Diversifying Power of Longer Term US Treasuries

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Diversifying Power of Longer Term US Treasuries

Post by Robert T » Tue May 08, 2007 9:17 pm

.
Note: I've added more analysis to this post - thought it would be useful to have all the examples in one place.

Swensen stresses the diversifying power of US treasuries in his books – including protection against financial crises.

“No other asset type comes close to matching the diversifying power created by long-term, non-callable, default-free, full-faith-and-credit obligation of the US government.”

My impression in that he views diversifying power as downside risk protection rather than mean-variance efficiency.

Here are the returns of various funds during three shorter term 'crises' and the great depression.
  • - 1998 Asian financial crisis (6 month returns from April to Sept. 1998).
    - 1987 'Black Monday' (1 month returns - October)
    - 1990 S&L and banking crisis (12 month returns Oct 1989 to Sept. 1990)
    - 1929-32 Great depression (34 month returns Sept 1929 to June 1932)
1. Asian Crisis [performance from April-Sept. 1998]

Code: Select all

Returns from April to September 1998 [%]
	 
Vanguard Long-Term Treasury                       12.7
Vanguard Intermediate Treasury                     9.8
Vanguard Long-Term Inv. Grade                      7.7
Vanguard Intermediate Term Investment Grade        6.9
Vanguard Total Bond Mkt                            6.6
Vanguard Short-Term Treasury                       5.5
Vanguard Long-Term Tax-exempt                      4.6
Vanguard Short-Term Corp                           4.5
Vanguard Int. Term Tax-exempt                      3.9
DFA Two-Year Global                                3.1
Vanguard Limited Term Tax-exempt                   2.9
Vanguard High Yield Corp                          -0.1
Vanguard Europe Index                             -9.6
Vanguard Total Stock Mkt                         -10.5
DFA Intl Large Co.                               -12.5
Vanguard Value Index                             -12.5
Vanguard REITs                                   -14.2
Vanguard International Value                     -16.3
DFA US Large Value                               -17.5
Oppenheimber Real Asset (Commodities)            -17.7
DFA Intl Small                                   -19.8
DFA Intl Small Value                             -20.6
Vanguard Pacific Index                           -21.4
Vanguard Small Cap Index                         -24.2
DFA US Small Value                               -25.3
DFA US Micro cap                                 -26.9
Fidelity New Markets Fund (Emerging Market Bond) -34.2
Vanguard Emerging Market Index                   -35.4
That’s enough to test the bravest of souls IMO. Since my equity allocation has many of the asset classes at the bottom of the list, I prefer to hold fixed income assets close to the top of the list (US intermediate treasuries) to provide protection when needed the most (downside risk protection).


2. Aftermarth of Black Monday [Performance during October 1987]

Code: Select all

 Returns - October 1987 [%] 

Vanguard Long-Term Treasury                        5.8 
Vanguard Long-Term Inv. Grade                      3.7 
Vanguard Total Bond Market                         3.5 
LB Intermediate Treasury                           3.0 
LB 1-3yr Government                                2.0 
Vanguard Short-Term Inv. Grade                     1.6 
DFA One-Year                                       1.2 
Vanguard Int. Term Tax-exempt                      1.1
Vanguard Long-Term Tax-exempt                      0.8
Vanguard HY Corp                                  -3.5 
DJ Wilshire REIT                                 -14.2 
MSCI Pacific                                     -15.3 
Vanguard International Value                     -17.7 
MSCI EAFE                                        -18.5 
Russell 1000 Value                               -20.2 
Vanguard 500 Index                               -21.7 
Russell 3000                                     -22.4 
MSCI Europe                                      -23.6 
Russell 2000 Value                               -28.3 
DFA US Micro                                     -29.2 
Vanguard Small Cap Index                         -32.1 
Unfortunately some of the funds used in the 1998 example were not in existence in 1987 so I used indexes for several asset classes. Long-term Treasuries still came out on top, although with about half the return of the 1998 example while equities experienced similar size losses. Small value, small market and micro caps had the largest losses (as in the 1998 example). Another test for the emotions…


3. US S&L and banking crisis (Performance from Oct. 1989 - September 1990)

Code: Select all

Returns - October 1989-September 1990 [%]
					
LB 1-3yr Government                                9.3
Vanguard Short-Term Inv. Grade                     9.0
DFA One-Year                                       8.9
LB Intermediate Treasury                           8.5
Vanguard Total Bond Market                         7.3
Vanguard Limited Term Tax-exempt                   6.5
Vanguard Int. Term Tax-exempt                      6.3
Vanguard Long-Term Tax-exempt                      3.5
Vanguard Long-Term Inv. Grade                      2.8
Vanguard Long-Term Treasury                        1.6
Vanguard HY Corp                                  -9.3 
Vanguard 500 Index                                -9.4
Vanguard International Value                     -12.4
Russell 3000                                     -12.6
Russell 1000 Value                               -15.3
Vanguard Small Cap Index                         -27.8
DJ Wilshire REIT                                 -28.3 
DFA US Micro                                     -28.0 
Russell 2000 Value                               -28.2
MSCI EAFE                                        -33.4
MSCI Europe                                      -33.4
MSCI Pacific                                     -41.8
A slightly different result. Short-term bonds came out on top. But the usual suspects were near the bottom (small, micro, small value).


4. Great depression [performance from Sept. 1929–June 1932]

Code: Select all

Cumulative returns from September 1929–June 1932 [%]
[Period of greatest cumulative equity mkt loss is used]

Long-term Treasury                                14.3
Intermediate Treasury                             12.5
Long-term Corporate                                8.7
T-bills                                            6.0
Total Market                                     -83.3
Small cap                                        -83.8
Large Value                                      -88.4
Small Value                                      -88.4
Micro caps [CRSP10]                              -89.1

Equity asset class returns are the Fama-French Benchmark portfolios and the CRSP10 [lowest decile by size].
Long-term treasuries came out on top. Intermediate treasuries were not too far behind. Lower quality bonds (corporates) lagged high quality obligations. Equity declines were huge across the board. Microcaps experienced the largest declines.


Lessons (at leat to the me).

1. Risks do show up and when they do market declines can accumulate rapidly
2. High quality bonds provided more protection against equity market declines than low quality bonds (e.g. HY and EM bond)
3. Long-term treasuries provided greatest protection during periods when there were signficant market declines - but this is not always the case (as in 1990 when short-term bonds outperformed).

Hope the numbers are useful. I’ve been meaning to post this for a while – but just got around to it (From the Four Pillars – “During the good times it is important to remember that things can go to hell in a hand basket with brutal dispatch.”)…

Robert
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Last edited by Robert T on Thu May 10, 2007 3:38 am, edited 6 times in total.

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Post by sterjs » Tue May 08, 2007 9:25 pm

Here is a table of S&P 500 vs. Long Term Government Bonds.

Code: Select all

       S&P500  LT Govt
1927	37.5%	8.9%
1928	43.6%	0.1%
1929	-8.4%	3.4%
1930	-24.9%	4.7%
1931	-43.3%	-5.3%
1932	-8.2%	16.8%
1933	54.0%	-0.1%
1934	-1.4%	10.0%
1935	47.7%	5.0%
1936	33.9%	7.5%
1937	-35.0%	0.2%
1938	31.1%	5.5%
1939	-0.4%	5.9%
1940	-9.8%	6.1%
1941	-11.6%	0.9%
1942	20.3%	3.2%
1943	25.9%	2.1%
1944	19.7%	2.8%
1945	36.4%	10.7%
1946	-8.1%	-0.1%
1947	5.7%	-2.6%
1948	5.5%	3.4%
1949	18.8%	6.4%
1950	31.7%	0.1%
1951	24.0%	-3.9%
1952	18.4%	1.2%
1953	-1.0%	3.6%
1954	52.6%	7.2%
1955	31.5%	-1.3%
1956	6.6%	-5.6%
1957	-10.8%	7.5%
1958	43.4%	-6.1%
1959	12.0%	-2.3%
1960	0.5%	13.8%
1961	26.9%	1.0%
1962	-8.7%	6.9%
1963	22.8%	1.2%
1964	16.5%	3.5%
1965	12.5%	0.7%
1966	-10.0%	3.6%
1967	24.0%	-9.2%
1968	11.1%	-0.3%
1969	-8.5%	-5.1%
1970	4.0%	12.1%
1971	14.3%	13.2%
1972	19.0%	5.7%
1973	-14.7%	-1.1%
1974	-26.5%	4.4%
1975	37.2%	9.2%
1976	23.8%	16.8%
1977	-7.2%	-0.7%
1978	6.6%	-1.2%
1979	18.4%	-1.2%
1980	32.4%	-4.0%
1981	-4.9%	1.9%
1982	21.4%	40.4%
1983	22.5%	0.7%
1984	6.3%	15.5%
1985	32.2%	31.0%
1986	18.5%	24.5%
1987	5.2%	-2.7%
1988	16.8%	9.7%
1989	31.5%	18.1%
1990	-3.1%	6.2%
1991	30.5%	19.3%
1992	7.6%	9.4%
1993	10.1%	18.2%
1994	1.3%	-7.8%
1995	37.6%	31.7%
1996	23.0%	-0.9%
1997	33.4%	15.9%
1998	28.6%	13.1%
1999	21.0%	-9.0%
2000	-9.1%	21.5%
2001	-11.9%	3.7%
2002	-22.1%	17.8%
2003	28.7%	1.4%
2004	10.9%	9.3%
2005	4.9%	7.8%
2006	15.6%	9.8%

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Post by Kevinm1986 » Tue May 08, 2007 9:35 pm

Correct me if I'm wrong: in a nasty bear market, interest rates go down, so long term bonds benefit more than short term bonds. And all bonds benefit because people run from stocks in a panic.

I guess this is an argument for longer term bonds, but the risk is that interest rates will skyrocket at some later date, making the bonds go down in price. There's always a trade-off, isn't there? ;)

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Post by Robert T » Wed May 09, 2007 3:26 am

... have added this post to the first to put all the analysis in one place.

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Stress test

Post by Robert T » Wed May 09, 2007 9:04 am

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I did a quick stress test for the three periods above using my 75:25 equity:fixed income portfolio benchmark (value and small cap tilted portfolio). The estimated returns were:

1. During Asian crisis: -9.3% (vs. 15.2% without bonds)
2. Black Monday and aftermarth: -17.1% (vs. -23.8% without bonds)
3. S&L and banking crisit: -16.0% (vs. -24.6% without bonds)

Prepare for the inevitable bad markets (as Rick says in his books). I find some of these stress-tests useful and am comfortable with our current holdings. Of course the emotions associated with a simulated loss of about 20% in a month (as in October 1987) are quite different from actually seeing this on a month end account balance. But hopefully some knowledge of the past will increase the likelihood of staying the course.

Robert
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Post by SteveB3005 » Wed May 09, 2007 9:36 am

Some very nice work, thank you for the data. You should archive this in the Library under the Bond section. This fight to quality stuff comes up often, it would be nice to have it handy.

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Post by yobria » Wed May 09, 2007 9:36 am

Robert,

Thanks, great information. I'm a fan of LT bonds (use zeros for maximum concentration) not only for short term examples like yours, but also longer term events that would affect my human capital and real estate values.

The Great Depression would be the best example, or Japan since the late 1980s.

Nick

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Post by mikenz » Wed May 09, 2007 8:06 pm

Some very nice work, thank you for the data. You should archive this in the Library under the Bond section
Vanguard Total Bong Market 3.5
I think the OT "Hippie Thread" might be more appropriate :lol:

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Municipals

Post by markh » Thu May 10, 2007 12:51 am

Robert, thank you for the analysis.

How do municipals fit into the picture?

mark

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Post by Robert T » Thu May 10, 2007 3:10 am

.
Nick - I have added some numbers from the Great Depression. They certainly put things in perspective. As you indicate human capital risk also showed up – from 1929 to 1933 unemployment increased from 3 percent to 24 percent. I couldn't find the corresponding data for real estate values over this time period.

Mikenz - Thanks. Have corrected the spelling. Although not sure which one I prefer:)

Markh - Municipal bond performance has been added to the above table were I had the data.

Robert
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Post by Russell F. » Thu May 10, 2007 6:58 am

Robert T.,

Thank you for your work on this. It is indeed interesting and helpful. I've saved this post (along with other threads of yours) for future reference.


Best,

Russell F.

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Post by alec » Thu May 10, 2007 8:08 am

Also, don't forget about 1/73 - 9/74:

Code: Select all

Tbill             13%
5yr T note        5%
LT Treas         -6%
FF LV            -28%
FF SV            -38%
1-10             -45%
REITS            -53%
9-10             -54%
- Alec

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Post by Robert T » Thu May 10, 2007 1:07 pm

.
Russell - I am pleased it was helpful.

Thanks Alec.

Getting back to Swensen in the first post and the subsequent results - what fixed income does Swensen use for the Yale endowment?

Code: Select all

Last 10 years annualized returns to June 30, 2006

Yale endowment fixed income returns                        6.6
Endowment benchmark [LB Treasury Index]                    6.2

Vanguard Intermediate Treasury                             6.2
Vanguard Long Term Treasury                                7.4

Source: http://www.yale.edu/investments/Yale_Endowment_06.pdf and Vanguard Semi-Annual Reports

The answer seems to be closer to intermediate treasuries than to long-term treasuries.

At one stage I seriously considered using long-term treasuries but for a number of reasons settled for intermediate term - including that:

- Long-term treasuries are more volatile [not sure I could handle seeing so much volatility in what’s supposed to be a stable part of my portfolio –despite the superior protection in financial crises]

- Intermediate treasuries on average didn’t lag long-term treasuries that much as in the above examples so still provide some protection in financial crises and in a few market declines LT treasuries did not out-perform

- On a mean variance basis intermediate treasuries outperformed in a portfolio setting [as illustrated in an earlier post][/list]

So in the end, for better or worse, I decided on a middle road.

Robert
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Last edited by Robert T on Thu May 10, 2007 3:12 pm, edited 1 time in total.

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Post by mikenz » Thu May 10, 2007 2:58 pm

I believe Yale have 15% TIPS and 15% ST Treasuries. I think I read that in the marketwatch article on lazy portfolios.

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Post by Random Musings » Thu May 10, 2007 3:16 pm

It looks like intermediate treasuries fit the bill - they protect against "black swans" pretty well but also provide good diversification (with respect to how they correlate with equities) the remainder of the time.

Since "black swans" can not be predicted, IT's seem to fit the bill as a better all purpose vehicle when compared to LT's.

RM

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Yale Endowment

Post by Robert T » Thu May 10, 2007 3:23 pm

.
Mikenz

As I understand it, the Yale endowment policy target is 4 percent fixed income. And the benchmark for this allocation is the Lehman Brothers U.S. Treasury Index (as per the endowment annual report). I am not sure whether they use TIPS in the portfolio – they are excluded from the Treasury Index.
http://www.lehman.com/fi/indices/pdf/US ... _Index.pdf

Swensen’s suggested ‘starting point’ portfolio for individual investors in “Unconventional Success” is 15% TIPS and 15% US Treasuries [he’s not explicit on duration in his book but from other M* conversations I understand it is intermediate ie. the same as the US Treasury Index].
It is an excellent book BTW.

Robert
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Post by Russell F. » Thu May 10, 2007 4:03 pm

Here's a link to a conversation from the M* forum regarding Mr. Swensen's suggested duration of US Treasury Bonds in a generic, starting point portfolio. Mr. Swensen's reply is posted in the op.

--->Link<---



Best,

Russell F.

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Post by mikenz » Thu May 10, 2007 4:39 pm

I didn't realise the lazy portfolio he suggested was quite different from the one actually used by Yale.

In the marketwatch article here he suggests TIPS and VFISX which is ST Treasury index.

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Post by AzRunner » Thu May 10, 2007 5:41 pm

Yes, I can understand the diversifying nature of long term treasury bonds, but at what price? I just took a look at Bloomberg and got the following current yields for Treasuries and TIPS:

Code: Select all

..........Treasury.....TIPS.......Difference
2 Yr........4.68
3 Yr........4.59
5 Yr........4.55.........2.15...........2.40
10 Yr.......4.64.........2.25...........2.39
20 Yr....................2.37
30 Yr.......4.82.........2.28...........2.54
The Difference covers the expected inflation plus the TIPS insurance premium. I can understand that the insurance premium is going to be higher for a 30 year TIP than a 10 year TIP and perhaps the market has higher inflation expectations further out.

If you are going for long term treasury bonds just be aware of the risk being taken in terms of your purchasing power in real terms. Personally I haven't purchased any long term treasuries, but if I did it would be only a small percent of my portfolio and they would have to be yielding significantly more than shorter term treasuries.

JMHO.

Norm

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Post by Robert T » Fri May 11, 2007 3:04 am

.
Here are the nominal and real cumulative returns [%] of various asset class during the 1929-32 and 1973-74 periods [months of greatest market decline used]. It certainly makes a difference.

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                              Sept.1929-June 1932               

                                Nominal     Real       
Long-term Treasury                14.3      45.3
Intermediate Treasury             12.5      43.0
Long-term Corporate                8.7      38.3
T-bills                            6.0      34.8
Total Market                     -83.3     -78.8
Small cap                        -83.8     -79.8
Large Value                      -88.4     -85.3
Small Value                      -88.4     -85.3
Micro caps [CRSP10]              -89.1     -86.1

                              Jan.1973-Sept.1974               
          
                                Nominal     Real  
T-bills                           13.5      -4.7
Intermediate Treasury              3.9     -12.8
Long-term Corporate               -2.7     -18.4
Long-term Treasury                -6.1     -21.1
Large Value                      -27.1     -38.8
Small Value                      -37.3     -47.7
Total Market                     -43.5     -54.1
Small cap                        -49.5     -57.6
Micro caps [CRSP10]              -51.2     -59.1

In the context of the discussion, this article may be useful.

Who Should Buy Long Term Bonds?

It was subsequently published in the American Economic Review. At least this version has an executive summary:)..


Robert
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Post by alec » Fri May 11, 2007 11:49 am

Robert,

If people want to skip all the math, they can go right to "Bond demand in the presence of equities" [page 31] of your link.

btw - Here's the short version :wink: :

Who Should Buy Long-Term Bonds?

I think this is the pertinent section:
A long-horizon analysis treats bonds very differently, and assigns them a much more important role in the optimal portfolio. For long-term investors, money market investments are not riskless because they must be rolled over at uncertain future interest rates. Just as borrowers have come to appreciate that short-term debt carries a risk of having to refinance at high rates during a financial crisis, so long-term investors must appreciate that short-term investments carry the risk of having to reinvest at low real rates in the future. For long-term investors, an inflation-indexed long-term bond is actually less risky than cash. A long-term bond does not have a stable market value in the short term, but it delivers a predictable stream of real income and thus supports a stable standard of living in the long term.

I have recently completed an empirical analysis of optimal portfolio choice for long-term investors. Using a statistical model of nominal interest rates, real interest rates, inflation, and stock prices, I have calculated optimal portfolios for long-lived investors with varying attitudes towards risk. My analysis provides qualified support for the commonsense advice of financial planners. It directs conservative long-term investors to hold more bonds and fewer equities than aggressive long-term investors. The figure illustrates this pattern. The horizontal axis shows risk aversion, with aggressive investors to the left and conservative investors at the right. The vertical axis shows the division of the optimal portfolio among stocks, nominal bonds, and cash. Aggressive investors should hold almost 100% equity portfolios, but more conservative investors should shift largely into bonds along with a very modest allocation to cash. (A larger cash position can be justified as a contingency reserve to meet unexpeced consumption needs, but I do not attempt to model this sort of cash demand.)

The conventional wisdom of financial planners comes out well from this analysis: Buyers of long-term bonds should be conservative long-term investors, or institutions such as pension funds acting on their behalf. There is however one important qualification. The analysis looks at recent historical data from the period 1983-96, during which monetary policy has successfully contained inflation. If I consider historical data from the whole postwar period 1952-96, I estimate a much larger risk of inflation that could erode the real value of long-term nominal bonds. When there is a significant risk of inflation, nominal bonds are far less appealing because they are not good substitutes for inflationindexed bonds and are not in any sense riskless for long-term investors. Conservative long-term investors who are concerned about the possible return of inflation should instead hold US Treasury inflation-indexed bonds.
Back in 03, J. Norstad wrote the following about Campbell's argument in conversation 9792:
He has an interesting and I think valid argument - basically, MPT makes long bonds look bad because MPT (mean-variance portfolio analysis) focuses only on the short term, using short-term return and variance data. For long-term investors we need to use more appropriate (and significantly more complicated) analytic techniques, and when we do, long bonds are quite attractive - much more so than short bonds under many quite reasonable scenarios.

As a simple example he uses to make his basic point, most people think of "cash" (e.g., short US Treasuries, savings accounts, or money market funds) as the "safest" investments. But for a long-horizon investor there's huge reinvestment risk, and in fact for such a long-horizon investor long-term inflation-protected bonds are actually the "riskless" asset. In low inflation environments he also shows using his statistical and mathematical models that long-term nominal bonds are better for long-horizon investors than short-term bonds are.

It's certainly food for thought. Unfortunately, the math is really hard to understand even if the conclusions based on the math are not so difficult.

The book I mentioned goes into this in much more detail and covers many other interesting topics where "strategic" or "long-horizon" investing is often different and more complicated than the "tactical" or "short-horizon" investing modeled by simple MPT.

John Norstad
For anyone interested chapter 3 of Campbell's Strategic Asset Allocation is a good read for this issue.

- Alec

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Risk in fixed income

Post by Robert T » Fri May 11, 2007 8:18 pm

.
Alec,

Thanks for adding the links. Very interesting.

I agree that other factors beyond just mean-variance analysis should be considered in portfolio construction (although I use the latter often and find it useful).

I do see TIPS (bought and held to maturity) as a useful ‘low risk addition’. For example, if investors have expected [target] real returns of 3 percent for a bond allocation [I changed this to a 'real' example to be more explicit] to achieve their long-term objectives based on retirement needs, expected savings, and expected equity returns. And if TIPS have a real yield of 4% as mentioned in John’s article (real yields are obviously lower now) – then holding long-term TIPS 'guarantees' reaching the real 3 percent bond return target. The approach seems to have lower risk than short-term bonds (as the article also suggests). This also satisfies the approach of only taking ‘risk units’ on the equity side and using fixed income for safety and stability.

If investing is about maximizing the likelihood of reaching financial objectives, and if TIPS can almost guarantee an investors needed return from fixed income (obviously this may differ by investor and with temporal changes in TIPS yields) then it seems rationale to me to hold TIPS in fixed income.

However – there are also other things to consider such as rebalancing which IMO is a benefit of holding bonds. This becomes more complicated with direct holdings of longer term fixed income. So supplementing this with shorter term fixed income fund may make sense.

These, among others, are some of the reasons that I currently hold half my bond allocation as inflation indexed fixed income. I’m also comfortable extending duration from short to intermediate term for my nominal allocation (greater deflationary recession risk protection – particularly as I also have a tilt to small and value).

Robert
.

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Post by yobria » Sat May 12, 2007 12:23 pm

Robert T wrote:.
Nick - I have added some numbers from the Great Depression. They certainly put things in perspective. As you indicate human capital risk also showed up – from 1929 to 1933 unemployment increased from 3 percent to 24 percent. I couldn't find the corresponding data for real estate values over this time period.
Thanks, good stuff. I assume those are total return numbers not price changes.

Btw your return data in recent years is quite a bit different than the returns of Vanguard's LT bond fund according to M*. So I guess we should expect plenty of variation depending on the composition of one's bond port.

Nick

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Post by snowman9000 » Tue Feb 09, 2010 4:50 pm

In the Harry Browne Permanent Portfolio, 25% of the AA are long term treasuries, because they provide the diversification and risk/reward profile he sought.

Not TIPS, they don't provide the upside to carry the portfolio when it is their turn to do so.

Not intermediates, same deal.

Not munis, because they are not as solid as treasuries when times are tough. I found that out personally in 08.

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Post by neverknow » Tue Feb 09, 2010 6:58 pm

..
Last edited by neverknow on Mon Jan 17, 2011 10:22 am, edited 1 time in total.

TallyMan
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LT bond data for period of sustained rising FedFunds rate?

Post by TallyMan » Tue Feb 09, 2010 9:32 pm

Some interesting stuff in this thread, but I didn't notice much data (other than sterjs's) for the ~5 years of rising FedFund rates 1976-77 to 1982:

[annual avgs of monthly data]
1970:7.18
1971:4.66
1972:4.43
1973:8.73
1974:10.5
1975:5.82
1976:5.05
1977:5.54
1978:7.93
1979:11.19
1980:13.36
1981:16.38
1982:12.26
1983:9.09
1984:10.23
1985:8.1
1986:6.81
1987:6.66
1988:7.57
1989:9.22
1990:8.1
1991:5.69
1992:3.52
1993:3.02
1994:4.2
1995:5.84
1996:5.3
1997:5.46
1998:5.35
1999:4.97
2000:6.24
2001:3.89
2002:1.67
2003:1.13
2004:1.35
2005:3.21
2006:4.96
2007:5.02
2008:1.93

Source: calculated annual averages from
Board of Governors of the Federal Reserve System
H.15 Selected Interest Rates
http://www.federalreserve.gov/releases/ ... 5_FF_O.txt
See also http://www.federalreserve.gov/releases/ ... 5_FF_O.txt

Over the next decade, perhaps the FedFunds rate won't go into double digits, perhaps it will. Perhaps it won't rise for 5 successive years, but perhaps it will, as it did 1976-1982, perhaps longer.

In the next decade, if the FedFund rates steadily and substantially rise, I am looking forward to all the posts lauding what a great investment money markets and T-bills are; could that be an indicator that I should start moving some money into LT bonds?

Steve

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Re: LT bond data for period of sustained rising FedFunds rat

Post by market timer » Tue Feb 09, 2010 9:57 pm

TallyMan wrote:Some interesting stuff in this thread, but I didn't notice much data (other than sterjs's) for the ~5 years of rising FedFund rates 1976-77 to 1982:

[annual avgs of monthly data]
1970:7.18
1971:4.66
1972:4.43
1973:8.73
1974:10.5
1975:5.82
1976:5.05
1977:5.54
1978:7.93
1979:11.19
1980:13.36
1981:16.38
1982:12.26
1983:9.09
1984:10.23
1985:8.1

1986:6.81
1987:6.66
1988:7.57
1989:9.22
1990:8.1
1991:5.69
1992:3.52
1993:3.02
1994:4.2
1995:5.84
1996:5.3
1997:5.46
1998:5.35
1999:4.97
2000:6.24
2001:3.89
2002:1.67
2003:1.13
2004:1.35
2005:3.21
2006:4.96
2007:5.02
2008:1.93


Source: calculated annual averages from
Board of Governors of the Federal Reserve System
H.15 Selected Interest Rates
http://www.federalreserve.gov/releases/ ... 5_FF_O.txt
See also http://www.federalreserve.gov/releases/ ... 5_FF_O.txt
And people wonder why savings rates used to be so much higher...

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Post by Robert T » Tue Feb 09, 2010 11:01 pm

.
The OP was May 08, 2007

Then we had the credit crisis. Here are some 2008 returns.

Code: Select all

BC 20+yr Treasury            +33.72      
BC 10-20yr Treasury          +19.69      
BC 7-10yr Treasury           +17.97      
BC 3-7yr Treasury            +13.26      
BC 1-3yr Treasury             +6.67      
BC 1-3yr Credit               +0.30 
BC US Intermediate Credit     -2.76 
iBoxx $ Liquid HY            -23.88 
MSCI US Small                -36.20 
MSCI US MidCap Value         -36.50 
MSCI US Broad Mkt            -37.04 
MSCI EAFE                    -43.38 
MSCI EAFE Value              -44.09 
MSCI EAFE Small              -47.01        
MSCI EM Value                -50.27            
MSCI EM                      -53.33 
MSCI EM Small                -58.23            
  
Source: MSCI and iShares website.
Another Swensen quote:
  • By holding portfolios of high-quality, long-term, noncallable instruments, investors emphasize the attributes of bonds that provide the greatest protection in times of financial crisis. When investors seek refuge from the volatility induced panics, securities backed by the full faith and credit of the US government outperform risky assets, sometimes dramatically.
And banking panics and severe financial distress seem to have been a prominent factor in historical real stock market declines (at least according to this article).

But what happened in the 1970s/early 1980s (high inflation/rising rates)?

T-bills, Intermediate bonds and LT bonds all had negative real returns (T-bills did better than intermediate which did better than LT). Real returns over this period came from small cap and value stocks, not nominal bonds. Although T-bills weren’t far off the inflation rate (8.2 vs. 9.2).

Code: Select all

    Inflation   Large  Midcap    Small   LT Gov  Intermediate 
                Caps   Value      Cap    Bonds      Bonds     t-bills 

1973    8.8    -14.7    -15.6    -30.9    -1.1      4.6         6.9 
1974   12.2    -26.5    -21.1    -20.0     4.4      5.7         8.0 
1975    7.0     37.2     60.5     52.8     9.2      7.8         5.8 
1976    4.8     23.8     48.6     57.4    16.8     12.9         5.1 
1977    6.8     -7.2      7.3     25.4    -0.7      1.4         5.1 
1978    9.0      6.6      9.1     23.5    -1.2      3.5         7.2 
1979   13.3     18.4     28.2     43.5    -1.2      4.1        10.4 
1980   12.4     32.4     17.3     39.9    -4.0      3.9        11.2 
1981    8.9     -4.9     11.3     13.9     1.9      9.5        14.7 
                         
AR      9.2      5.2     13.5     18.8     2.5      5.9         8.2 

AR=annualized return 
Source: Ibbotson Yearbook 2006.
So IMO term (duration) choice depends on what role you want fixed income to play in your portfolio. Greater protection from financial crises (and deflation), or from inflation. My current preference (accumulation phase with 75% stocks) is intermediate term. May consider shortening during retirement when I get there (but still a long way off).

Robert
.

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Post by baw703916 » Tue Feb 09, 2010 11:45 pm

If one has the tax-advantaged space, then a 50/50 combination of LT Treasuries and LT TIPS should work. Of course there's not much historical record for TIPS, but they should protect you in a 70s/80s situation.

Brad
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Post by neverknow » Wed Feb 10, 2010 7:33 am

..
Last edited by neverknow on Mon Jan 17, 2011 10:23 am, edited 1 time in total.

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Post by Robert T » Wed Feb 10, 2010 9:12 am

neverknow wrote:Beware of backtesting as a mechanism for future investing. Past Performance is not indicative of future performance.
Few thoughts on fixed income - IMO:
  • 1. Backtesting is useful to determined how bonds perform under different market conditions (then its for each of us to decide which type of market conditions we want greatest protection against).

    2. On 2008 as an anomaly. If we believe Taleb, then in finance outliers (anomalies) drive the mean. It happened. But IMO the behavior of the bond markets should have been no surprise to anyone who has done some backtests of different market conditions. They were useful in this respect.

    3. On rising rate sensitivity. IMO its important to look at a portfolio as a whole. For example – a value tilted equity portfolio has shorter duration than a growth tilted equity portfolio, so in this sense is less sensitive to interest rate increases. So adding longer-term fixed income to a value tilted equity allocation may not increased overall portfolio sensitivity to interest rate changes relative to a growth tilted portfolio with shorter-term bonds (re: references: Value-Growth Dynamics in Interest Rate Cycles, Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium, Who Killed Value?)
neverknow - you seem to have found an approach that works for you and thats the important thing – stick with it.

Robert
.

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Post by BlueEars » Wed Feb 10, 2010 11:47 am

Robert T wrote:...(snip)...
2. On 2008 as an anomaly. If we believe Taleb, then in finance outliers (anomalies) drive the mean. It happened. But IMO the behavior of the bond markets should have been no surprise to anyone who has done some backtests of different market conditions. They were useful in this respect.
...
I have to admit that the behavior of TIPS and short term investment grade was surprising to me in the Fall 2008 period. The large spreads that developed in TIPS was disconcerting as well as the kinks that developed in the TIPS yield curve. An interesting lesson in liquidity.

Just looking at bonds in isolation, I'm impressed that one could have done pretty well on a real return basis just sticking with short term Treasury (~2yr) and maybe a little better with a short term IG + Treasury combo. Because of the low current rates, I prefer the short term IG right now but may have to accept negative real rates over the next 2 years as was seen in 2004-2005 when we also had low rates.

P.S. I posted a bond data table for 2001-2009 that may be of interest. See here: http://www.bogleheads.org/forum/viewtop ... highlight=

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Post by Noobvestor » Fri Nov 12, 2010 11:39 am

I just wanted to give this a bump - it has been on my bookmarks list for a long time, and I refer back to it when I wonder about the correlation to equities and short-term properties of bonds during crises. Maybe some of these charts/examples belong in the Wiki somewhere?
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Post by Robert T » Sun Aug 14, 2011 8:17 am

.

Code: Select all

Index                                                    Last 30 days
                                                          To 8/12/11 

Barclays Capital U.S. 20+ Year Treasury Bond Index           8.95
Barclays Capital U.S. 10-20 Year Treasury Bond Index         7.35
Barclays Capital U.S. 7-10 Year Treasury Bond Index          5.26
Barclays Capital U.S. 3-7 Year Treasury Bond Index           2.38
Barclays Capital U.S. 1-3 Year Treasury Bond Index           0.38
		
Barclays Capital U.S. 1-3 Year Credit Bond Index             0.05
Barclays Capital U.S. Intermediate Credit Bond Index         1.00
iBoxx $ Liquid High Yield Index                             -4.80
		
Russell 1000 Index                                         -10.81
Russell 1000 Value Index                                   -13.69
Russell MidCap Index                                       -13.45
Russell MidCap Value Index                                 -15.56
Russell 2000 Index                                         -16.59
Russell 2000 Value Index                                   -17.96
Russell Microcap(R) Index                                  -17.63

Source: iShares website
.

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Post by tripleb » Sun Aug 14, 2011 9:53 am

The Permanent Portfolio relies on using 25% Long Term Treasuries for the reasons mentioned in this thread.

Prior to me going into the PP almost 2 years ago, I was using a very stock-heavy portfolio of about 80% to 90% stocks. At this time, I allocated all of my bonds to long-term treasuries.

It's my believe that the longer the duration of the bonds, and the higher the rating (i.e. treasuries are higher rated than corporate) the less correlated they are with stocks, and the stronger movements in opposite directions they will exhibit. In my opinion, the greater stock percentage you use, the longer duration of bonds you should use and the more treasuries you should use.

i.e.

If you are 90% stocks, then go 10% long term treasuries.

If you are 80% stocks, go with 20% intermediate/long term treasuries

If you are 70% stocks, go with intermediate term treasuries

If you are 60% stocks, go with TBM, which is intermediate term, but also a slightly lower bond rating since corporates are mixed in.

NOTE: I am using the term bond rating outside of any rating agency. I don't care if US Treasuries get downgraded to A, they are still higher rated than corporates, since corporations cannot print their own money or levy taxes. Thus, US Treasuries will always be safer and have a lower correlation to stocks, than an equivalent duration corporate bond.

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Post by Noobvestor » Sun Aug 14, 2011 11:33 am

Robert T wrote:.

Code: Select all

Index                                                    Last 30 days
                                                          To 8/12/11 

Barclays Capital U.S. 20+ Year Treasury Bond Index           8.95
Barclays Capital U.S. 10-20 Year Treasury Bond Index         7.35
Barclays Capital U.S. 7-10 Year Treasury Bond Index          5.26
Barclays Capital U.S. 3-7 Year Treasury Bond Index           2.38
Barclays Capital U.S. 1-3 Year Treasury Bond Index           0.38
		
Barclays Capital U.S. 1-3 Year Credit Bond Index             0.05
Barclays Capital U.S. Intermediate Credit Bond Index         1.00
iBoxx $ Liquid High Yield Index                             -4.80
		
Russell 1000 Index                                         -10.81
Russell 1000 Value Index                                   -13.69
Russell MidCap Index                                       -13.45
Russell MidCap Value Index                                 -15.56
Russell 2000 Index                                         -16.59
Russell 2000 Value Index                                   -17.96
Russell Microcap(R) Index                                  -17.63

Source: iShares website
.
Excellent. Thanks for the update, Robert.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Post by fredflinstone » Sun Aug 14, 2011 11:42 am

tripleb wrote:The Permanent Portfolio relies on using 25% Long Term Treasuries for the reasons mentioned in this thread.

Prior to me going into the PP almost 2 years ago, I was using a very stock-heavy portfolio of about 80% to 90% stocks. At this time, I allocated all of my bonds to long-term treasuries.

It's my believe that the longer the duration of the bonds, and the higher the rating (i.e. treasuries are higher rated than corporate) the less correlated they are with stocks, and the stronger movements in opposite directions they will exhibit. In my opinion, the greater stock percentage you use, the longer duration of bonds you should use and the more treasuries you should use.

i.e.

If you are 90% stocks, then go 10% long term treasuries.

If you are 80% stocks, go with 20% intermediate/long term treasuries

If you are 70% stocks, go with intermediate term treasuries

If you are 60% stocks, go with TBM, which is intermediate term, but also a slightly lower bond rating since corporates are mixed in.

NOTE: I am using the term bond rating outside of any rating agency. I don't care if US Treasuries get downgraded to A, they are still higher rated than corporates, since corporations cannot print their own money or levy taxes. Thus, US Treasuries will always be safer and have a lower correlation to stocks, than an equivalent duration corporate bond.
Excellent advice.

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Post by yobria » Sun Aug 14, 2011 12:17 pm

yobria wrote:Robert,

Thanks, great information. I'm a fan of LT bonds (use zeros for maximum concentration) not only for short term examples like yours, but also longer term events that would affect my human capital and real estate values.

The Great Depression would be the best example, or Japan since the late 1980s.

Nick
That post was from Wed May 09, 2007.

I guess I one more example to add - the US since 2008...

Nick

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Post by biasion » Sun Aug 14, 2011 6:26 pm

Fixed with duration up to 1 year has no equity correlation.

After 1 year the correlation increases. Past 5 it really, really increases.

The real return of 5 year treasuries vs 20 year treasuries for the last 80 years is only about 40 basis points more. There is a post that is made on this forum once or twice a year that contradicts the long treasury bulls and puts everyone right in line with its shocking documentation that from 1940 until 1980 20 year treasuries actually lost money (that's right, a 40 year bear market!!!).

However, according to Larry Swedroe, long bonds do help sometimes.

For high equity portfolios, 70% or more equity, they don't increase volatility, but they seem to increase reward for reasons you said: basically the volatility is dominated by the equity and by extending duration you increase reward without significantly affecting volatility one way or the other. Once you get to 60/40 or less, reward increases as well by extending maturity, but past 5 year duration the risk also increases substantially. With bond heavy portfolios whose purpose is more for risk control and volatility avoidance, long bonds are horrendous and should be avoided, even 5 y might be too much because it increases portfolio volatility.

One way to dampen the duration effect on volatility at all bond duration and equity proportion level is to add 5% commodities in the form of the fund PCRIX, available in your Vanguard IRA for 25k minimum and a small fee.

Commodities work because they are risky, and will tank like stocks at the wrong moment like 2008 or now. However, they hedge the longer bonds risk in a rising rate, rising inflation environment. And if rates drops like they have the last few years, the extra duration comes in very, very handy. You never had, long bonds, stocks and commodities losing all three at the same time. It's possible, but regardless gives you a slight diversification edge. So instead of using cash or a 1 year duration, you can extend your maturities to create a 3-4 year in conservative portfolio, 5y in a 60/40, and longer in the equity heavy situations for a more efficient plan overall
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Post by biasion » Sun Aug 14, 2011 6:32 pm

tripleb wrote:
If you are 60% stocks, go with TBM, which is intermediate term, but also a slightly lower bond rating since corporates are mixed in.

NOTE: I am using the term bond rating outside of any rating agency. I don't care if US Treasuries get downgraded to A, they are still higher rated than corporates, since corporations cannot print their own money or levy taxes. Thus, US Treasuries will always be safer and have a lower correlation to stocks, than an equivalent duration corporate bond.
Never. Corporates are coprorates (latter is more appropriate spelling).

They are prone to all the investment risks, and in a rising rate environment, at least historically, actually lose more value than equivalent treasuries despite higher coupon. This is because rising rates not only devalue the bonds from an interest point of view, but rising rates also increase credit and default risk at the same time!

Also coprorates are callable, so if you buy low, it can't improve that much without the bond going past par, at which point it will be called for a lower rate and you have to re-invest at that lower rate at par. But if things worsen then or ever, then you are stuck holding the bag, strongly limiting the upside.

Short corporates of very high quality actually have been shown to be worth the risk (3 years or less) because the higher coupons do help reduce duration in a rising rate environment, and that short maturity helps you avoid call and excessive credit risk. But the equity correlation and lack of diversification in a crisis remains (just look at VG ST investment grade in 2008-2009).

Also realize as a whole, coprorates (spelled correctly now) outperformed treasuries by only 50 basis points, but for a lot more risk. And the yields are more taxable at the state and local level too. YUK!

GNMA's are not as bad, but the call risk really screws you too.

Avoid TBM unless it's your only choice for fixed in your company 401k

http://moneywatch.bnet.com/investing/bl ... fund/1750/

http://moneywatch.bnet.com/investing/bl ... ment/1443/

http://moneywatch.bnet.com/investing/bl ... onds/2555/
1. Do not confuse strategy with outcome | 2. Those who fail to plan plan to fail | 3. Do not assume the unlikely is impossible, and | 4. Be ready to deal with the consequences if you do.

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Post by plnelson » Sun Aug 14, 2011 7:16 pm

OK, so what would you suggest as a practical strategy at this juncture?

I say this as someone who already has an extensive ladder of (buy and hold) bonds with a heavy weighting of Treasuries. But at the moment I'm emphasizing corporates because I don't see how to capitalize on Treasuries. ( Not to mention that I have a strict policy of only investing in AAA rated bonds by both Moody's and S&P. but that aside for now . . . )

Treasuries are priced very high right now and have yields that are less than the inflation rate when you take taxes into account. (no surprise given the inverse relationship of price and yield in bonds) So they seem like they almost guarantee a loss in real dollar terms unless you are gambling on interest rates falling even farther below their already extreme lows.

So I'm a little unclear on how one might take advantage of this in the current environment.

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Robert

Post by larryswedroe » Sun Aug 14, 2011 7:27 pm

The answer depends on what causes the bear market--if it is inflation then long term bonds hit you with double whammy. If it is financial crisis (deflationary) then LT bonds provide the best answer. So one should decide which to own depending on which is the greater risk to THEM. For retireees likely to be inflationary risks (so own TIPS). For those working might be deflation (labor capital could be put at risk) and might want to own LT nominals (though TIPS still provide hedge against deflation, though not as good as nominals)

Good example of why cookie cutter solutions not good--need to adapt policy to your situation.

The Only Guide You'll Ever Need to the Right Financial Plans asks these type questions.

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Post by baw703916 » Sun Aug 14, 2011 7:51 pm

Based on this and similar discussions over the last few years, I decided several months ago to add some EDV (zero coupon Treasuries) and LTPZ (20+ year TIPS) as diversifiers in my IRAs, which otherwise contain a bunch of high risk equity classes (US SV, ISV, EM SV, Intl. RE, etc.). About a 2:1 ratio of TIPS to nominals.

The bonds served me very well last week.

Brad
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Re: Robert

Post by biasion » Sun Aug 14, 2011 8:04 pm

larryswedroe wrote:The answer depends on what causes the bear market--if it is inflation then long term bonds hit you with double whammy. If it is financial crisis (deflationary) then LT bonds provide the best answer. So one should decide which to own depending on which is the greater risk to THEM. For retireees likely to be inflationary risks (so own TIPS). For those working might be deflation (labor capital could be put at risk) and might want to own LT nominals (though TIPS still provide hedge against deflation, though not as good as nominals)

Good example of why cookie cutter solutions not good--need to adapt policy to your situation.

The Only Guide You'll Ever Need to the Right Financial Plans asks these type questions.
This is pretty much where I learned it.

It's not cookie cutter, but the question to ask oneself is one's ability, willingness and need to take risk, decide on an equity allocation, and the rest will be based on that choice.

If someone's liquid net worth is most of their treasure vs their human capital, inflation would be a problem. In this case, shorter durations are better.

If someone's treasure is still mostly their human capital with low net worth, such that they are young, can earn a lot more money in future years and retirement is far away, then deflation is the bigger danger and higher equity allocations with longer bond durations are probably better.

Generally younger people tend to have higher equity allocations and be more damaged by deflation, so the cookie cutter "almost" fits there, but not quite because there are exceptions.

Some young people might sell a business, get an inheritance, or have a trust fund such that if they themselves worked a lifetime, they could not assemble what their nest egg is worth. This is why people's need to take risk can change, and their approach must change with it. In that case, such an investor with more money in net worth than they could earn might still have more in common with an older retiree in terms of inflation risk and need for shorter bonds.

The biggest question to answer is your equity allocation which is dictated by your ability, willingness and need to take risk. Once this is in place, everything else falls into place, IE, high equity has better sharpe ratio w/ longer bonds and vice versa.
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Post by Charleville » Sun Aug 14, 2011 11:13 pm

Great information. So often there is so much market noise this cuts through all of that. Nobody talks treasuries up(except the fed) they don't need cheerleaders but many try to tear them down. Yes there are problems with the good ol USA. So what-- it is the most free, the deepest flexible market in the world. Plus the government was willing to bail out foreign banks and wall street even when it was damaging politically and that my folks is the reason the greenback will maintain it's reserve currency status.

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Re: Robert

Post by yobria » Mon Aug 15, 2011 11:17 am

larryswedroe wrote:The answer depends on what causes the bear market--if it is inflation then long term bonds hit you with double whammy. If it is financial crisis (deflationary) then LT bonds provide the best answer. So one should decide which to own depending on which is the greater risk to THEM. For retireees likely to be inflationary risks (so own TIPS). For those working might be deflation (labor capital could be put at risk) and might want to own LT nominals (though TIPS still provide hedge against deflation, though not as good as nominals)
Yes, I've been advocating what I call the "specific risks" bond allocation model for years on this and the old Diehards board.

The idea is - long term bonds when you're young (recession/depression is your enemy), TIPS when your retire (inflation is the enemy).

The idea never seemed to gain much traction, especially among the "stay short no matter what" DFA contingent.

Maybe this is an idea whose time has come.

Nick

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Post by ddb » Mon Aug 15, 2011 11:39 am

Robert T wrote:.

Code: Select all

Index                                                    Last 30 days
                                                          To 8/12/11 

Barclays Capital U.S. 20+ Year Treasury Bond Index           8.95
Barclays Capital U.S. 10-20 Year Treasury Bond Index         7.35
Barclays Capital U.S. 7-10 Year Treasury Bond Index          5.26
Barclays Capital U.S. 3-7 Year Treasury Bond Index           2.38
Barclays Capital U.S. 1-3 Year Treasury Bond Index           0.38
		
Barclays Capital U.S. 1-3 Year Credit Bond Index             0.05
Barclays Capital U.S. Intermediate Credit Bond Index         1.00
iBoxx $ Liquid High Yield Index                             -4.80
		
Russell 1000 Index                                         -10.81
Russell 1000 Value Index                                   -13.69
Russell MidCap Index                                       -13.45
Russell MidCap Value Index                                 -15.56
Russell 2000 Index                                         -16.59
Russell 2000 Value Index                                   -17.96
Russell Microcap(R) Index                                  -17.63

Source: iShares website
.
Nice to hear from you, Robert, if only for this brief update. Hope all is well...

- DDB
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB

DaveS
Posts: 1308
Joined: Fri Jun 15, 2007 9:42 am
Location: Reno, NV

Post by DaveS » Mon Aug 15, 2011 1:52 pm

Frankly I think the long bond people are fighting the last war , when the "new war" demands different weapons. I can remember when long term rates that were 10% or more in the inflationary early 80's. The most likely direction for rates then was down. Saying long bonds were were good then does not predict much for now when rates are negligible when the most likely direction, at some unknown point, is up. Dave

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