over their heads trying to compete with the likes of Dalio or even Buffett. Larry is well known, really smart, and I really admire him for eating his own cooking. He certainly has much better reach than I do and access to better resources and brainpower than I. I just wonder if Ray Dalio, Warren Buffett, or James Simons would return Larry's phone call. The best I can do is get calls returned from three investment advisors that I know and Larry will answer the rare occasions that I e-mail him. Larry is really good at what he does but he can't be good at everything in the investment world and I wonder if the AQR and Stone Ridge Alternatives were just a bridge too far. The markets are more efficient and more brutal than you think, if one gets too far beyond your expertise the markets can hand your head back to you. There is a point where you are outmanned and outgunned.

Perhaps Larry's recommendations for the Alternatives will be vindicated. 2020 was an odd year, sort of like Egypt facing the 10 plagues. We are at about seven now, then I read somewhere that Neil deGrasse Tyson said that an asteroid could hit the earth right around election time. Lions and Tigers and Bears, oh my. I wish Larry well on his recommendations, I was excited about them and sincerely wanted them to work. So far Variance Risk Premium, AQR Style Premia Alternative, and Reinsurance have disappointed. Only Alternative Lending has done fairly well but it has done about the same as the bond index. Perhaps 2021 will vindicate Larry, I sincerely hope so.

For years I bought into the commodities diversification theory. But then over time as I learned about their long term middling return, contango, the fact that the derivative based ETF can't exactly track and index, usually worse, and high expense ratios I finally bailed on that. Just redirected to gold and silver which are hard assets and easier to track.

I agree on not knowing if there are some out there that can beat the market, but even if they can it is difficult to replicate in scale and expenses usually negate any theoretical advantage.

Yes, many people bought into that because Swedroe told them so. And it cost real people real money.

And many people bought into his new Alt fund theory. And it has cost real people real money.

But it could still turn around. Maybe.

In my case I had no idea who Swedrow was. But I'm not going to fault people for pursuing additional diversification. I got in early/mid 2000's as commodities were making a run. Then Grantham came to the conclusion that commodity surge was not a bubble. Then of course 2008 happened and commodities never recovered, but the reasons varied by commodity.

They were never a big piece of my portfolio so I'm not to worried about it. And of course, diversifiers can and do go down. Stocks and bonds have been on decades long tear, so in that sense commodities diversification effect is "working".

[JBTX]

I am also about 60% stocks and just a few years behind you. The other 40% is a fairly unruly composition of approximately:

5% cash (includes emergency / liquidity fund)
4% ibonds
5% gold/silver
4% REITS
10% TIPS
12% conventional bonds

Aren't REIT's in the same class as stocks?

Call it a tilt if that suits your fancy.

I would call it 64% stocks, 31% bonds, and 5% precious metals.

Alrighty then!

[loukycpa]

I enjoyed the podcast.

Most important reflection afterward for me. He mentioned facing reality in investing. Although he didn't say this specifically, one reality that matters for many us that doesn't matter nearly as much for Dalio or his clients. Someone who is retired or trying to retire soon on a limited sum of money doesn't have the luxury of completely setting aside short term capital preservation concerns for the sake of better long term returns. Someone with a net worth of $1 billion can play the game a lot differently than someone with a net worth of $2 million. If my net financial worth was $1 billion, I wouldn't have a 40% allocation to bonds right now either.

Reality.

[BV3273]

I haven’t read all the responses. I think bonds are a tough horse to hitch your cart to right now with low interest rates with the exception of iBonds. After that there are better yielding fixed income options out there - rewards checking, rewards savings, etc. The leg work is easier on some accounts than others, but at least there is some sort of yield.

[atdharris]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

[stan1]

I think that REITS are a separate class than stocks or bonds but I am not smart enough to cherry pick the REITS that will perform well going forward and I do not think that commercial real estate is going to be a good investment for some time to come. As a result the only REITS that I own are the ones in my total stock market fund.

Just buy the REIT Index.

REIT Index may not be what you think it is since the index change from a few years ago. Top holdings now include companies that provide cell infrastructure, data centers, and logistics operations. If you expect the diversification benefit to come from renting apartments, offices, and warehouses to tenants that's not what is predominately in REIT Index any more. Then again, maybe you are fine with overweighting the above real estate heavy infrastructure.

[Elysium]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot go lower and they cannot act as a buffer to market sell off is not based on data we know of. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

[willthrill81]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot do down and they cannot act as a buffer to market sell off is not based on sound fundamentals. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

The Fed has made it clear that they aren't interested in pursuing negative interest rates, so that seems to pretty much rule out that possibility.

TBM is paying very little more than cash these days, about 1.2% vs. .6%.

There was no 'flight to safety' back in March when stocks were plummeting. On the contrary, intermediate-term Treasuries fell by a not insignificant amount just as stocks were dropping.

[Elysium]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot do down and they cannot act as a buffer to market sell off is not based on sound fundamentals. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

The Fed has made it clear that they aren't interested in pursuing negative interest rates, so that seems to pretty much rule out that possibility.

TBM is paying very little more than cash these days, about 1.2% vs. .6%.

There was no 'flight to safety' back in March when stocks were plummeting. On the contrary, intermediate-term Treasuries fell by a not insignificant amount just as stocks were dropping.

Fed said they are not pursuing it as of now, that doesn't mean it will not change in future. I don't expect Fed to speak of policy any more than as a point in time based on available factors, when the situation changes I expect the policy to adjust. We do not know, and we should not speculate.

As for flight to safety this year, I don't know about everyone else, but the bond portion of my portfolio is up more than the stock allocation this year so far, my bond returns are in double digits compared to equity allocation. I do remember bonds going up in Feb/March and allowing me to sell some to buy equities that went down.

[willthrill81]

As for flight to safety this year, I don't know about everyone else, but the bond portion of my portfolio is up more than the stock allocation this year so far, my bond returns are in double digits compared to equity allocation. I do remember bonds going up in Feb/March and allowing me to sell some to buy equities that went down.

TBM was only up 1.1% from 2/1/2020 through 3/31/2020. On 3/19, it was down more than 3% from where it was on 2/1.

[Elysium]

Here is a graph that shows value of bonds in a sell off.

I would take only 1.1% up when stock market is down -20% across the world.

[PicassoSparks]

There was no 'flight to safety' back in March when stocks were plummeting. On the contrary, intermediate-term Treasuries fell by a not insignificant amount just as stocks were dropping.

That's not what I see in PV…

[willthrill81]

There was no 'flight to safety' back in March when stocks were plummeting. On the contrary, intermediate-term Treasuries fell by a not insignificant amount just as stocks were dropping.

That's not what I see in PV…

You're looking at a different period. Check out the daily graph below from M* over the period we're discussing. There was no flight to safety in March.

[Angst]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot go lower and they cannot act as a buffer to market sell off is not based on data we know of. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

Yes indeed, and then rates could just hang out there, bouncing around in a low, barely positive range for another decade or more. And then it doesn't matter that the Fed has drawn a zero (nominal) rate line in the sand as others have stressed. Sand can shift... and for goodness sake, real rates are already negative, across the entire yield curve! The nominal zero rate boundary is much more psychological and illusory than the real rate boundary of zero.

I'm fascinated how people today are so affected by and focused on fear of not earning enough on their bonds. I own bonds for the protection of a certain portion of my portfolio from catastrophic long-term loss. I accept the potential for my equity to plummet 50% or more and just stay there for decades, but I also cling to the idea that this will not happen to my fixed income portfolio. Just because my bonds stand a risk of earning something like 0% real for decades, I feel that they are a lot safer than my equity holdings.

[Elysium]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

[aristotelian]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

Exactly. Even if LTT don't go to the moon, just treading water is still "diversification benefit" when stocks are dropping 20-30%. If bonds go up, so much the better but the important thing is to have some part of your portfolio that isn't going down.

[willthrill81]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

A 'flight to safety' should result in more than a 1% rise in prices.

[willthrill81]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

Exactly. Even if LTT don't go to the moon, just treading water is still "diversification benefit" when stocks are dropping 20-30%. If bonds go up, so much the better but the important thing is to have some part of your portfolio that isn't going down.

I never said that there wasn't a diversification benefit. I just showed the graph that clearly demonstrated that there wasn't a flight to safety when stocks were tanking. ITT initially went up but then went down significantly just in time when stocks were also headed down. ITT just didn't go down as much.

[aristotelian]

I never said that there wasn't a diversification benefit. I just showed the graph that clearly demonstrated that there wasn't a flight to safety when stocks were tanking. ITT initially went up but then went down significantly just in time when stocks were also headed down. ITT just didn't go down as much.

Sorry, I wasn't taking issue with you. "Diversification benefit" is the language of the OP.

[Elysium]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

A 'flight to safety' should result in more than a 1% rise in prices.

And, it did. Just check the graph I posted few replies above, where VGLT produced 12%+ between February & March, the sell off started last week of Feb and the money went into LTT. There is no arguing this point. Next time there is a sell off, everyone will wish they held more government bonds, not less. Just look at today, VGLT up 1% as we speak while VTI down 2.5%.

[willthrill81]

There was no flight to safety in March.

Oh there was plenty of flight to safety in March. You don't get to buy insurance after the fact, you needed to be in Treasury bonds in February and in January, December, so on... Last week of February alone produced enough flight to safety from Treasury bonds, especially LTT. As I said before, I will take 1% or even 0.50% when my equities are tanking -20%, -30%, fear is gripping the street with potential to drop -50%, -60%, or even more. Take for instance today, VTI -2%, VGLT +0.87%, BND +0.16%, that's the thing with diversification, when something risky as equities go down you want the safety of bonds in your portfolio.

A 'flight to safety' should result in more than a 1% rise in prices.

And, it did. Just check the graph I posted few replies above, where VGLT produced 12%+ between February & March, the sell off started last week of Feb and the money went into LTT. There is no arguing this point. Next time there is a sell off, everyone will wish they held more government bonds, not less. Just look at today, VGLT up 1% as we speak while VTI down 2.5%.

I've already shown that when stocks were dropping, so did ITT. LTT dropped too but remained ahead over the entire period. That said, when people are talking about 'bonds' in general, they aren't generally talking about long-term Treasuries. If they are, they should be specific about it.

[Elysium]

I've already shown that when stocks were dropping, so did ITT. LTT dropped too but remained ahead over the entire period. That said, when people are talking about 'bonds' in general, they aren't generally talking about long-term Treasuries. If they are, they should be specific about it.

You and I are talking different things, I am using LTT in my examples and you are using TBM/ITT, perhaps to help your argument, but you should know that's not how "flight to safety" is defined. There is no discussion on flight to safety without discussing LTT, as anyone who knows what flight to safety means would automatically equate that with LTT. They are the ultimate and the most reliable flight to safety asset. LTT did rally 12% in Feb/March with US & Intl down -20%, and it was up 6% in March with US & Intl down -15%. They are up 16% YTD when US & Intl are 8.5% & -3%. That's flight to safety. As for Agg bonds, for many people treading water at 1% is good enough when equities are down -20%. This isn't flight to safety, but no one really would equate that term with Agg bonds, you need Treasury bonds, longer the better.

[NoRegret]

In this week's Masters in Business podcast episode, Barry Ritholz has a conversation with Ray Dalio. Starting around 53 minutes into the conversation, Dalio said the following about investors chasing yield, and diversifying across cash vs fixed income vs other asset classes in the current environment of near-zero interest rates, as well as highlighting currency risk:

Think about price changes. Think about the value of money with interest rates being where they are. [...] Most investors think the safest investment is in cash, as cash doesn't have much volatility. But cash is going to be the worst investment, particularly in this environment, because its a tax. [Cash] doesn't have the volatility to it, but now its a -2% per year. It's a non-volatile hidden tax of 2% per year - look at compounded effect of 1,2,3% a year on your life.

Cash, no in this environment, and bonds in this environment in my opinion are not good asset classes. [...] so go away from yield and you have to think what are the other storeholds of wealth.

Stocks has always been a beneficiary, a storehold of wealth, back to march 1933 valuation, august 1971 and so on - yes we saw gold but we saw stocks - real things real income streams - they don't have to be the most stable, they can have growth to them, multiples go up and so on.

Balance is the most important thing. You don't want cash, I don't think you want bonds. I do think you want alternative stores of wealth but diversified wealth. When I say diversification I mean diversification not just of stocks and stock sectors but diversification of asset classes, diversification of currency and diversification of country to achieve balance. If you balance well you don't give up any return in order to reduce your risk because all assets compete with each other and so on.

Do pay attention to the currency because there is a currency risk. We have gotten used to looking at everything through the lens of our currency. So when we say [...] you know, "how're you doing? I'm doing great [...] my portfolio has increased by 10% this year" - because you're measuring it in a currency. Those currencies that depreciate the most often have that price rise but you can lose money and buying power because you're viewing it through that lens. It's a little bit like being in a boat in the water that's going up and down and you look at land and think land is volatile. The asset classes that you're looking at through that lens [...] so you need currency diversification too.

Fixed income exposure has declined a lot as interest rates approach zero because of the mechanics of what zero interest rates mean. When you get interest rates low enough, not only don't they provide a return but they don't provide a diversification benefit because there's a limitation of how much interest rates can go down which means a limitations on how much those [fixed-income] assets can rise in price.

[...] that's a problem for the central banks too. I mentioned that there's monetary policy 1, 2 and 3. monetary policy 1 -- you can't cut the interest rates. So historically then what you get is the printing of money, buying of financial assets, buying of government assets and so on - the reflationary type of policies we have here. So if you're seeking diversification when interest rates are close to zero -- bond yields are close to zero -- you wont get [diversification] in bonds [...] the way monetary policy works is to produce an easing is to have reflation assets such as that which happened on april 9.

(i've attempted to transcribe this from the audio, all errors are mine)

I found the remark about bonds not providing a diversification benefit somewhat surprising - but the argument makes sense - if interest rates don't have much or any room to drop further, the price of any existing bonds you might hold in your portfolio cannot substantially appreciate. This suggests bonds could be removed from a portfolio until such a time in future once interest rates have increased so that there are opportunities for bond price appreciation if interest rates are dropped again.

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

[GaryA505]

In a few years some people who went with Harry Browne's Permanent Portfolio, or the Golden Butterfly, or some variation of those instead of being in just stocks and bonds may be laughing all the way to the bank.

Or not.

[klaus14]

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

This is interesting. However, those countries were at their limit. US is not, even without negative rates.
UK short term rate is also zero today. Their 30y is at 0.85%. US 30y is at 1.59%. If US 30y moves to 0.85%, that would mean about 19% gain for EDV. And going to where German 30y (-0.161%) would mean 44% gain.

[ivgrivchuck]

This is interesting. However, those countries were at their limit. US is not, even without negative rates.
UK short term rate is also zero today. Their 30y is at 0.85%. US 30y is at 1.59%. If US 30y moves to 0.85%, that would mean about 19% gain for EDV. And going to where German 30y (-0.161%) would mean 44% gain.

You are of course right that there is still some fire power left in long term treasuries. The question is: is it enough?

Long term treasuries are a low-yield high-risk asset (which is an obvious downside), but people use them in all-weather portfolios as a hedge against deflationary recessions. If interest rates were around 4%-5%, their value in a deflationary recession could raise 75%-100%.

Now their maximum upside is ~40%. Is this enough so that they are still worth it? Maybe, but we are approaching the limit...

[000]

This is interesting. However, those countries were at their limit. US is not, even without negative rates.
UK short term rate is also zero today. Their 30y is at 0.85%. US 30y is at 1.59%. If US 30y moves to 0.85%, that would mean about 19% gain for EDV. And going to where German 30y (-0.161%) would mean 44% gain.

You are of course right that there is still some fire power left in long term treasuries. The question is: is it enough?

Long term treasuries are a low-yield high-risk asset (which is an obvious downside), but people use them in all-weather portfolios as a hedge against deflationary recessions. If interest rates were around 4%-5%, their value in a deflationary recession could raise 75%-100%.

Now their maximum upside is ~40%. Is this enough so that they are still worth it? Maybe, but we are approaching the limit...

What are your thoughts on negative rates?

[spdoublebass]

I guess that the application depends much on your personal situation...

I'm in my late 30s, married and manage a mid-six-figure 80/20 portfolio, so my actions have been:
- Have a broad international exposure in stocks (45%)
- Moving all my bond fund holdings into I-bonds and EE-bonds.

I’m just curious about your portfolio. Do you max out your tax deferred space? I’m just curious if that makes EE bonds more attractive to you because you are adding more tax deferred Bonds.

One question I do have is since you are in your 30’s, do you plan on being retired in 20 years? Or if you are still working would you just wait to cash the bonds until you need them since you can wait until 30 years with an EE bond.

I ask because I have a weird fascination with how people use EE bonds in their portfolio.

[ivgrivchuck]

What are your thoughts on negative rates?

We have seen central bank rates down to -0.75%. Going below that introduces serious risks (bank runs, financial sector collapse, people losing trust in fiat currency), because it becomes cheaper to store cash in vaults than keep it in the bank, so I think it's unlikely, but who knows.

If we assume that -0.75% is the floor for central bank rates, then the practical bottom for 30 year rate is probably around -0.4%.

[000]

What are your thoughts on negative rates?

We have seen central bank rates down to -0.75%. Going below that introduces serious risks (bank runs, financial sector collapse, people losing trust in fiat currency), because it becomes cheaper to store cash in vaults than keep it in the bank, so I think it's unlikely, but who knows.

If we assume that -0.75% is the floor for central bank rates, then the practical bottom for 30 year rate is probably around -0.4%.

Thanks. Everything you say sounds reasonable to me.

[ivgrivchuck]

I’m just curious about your portfolio. Do you max out your tax deferred space? I’m just curious if that makes EE bonds more attractive to you because you are adding more tax deferred Bonds.

One question I do have is since you are in your 30’s, do you plan on being retired in 20 years? Or if you are still working would you just wait to cash the bonds until you need them since you can wait until 30 years with an EE bond.

I ask because I have a weird fascination with how people use EE bonds in their portfolio.

Almost all of my portfolio is in taxable. The reason being I've been moving a lot internationally (I'm not a U.S. citizen), and tax-deferred accounts are a major headache in international context, double taxation traps and big penalties everywhere.

I arrived to EE-bonds by method of exclusion:
- Short/Mid Treasuries: Zero yield
- Munis: Low yields, one-sided duration risk, credit risk: I'm not being compensated enough for the risk
- Corporate bonds: one-sided duration risk, credit risk: I'm not being compensated enough for the risk
- Savings accounts/CDs: 0.6%-0.7% yield and getting lower
- I-bonds (these are great but what to do after maxing them out)

So I'm putting my money in EE-bonds with 0.1% yield (0.5% below saving account rates) and having an option to hold them for 20 years and getting 3.5% APR. But it's only an option, and I don't need to exercise, if for example interest rates raise significantly during the next 5 years.

EE-bonds are a weird hybrid. During the years 1-7 they are highly liquid (can be used as part of emergency fund) and can be cashed out with minimal loss (compared to having hold money in savings account). After that their annual yield exceeds stocks, so you really want to hold them until maturity, and they become highly illiquid.

I have no idea where I'm 20 years from now and what I'll be doing. If I'm in a high tax bracket that probably means that I've had a long and successful career and these bonds don't really matter in the big picture. If I'm in a low tax bracket, then I can cash them out cheaply. So it's also a kind of tax diversification if you so prefer...

[Always passive]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot go lower and they cannot act as a buffer to market sell off is not based on data we know of. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

Check exhibit 4: COVID-19 CRISIS BOND RETURNS AND STARTING SHORT RATES
in GMO write up, and decide for yourself whether negative rates (if the Fed ever decides to allow it) will do much for you.

GOVERNMENT BONDS HAVE GIVEN US SO MUCH
https://www.gmo.com/asia/research-libra ... ly-letter/

[Forester]

Bond bulls are getting excited over a few basis points for the US to go even more negative in real terms. Reality is that bonds have moreorless cratered. IMHO the 20yr real yield needs to be at least 1% and the 10yr flat, otherwise these assets are in the realm of speculation and should not be in a portfolio. Probably the US bond market will die off like the Japanese bond market.

[Lauretta]

You came in with a very strong opinion, and so far, it wasn't correct.

It's not really an opinion. It's a fact. Based on simple maths.

If a bond has negative yield (as in the EU, unless you buy bonds from the Greek government say) you will lose money if you hold it till maturity. The bond might go up in price in the intervening time if rates go down but if you hold it till the end (which is what a bond fund does) you will have lost money.

For a bond fund there's a very high correlation between the yields at the time you buy it and what you will have earnt at maturity. But a simplified way to think about it is this: a bond fund is the sum of a large number of bonds, all of which (unless you have junk bonds fund) have negative yields in the EU. Since each bond loses money, the sum of all those bonds (the fund) will also lose money if you old it long enough. But in the short term it might go up in value, if (and only if) rates go down even more so that the bonds in the fund increase in value. (However, in that case the fund which buys new bonds continuously, will buy bonds at even lower yields, so that the long term returns of the fund will be even more catastrophic).

That's at least my understanding.

Bond funds are self-correcting.

If interest rates drops, bond funds will increase in value, but yes, bond fund yields will go down as old bonds are replaced with lower yield bonds.

If interest rates rise, bond funds will decrease in value, but bond fund yields will go UP as old bonds are replaced with higher yield bonds.

There is NOTHING catastrophic about bonds.

Steady-eddy, no great returns, no great losses.

No matter which way interest rates go from here, short-term and intermediate bond funds will do okay, not great, but okay. They definitely won't drop like the stock market could.

So they still provide a diversification benefit.

Short-term and intermediate-term bond funds are not going to give you great returns the next few years. But they won't crash either. And that's a real difference compared to stock market funds.

Inflation is the real danger, not interest rates. I hope for rates to increase in a year or two. I will gladly take a small short-term hit in order to slowly get yields up again for long-term decent yields.

When you are only pulling 3%-4% from your portfolio, 2% yields from the bond side is pretty solid.

I see what you are saying. As the saying goes: Slow and steady wins the race
I am totally incapable however to understand how you can obtain 2% long term yields from bonds starting from now say (leaving aside the question nominal or real). Also I don't understand whether you mean the in the US (where 10 year rates are now 0.8%) or the Eurozone (for German bunds 10 year rates are negative 0.6%).
Perhaps you are betting on yields falling further? That's the only way I see how one could have a (temporary) gain on 10 year bonds.
Perhaps you are suggesting going further out in the yield curve (buy only 30 year bonds say) and accept much greater duration risk?
Or perhaps your analysis is based on the ideas of 'stay the course', 'slow and steady wins the race', 'bonds have been a great investment for the past 40 years or so' etc, without getting interested in the actual mechanics and mathematics of how bonds work?
PS by catastrophic I meant a slow and sure bleed, not a huge sudden drawdown. To me psychologically the former is worse (I can't predict a drawdown - nobody can - so I will not beat myself up for it, but I can predict long term negative returns for bonds, so I would not be able to respect myself if I invested in them just based on some motto or just because other people do it).

[Always passive]

You came in with a very strong opinion, and so far, it wasn't correct.

It's not really an opinion. It's a fact. Based on simple maths.

If a bond has negative yield (as in the EU, unless you buy bonds from the Greek government say) you will lose money if you hold it till maturity. The bond might go up in price in the intervening time if rates go down but if you hold it till the end (which is what a bond fund does) you will have lost money.

For a bond fund there's a very high correlation between the yields at the time you buy it and what you will have earnt at maturity. But a simplified way to think about it is this: a bond fund is the sum of a large number of bonds, all of which (unless you have junk bonds fund) have negative yields in the EU. Since each bond loses money, the sum of all those bonds (the fund) will also lose money if you old it long enough. But in the short term it might go up in value, if (and only if) rates go down even more so that the bonds in the fund increase in value. (However, in that case the fund which buys new bonds continuously, will buy bonds at even lower yields, so that the long term returns of the fund will be even more catastrophic).

That's at least my understanding.

Bond funds are self-correcting.

If interest rates drops, bond funds will increase in value, but yes, bond fund yields will go down as old bonds are replaced with lower yield bonds.

If interest rates rise, bond funds will decrease in value, but bond fund yields will go UP as old bonds are replaced with higher yield bonds.

There is NOTHING catastrophic about bonds.

Steady-eddy, no great returns, no great losses.

No matter which way interest rates go from here, short-term and intermediate bond funds will do okay, not great, but okay. They definitely won't drop like the stock market could.

So they still provide a diversification benefit.

Short-term and intermediate-term bond funds are not going to give you great returns the next few years. But they won't crash either. And that's a real difference compared to stock market funds.

Inflation is the real danger, not interest rates. I hope for rates to increase in a year or two. I will gladly take a small short-term hit in order to slowly get yields up again for long-term decent yields.

When you are only pulling 3%-4% from your portfolio, 2% yields from the bond side is pretty solid.

I see what you are saying. As the saying goes: Slow and steady wins the race
I am totally incapable however to understand how you can obtain 2% long term yields from bonds starting from now say (leaving aside the question nominal or real). Also I don't understand whether you mean the in the US (where 10 year rates are now 0.8%) or the Eurozone (for German bunds 10 year rates are negative 0.6%).
Perhaps you are betting on yields falling further? That's the only way I see how one could have a (temporary) gain on 10 year bonds.
Perhaps you are suggesting going further out in the yield curve (buy only 30 year bonds say) and accept much greater duration risk?
Or perhaps your analysis is based on the ideas of 'stay the course', 'slow and steady wins the race', 'bonds have been a great investment for the past 40 years or so' etc, without getting interested in the actual mechanics and mathematics of how bonds work?
PS by catastrophic I meant a slow and sure bleed, not a huge sudden drawdown. To me psychologically the former is worse (I can't predict a drawdown - nobody can - so I will not beat myself up for it, but I can predict long term negative returns for bonds, so I would not be able to respect myself if I invested in them just based on some motto or just because other people do it).

All what you two say is logical and well understood. However, no matter how you look at it, there is a very high likelihood that in real terms all investment grade bonds will lose value. This seems to be one of those times when unless you increase short term risk, there is no solution. Dalio explained the situation clearly in minute 50 of the tape

[typical.investor]

I found the remark about bonds not providing a diversification benefit somewhat surprising - but the argument makes sense - if interest rates don't have much or any room to drop further, the price of any existing bonds you might hold in your portfolio cannot substantially appreciate. This suggests bonds could be removed from a portfolio until such a time in future once interest rates have increased so that there are opportunities for bond price appreciation if interest rates are dropped again.

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

I think this line of thinking is pretty much non-sense. Sorry to be blunt. But just not really supportive of the idea that low rates means bonds don't offer protection.

Q) If you weren't holding US treasuries 2/19/2020 to 3/23/2020, what would have been the second best?
A) Swiss bonds.

The question is asked because 1) not everyone wants USD bonds and 2) people are mistakenly inferring that Swiss bonds did not protect the portfolio.

From 2/19/2020 to 3/23/2020, CHF (Swiss franc) clobbered CAD (Canadian Dollar) by over 8.9%. OK Canadian bonds did 8.3% better, but holders were still 0.7% less well off the Swiss bond holders.

The CHF (Swiss franc) pretty much outperformed everything. In fact, all the countries with low yields strengthened relative to countries with higher rates. This is true relative to the USD as well, but only for a while as the world's reserve currency came out roughly even with the group of low rate currencies.

Anyway, other than treasuries, Swiss bonds gave the best opportunity to rebalance into a global portfolio of equities.

I really dispute the conclusion that Swiss bonds didn't offer safety, and that the reason is low yields.

I understand many here are US investors who hedge their bonds to USD and so don't care about currency movements. The simple fact is though that while higher rates coming down certainly does boost NAV, so does currency strengthening. It's not realistic to consider only one side of the equation.

If the FED is unwilling to lower rates in a future crisis, I predict the USD will strengthen as a result of safety seeking inflows. US only investors might not be able to take advantage of the situation, but I will. US only investors would benefit from seeing their holdings vastly outperform many countries though.

[Elysium]

He laid out the argument I made to myself when I decided to dump my TLT holdings last month. Rates simply cannot fall much further and TLT was no longer acting as a buffer to market sell-offs. At this point, the proceeds are still sitting in cash, but I am not sure what I ultimately want to do with the money. I have little interest in bonds right now.

You could be very wrong on this, rates could fall much further, they could go to zero then negative, there are no rules that says it cannot happen, it has happened in Europe and Japan. Specifically, UK, Germany, Sweden, Switzerland all have gone lower/negative in the past 5 years, as of now US rates are where these countries were 5 years back. There is no compelling reason for US treasuries to continue paying more than other developed market sovereign debt. Speculating they cannot go lower and they cannot act as a buffer to market sell off is not based on data we know of. What else is going to act as buffer in equity market sell offs? there are no alternatives to government bonds in flight to safety. As for sitting in cash, you are losing to inflation every day you sit on it, while government bonds pay more than zero with still having ability to protect against sell offs. Next time there is a flighty to safety sell offs in the market, everyone will be wishing they held more government bonds not less.

Check exhibit 4: COVID-19 CRISIS BOND RETURNS AND STARTING SHORT RATES
in GMO write up, and decide for yourself whether negative rates (if the Fed ever decides to allow it) will do much for you.

GOVERNMENT BONDS HAVE GIVEN US SO MUCH
https://www.gmo.com/asia/research-libra ... ly-letter/

I have posted about this in another thread a while back with my own independent evaluation of changing rates over the globe. Read this post on the effects of lower/negative rates in other similar developed countries. US is about five years where some of these countries were, and the returns from UK, or an average of UK/Germany/Switzerland should be reasonable estimate on what that may look like. The returns and effect of protection from flight to safety will surely be lower, but not absent, and that's the best you can get.

[Lauretta]

I found the remark about bonds not providing a diversification benefit somewhat surprising - but the argument makes sense - if interest rates don't have much or any room to drop further, the price of any existing bonds you might hold in your portfolio cannot substantially appreciate. This suggests bonds could be removed from a portfolio until such a time in future once interest rates have increased so that there are opportunities for bond price appreciation if interest rates are dropped again.

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

I think this line of thinking is pretty much non-sense. Sorry to be blunt. But just not really supportive of the idea that low rates means bonds don't offer protection.

Q) If you weren't holding US treasuries 2/19/2020 to 3/23/2020, what would have been the second best?
A) Swiss bonds.

The question is asked because 1) not everyone wants USD bonds and 2) people are mistakenly inferring that Swiss bonds did not protect the portfolio.

From 2/19/2020 to 3/23/2020, CHF (Swiss franc) clobbered CAD (Canadian Dollar) by over 8.9%. OK Canadian bonds did 8.3% better, but holders were still 0.7% less well off the Swiss bond holders.

The CHF (Swiss franc) pretty much outperformed everything. In fact, all the countries with low yields strengthened relative to countries with higher rates. This is true relative to the USD as well, but only for a while as the world's reserve currency came out roughly even with the group of low rate currencies.

Anyway, other than treasuries, Swiss bonds gave the best opportunity to rebalance into a global portfolio of equities.

I really dispute the conclusion that Swiss bonds didn't offer safety, and that the reason is low yields.

I understand many here are US investors who hedge their bonds to USD and so don't care about currency movements. The simple fact is though that while higher rates coming down certainly does boost NAV, so does currency strengthening. It's not realistic to consider only one side of the equation.

If the FED is unwilling to lower rates in a future crisis, I predict the USD will strengthen as a result of safety seeking inflows. US only investors might not be able to take advantage of the situation, but I will. US only investors would benefit from seeing their holdings vastly outperform many countries though.

So what you are saying is that if you are willing to take currency risk and buy foreign bonds (unhedged) and if you were lucky, you would make a gain because the foreign currency has appreciated. Correct?
The trouble with your strategy seems to be that if you are unlucky & the foreign currency depreciates, you will lose.

[GaryA505]

I dunno. Vanguard total bond has $291B in it. I guess a lot of people are betting on something.

[nedsaid]

I think that REITS are a separate class than stocks or bonds but I am not smart enough to cherry pick the REITS that will perform well going forward and I do not think that commercial real estate is going to be a good investment for some time to come. As a result the only REITS that I own are the ones in my total stock market fund.

Just buy the REIT Index.

REIT Index may not be what you think it is since the index change from a few years ago. Top holdings now include companies that provide cell infrastructure, data centers, and logistics operations. If you expect the diversification benefit to come from renting apartments, offices, and warehouses to tenants that's not what is predominately in REIT Index any more. Then again, maybe you are fine with overweighting the above real estate heavy infrastructure.

Isn't that what you want? Would you want to be heavy in shopping malls and commercial office buildings right now?

[sid hartha]

I just don't see this as practical advise for most people unless they have a large nest egg already, can be 100% stocks and deal with the volatility because they earn enough in dividends. I guess Dalio or maybe the audience he is speaking to don't need bonds for safety because they can ride out any market volatility. But I guess us mere mortals probably can't do this and be able to sleep at night.

[Uncorrelated]

So what you are saying is that if you are willing to take currency risk and buy foreign bonds (unhedged) and if you were lucky, you would make a gain because the foreign currency has appreciated. Correct?
The trouble with your strategy seems to be that if you are unlucky & the foreign currency depreciates, you will lose.

That mostly already priced in, it's called interest rate parity.

Of course unexpected currency devaluations are not priced in, but that's why you should diversify instead of going all-in on the US dollar. The probability of the dollar depreciating unexpectedly is approximately the same as the probability that the dollar appreciates unexpectedly relative to other currencies.

[Robot Monster]

What are your thoughts on negative rates?

We have seen central bank rates down to -0.75%. Going below that introduces serious risks (bank runs, financial sector collapse, people losing trust in fiat currency), because it becomes cheaper to store cash in vaults than keep it in the bank, so I think it's unlikely, but who knows.

If we assume that -0.75% is the floor for central bank rates, then the practical bottom for 30 year rate is probably around -0.4%.

I have no idea if he's right about this, but in March, Scott Minerd said, “I hate to admit this, but our proprietary models indicate that fair value on the 10-yearTreasury note will reach -50 basis points before year end and the possibility that rates could overshoot to -2 percent".

[GaryA505]

What are your thoughts on negative rates?

We have seen central bank rates down to -0.75%. Going below that introduces serious risks (bank runs, financial sector collapse, people losing trust in fiat currency), because it becomes cheaper to store cash in vaults than keep it in the bank, so I think it's unlikely, but who knows.

If we assume that -0.75% is the floor for central bank rates, then the practical bottom for 30 year rate is probably around -0.4%.

I have no idea if he's right about this, but in March, Scott Minerd said, “I hate to admit this, but our proprietary models indicate that fair value on the 10-yearTreasury note will reach -50 basis points before year end and the possibility that rates could overshoot to -2 percent".

OK, let's say they do go to -2%. Then what?

[pseudoiterative]

I have no idea if he's right about this, but in March, Scott Minerd said, “I hate to admit this, but our proprietary models indicate that fair value on the 10-yearTreasury note will reach -50 basis points before year end and the possibility that rates could overshoot to -2 percent".

OK, let's say [10-yearTreasury note rates] do go to -2%. Then what?

Assuming we're talking about the coupon on a 10 year treasury note dropping from 0.625% to -2% then:

1. suppose you already owned 10 year treasury notes that were bought at market prices before the interest rate drop was announced, and the interest rate drop was somewhat surprising to the market (so it wasn't already priced in to what you'd paid)
2. a drop from 0.625% to -2% suggests the market price of a 10 year note with a 0.625% coupon might increase by roughly around 25%, based on boglerdude's link to https://portfoliocharts.com/2019/05/27/ ... convexity/
3. it doesn't make immediate sense to me why anyone would buy any of the new 10 year notes with a -2% coupon, if there was an alternative of holding cash instead.

[HomerJ]

You came in with a very strong opinion, and so far, it wasn't correct.

It's not really an opinion. It's a fact. Based on simple maths.

If a bond has negative yield (as in the EU, unless you buy bonds from the Greek government say) you will lose money if you hold it till maturity. The bond might go up in price in the intervening time if rates go down but if you hold it till the end (which is what a bond fund does) you will have lost money.

For a bond fund there's a very high correlation between the yields at the time you buy it and what you will have earnt at maturity. But a simplified way to think about it is this: a bond fund is the sum of a large number of bonds, all of which (unless you have junk bonds fund) have negative yields in the EU. Since each bond loses money, the sum of all those bonds (the fund) will also lose money if you old it long enough. But in the short term it might go up in value, if (and only if) rates go down even more so that the bonds in the fund increase in value. (However, in that case the fund which buys new bonds continuously, will buy bonds at even lower yields, so that the long term returns of the fund will be even more catastrophic).

That's at least my understanding.

Bond funds are self-correcting.

If interest rates drops, bond funds will increase in value, but yes, bond fund yields will go down as old bonds are replaced with lower yield bonds.

If interest rates rise, bond funds will decrease in value, but bond fund yields will go UP as old bonds are replaced with higher yield bonds.

There is NOTHING catastrophic about bonds.

Steady-eddy, no great returns, no great losses.

No matter which way interest rates go from here, short-term and intermediate bond funds will do okay, not great, but okay. They definitely won't drop like the stock market could.

So they still provide a diversification benefit.

Short-term and intermediate-term bond funds are not going to give you great returns the next few years. But they won't crash either. And that's a real difference compared to stock market funds.

Inflation is the real danger, not interest rates. I hope for rates to increase in a year or two. I will gladly take a small short-term hit in order to slowly get yields up again for long-term decent yields.

When you are only pulling 3%-4% from your portfolio, 2% yields from the bond side is pretty solid.

I see what you are saying. As the saying goes: Slow and steady wins the race
I am totally incapable however to understand how you can obtain 2% long term yields from bonds starting from now say (leaving aside the question nominal or real). Also I don't understand whether you mean the in the US (where 10 year rates are now 0.8%) or the Eurozone (for German bunds 10 year rates are negative 0.6%).
Perhaps you are betting on yields falling further? That's the only way I see how one could have a (temporary) gain on 10 year bonds.
Perhaps you are suggesting going further out in the yield curve (buy only 30 year bonds say) and accept much greater duration risk?
Or perhaps your analysis is based on the ideas of 'stay the course', 'slow and steady wins the race', 'bonds have been a great investment for the past 40 years or so' etc, without getting interested in the actual mechanics and mathematics of how bonds work?
PS by catastrophic I meant a slow and sure bleed, not a huge sudden drawdown. To me psychologically the former is worse (I can't predict a drawdown - nobody can - so I will not beat myself up for it, but I can predict long term negative returns for bonds, so I would not be able to respect myself if I invested in them just based on some motto or just because other people do it).

Sorry for the confusion. We're not getting 2% right now, I meant, I'd be happy to take a short-term hit to bond fund value if interest rates would go back up a bit and get us to 2% in a few years...

I hope for rates to increase in a year or two. I will gladly take a small short-term hit in order to slowly get yields up again for long-term decent yields.

When you are only pulling 3%-4% from your portfolio, 2% yields from the bond side is pretty solid.

Right now, Total Bond Fund is paying around 1.2% I think. I doubt there will be long-term negative returns... but I will watch interest rates to be sure.

I definitely agree that bonds are not likely to do well in the short-term.. But they won't crash or lose a ton of value either.

I have some of my fixed income in I Bonds and some in CDs. Bonds aren't great, but neither is anything else that is "safe". Just have to live with the low returns for now.

[typical.investor]

I found the remark about bonds not providing a diversification benefit somewhat surprising - but the argument makes sense - if interest rates don't have much or any room to drop further, the price of any existing bonds you might hold in your portfolio cannot substantially appreciate. This suggests bonds could be removed from a portfolio until such a time in future once interest rates have increased so that there are opportunities for bond price appreciation if interest rates are dropped again.

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

I think this line of thinking is pretty much non-sense. Sorry to be blunt. But just not really supportive of the idea that low rates means bonds don't offer protection.

Q) If you weren't holding US treasuries 2/19/2020 to 3/23/2020, what would have been the second best?
A) Swiss bonds.

The question is asked because 1) not everyone wants USD bonds and 2) people are mistakenly inferring that Swiss bonds did not protect the portfolio.

From 2/19/2020 to 3/23/2020, CHF (Swiss franc) clobbered CAD (Canadian Dollar) by over 8.9%. OK Canadian bonds did 8.3% better, but holders were still 0.7% less well off the Swiss bond holders.

The CHF (Swiss franc) pretty much outperformed everything. In fact, all the countries with low yields strengthened relative to countries with higher rates. This is true relative to the USD as well, but only for a while as the world's reserve currency came out roughly even with the group of low rate currencies.

Anyway, other than treasuries, Swiss bonds gave the best opportunity to rebalance into a global portfolio of equities.

I really dispute the conclusion that Swiss bonds didn't offer safety, and that the reason is low yields.

I understand many here are US investors who hedge their bonds to USD and so don't care about currency movements. The simple fact is though that while higher rates coming down certainly does boost NAV, so does currency strengthening. It's not realistic to consider only one side of the equation.

If the FED is unwilling to lower rates in a future crisis, I predict the USD will strengthen as a result of safety seeking inflows. US only investors might not be able to take advantage of the situation, but I will. US only investors would benefit from seeing their holdings vastly outperform many countries though.

So what you are saying is that if you are willing to take currency risk and buy foreign bonds (unhedged) and if you were lucky, you would make a gain because the foreign currency has appreciated. Correct?
The trouble with your strategy seems to be that if you are unlucky & the foreign currency depreciates, you will lose.

I'd advise that people not conclude that low rate bonds don't provide protection, and that people hold the bonds they typically would. I'm not going to go out an buy Swiss bonds as I don't see needing to spend CHF at any point. That said, Swiss bonds did protect Swiss investors and it's false to ignore currency movements and conclude otherwise.

[typical.investor]

[*]it doesn't make immediate sense to me why anyone would buy any of the new 10 year notes with a -2% coupon, if there was an alternative of holding cash instead.

No one would buy a bond with a -2% coupon if there were an alternative. Institutions may not have that same alternative.

For me, the question is whether a 0.6% USD savings account is better than a 1.34% to 1.57% 20 to 30 year treasury.

Even knowing that the treasuries will get hurt when rates go up in the next recovery (and they will jump after the Fed delays hiking them), I will still pick the treasuries. This is as I also know that rates will come down again in a future crisis. You can see how long bonds move more at low rates (1):



Of course, not all my bonds are long term and I am not taking duration risk on with money I see a possible spending need for (say in the case of job loss).

(1) https://portfoliocharts.com/2019/05/27/ ... convexity/

[Lauretta]

I found the remark about bonds not providing a diversification benefit somewhat surprising - but the argument makes sense - if interest rates don't have much or any room to drop further, the price of any existing bonds you might hold in your portfolio cannot substantially appreciate. This suggests bonds could be removed from a portfolio until such a time in future once interest rates have increased so that there are opportunities for bond price appreciation if interest rates are dropped again.

From GMO quarterly letter https://www.gmo.com/americas/research-l ... ly-letter/

Source: Datastream, GMO
Note: Short rates are levels as of 1/31/2020 and bond returns are the returns from 2/19/2020 to 3/23/2020.

As you can see, those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

I think this line of thinking is pretty much non-sense. Sorry to be blunt. But just not really supportive of the idea that low rates means bonds don't offer protection.

Q) If you weren't holding US treasuries 2/19/2020 to 3/23/2020, what would have been the second best?
A) Swiss bonds.

The question is asked because 1) not everyone wants USD bonds and 2) people are mistakenly inferring that Swiss bonds did not protect the portfolio.

From 2/19/2020 to 3/23/2020, CHF (Swiss franc) clobbered CAD (Canadian Dollar) by over 8.9%. OK Canadian bonds did 8.3% better, but holders were still 0.7% less well off the Swiss bond holders.

The CHF (Swiss franc) pretty much outperformed everything. In fact, all the countries with low yields strengthened relative to countries with higher rates. This is true relative to the USD as well, but only for a while as the world's reserve currency came out roughly even with the group of low rate currencies.

Anyway, other than treasuries, Swiss bonds gave the best opportunity to rebalance into a global portfolio of equities.

I really dispute the conclusion that Swiss bonds didn't offer safety, and that the reason is low yields.

I understand many here are US investors who hedge their bonds to USD and so don't care about currency movements. The simple fact is though that while higher rates coming down certainly does boost NAV, so does currency strengthening. It's not realistic to consider only one side of the equation.

If the FED is unwilling to lower rates in a future crisis, I predict the USD will strengthen as a result of safety seeking inflows. US only investors might not be able to take advantage of the situation, but I will. US only investors would benefit from seeing their holdings vastly outperform many countries though.

So what you are saying is that if you are willing to take currency risk and buy foreign bonds (unhedged) and if you were lucky, you would make a gain because the foreign currency has appreciated. Correct?
The trouble with your strategy seems to be that if you are unlucky & the foreign currency depreciates, you will lose.

I'd advise that people not conclude that low rate bonds don't provide protection, and that people hold the bonds they typically would. I'm not going to go out an buy Swiss bonds as I don't see needing to spend CHF at any point. That said, Swiss bonds did protect Swiss investors and it's false to ignore currency movements and conclude otherwise.

I don't understand what you mean when you say that Swiss bonds protected Swiss investors. Protected from what? IMO a Swiss investor would be much better off keeping their Swiss francs under the mattress if that is possible

[abuss368]

Not sure I am following this. While rates are near zero, bonds are providing ballast and dry powder to a portfolio.

Should stocks decline, bonds provide a pool of capital to rebalance.