Bond Investing when Yield Curve is Flat

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305pelusa
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Re: Bond Investing when Yield Curve is Flat

Post by 305pelusa » Wed Oct 09, 2019 4:56 pm

Doc wrote:
Wed Oct 09, 2019 4:44 pm
vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
vineviz wrote:
Wed Oct 09, 2019 7:00 am
No, my comment was not limited exclusively to a bond/equity portfolio. It would be true even for a 0% equity portfolio.
I don't understand. If going long does not mean you are taking on more risk but you get higher return why would anyone buy short term bonds?

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

Can you please give us some reasoning or a reference.
You're correct. He's talking about liability and duration matching aka bond immunization.

Risk is also defined by others as the volatility of an investment. In that sense, LT bonds are certainly "riskier" than ST bonds.

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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Wed Oct 09, 2019 8:38 pm

Doc wrote:
Wed Oct 09, 2019 4:44 pm
vineviz wrote:
Tue Oct 08, 2019 2:09 pm
Many people think that "(b)y going longer you take on more risk" but this isn't true.
vineviz wrote:
Wed Oct 09, 2019 7:00 am
No, my comment was not limited exclusively to a bond/equity portfolio. It would be true even for a 0% equity portfolio.
I don't understand. If going long does not mean you are taking on more risk but you get higher return why would anyone buy short term bonds?

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

Can you please give us some reasoning or a reference.
The first important principle is that - despite the colloquial usage - it's important to remember that fundamentally assets don't have risks, investors do. Generally speaking, investors increase their risk by investing in assets that mismatch their preferences/needs in some way.

The second principle to note is that there is only one risk which an investor potentially faces that is related to duration and that is interest rate rate risk. In other words, when you say that "(b)y going longer you take on more risk" you can only be referring to interest rate risk. The other risks you might face (e.g. inflation risk, default risk, etc.) aren't directly related to duration: only interest rate risk is.

Bringing these two principles together, you can probably see that the statement "(b)y going longer you take on more risk" isn't generally true. If your investment horizon is long-term, then you can only minimize interest rate risk by own long-term bonds. The common belief that you can avoid interest rate risk by buying short-term bonds ignores half of what actually makes a risk into a "risk".
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Thu Oct 10, 2019 7:17 am

vineviz & 305pelusa, thanks.
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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Fri Oct 11, 2019 6:07 pm

vineviz wrote:
Wed Oct 09, 2019 8:38 pm

Bringing these two principles together, you can probably see that the statement "(b)y going longer you take on more risk" isn't generally true. If your investment horizon is long-term, then you can only minimize interest rate risk by own long-term bonds. The common belief that you can avoid interest rate risk by buying short-term bonds ignores half of what actually makes a risk into a "risk".

That whole philosophy is predicated on the assumption that interest rates will remain low over the foreseeable and extended future. If interest rates rose to 4% like they were supposed to do every LT bond fund would have negative returns. So that information was imperfect but perfect in the sense that we can surmise the stock market is so weak that it cannot take a high or even a medium or normal interest rate. It has shown quite an allergy to higher rates when they started to rise. But that is not the investors fault that is the stock market's fault. A weak stock market.

The optimum time to buy LT bonds, of course, is when they yield above their historical mean. Otherwise they're not a bad strategic tilt but certainly not optimum. The next year or 2 looks like a better time to sell LT and probably a neutral time to buy.

Have to wait and see what else happens.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Fri Oct 11, 2019 7:33 pm

patrick013 wrote:
Fri Oct 11, 2019 6:07 pm
vineviz wrote:
Wed Oct 09, 2019 8:38 pm

Bringing these two principles together, you can probably see that the statement "(b)y going longer you take on more risk" isn't generally true. If your investment horizon is long-term, then you can only minimize interest rate risk by own long-term bonds. The common belief that you can avoid interest rate risk by buying short-term bonds ignores half of what actually makes a risk into a "risk".

That whole philosophy is predicated on the assumption that interest rates will remain low over the foreseeable and extended future.
Not at all. In fact, this approach is predicated on the assumption that we can't predict what interest rates will do over the investment horizon and on a desire to construct a bond portfolio in such a way that it doesn't matter what interest rates do.

When the bond duration matches the investment horizon, the investor is an a position of not caring at all what happens to interest rates. Up, down, or unchanged: it's irrelevant.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by 305pelusa » Fri Oct 11, 2019 8:47 pm

patrick013 wrote:
Fri Oct 11, 2019 6:07 pm
vineviz wrote:
Wed Oct 09, 2019 8:38 pm

Bringing these two principles together, you can probably see that the statement "(b)y going longer you take on more risk" isn't generally true. If your investment horizon is long-term, then you can only minimize interest rate risk by own long-term bonds. The common belief that you can avoid interest rate risk by buying short-term bonds ignores half of what actually makes a risk into a "risk".

That whole philosophy is predicated on the assumption that interest rates will remain low over the foreseeable and extended future. If interest rates rose to 4% like they were supposed to do every LT bond fund would have negative returns. So that information was imperfect but perfect in the sense that we can surmise the stock market is so weak that it cannot take a high or even a medium or normal interest rate. It has shown quite an allergy to higher rates when they started to rise. But that is not the investors fault that is the stock market's fault. A weak stock market.

The optimum time to buy LT bonds, of course, is when they yield above their historical mean. Otherwise they're not a bad strategic tilt but certainly not optimum. The next year or 2 looks like a better time to sell LT and probably a neutral time to buy.

Have to wait and see what else happens.
You have it backwards. If you're a long term investor (don't need the money for, say 30 years) and buy a 30 year treasury right now, you would be delighted if rates suddenly skyrocketed. Not only will you earn your 1.5% coupon like you were expecting, but you'll get to reinvest at higher rates too.

The "negative returns" you'd see if rates went up right now is can be thought of as the bond returns being pushed to the future (not lost!). And a little better even due to the reinvestment.

So vineviz is not technically completely correct here:
vineviz wrote:
Fri Oct 11, 2019 7:33 pm
When the bond duration matches the investment horizon, the investor is an a position of not caring at all what happens to interest rates. Up, down, or unchanged: it's irrelevant.
The only time you're completely indifferent to interest rates by matching duration to horizon is with a zero-coupon bond. Otherwise, you'll come out ahead overall if rates go up through the life of the bond. And vice versa if they drop.

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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Fri Oct 11, 2019 8:59 pm

305pelusa wrote:
Fri Oct 11, 2019 8:47 pm
The only time you're completely indifferent to interest rates by matching duration to horizon is with a zero-coupon bond. Otherwise, you'll come out ahead overall if rates go up through the life of the bond. And vice versa if they drop.
As long as the duration of the bond portfolio matches the investment horizon, the investor remains indifferent to changes in interest rate. This is true whether the portfolio is constructed entirely of zero-coupons bonds, coupon bonds, or a mix.
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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Fri Oct 11, 2019 9:40 pm

305pelusa wrote:
Fri Oct 11, 2019 8:47 pm

The only time you're completely indifferent to interest rates by matching duration to horizon is with a zero-coupon bond. Otherwise, you'll come out ahead overall if rates go up through the life of the bond. And vice versa if they drop.

I would never match maturities to horizon. I would never match duration to anything. You would miss many strategic opportunities. People think LT is a godsend but the history is from a long secular period of lowering rates and subsequent capital gains realized if taken. I can't see where rates can lower from previous levels to that extent when they're low to begin with. And reinvestments only recovers yield lost in pricing when rates peak suddenly leading to not much gain in long term yield considering other alternatives.

I can manage a 10 year TRSY ladder and get most of the long term yield. Any putz can. Plus make par investments at higher yields when bonds mature. A big difference in strategy. Par investments at higher market yields when your idea merely recovers bond original yield within the duration time period. This has been covered before but long story short the best time to go full weight LT is when those yields are above their historical mean. Some long term AA can be good but rational to perhaps a 10% AA. Maybe slightly more if adventurous.

This whole duration mindset is nauseating to me. It's like being on a sinking ship that hasn't sank yet. I can do everything I need using maturities and YTM formulations. So I'm not one to sell on that idea.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 6:06 am

patrick013 wrote:
Fri Oct 11, 2019 9:40 pm
This whole duration mindset is nauseating to me. It's like being on a sinking ship that hasn't sank yet. I can do everything I need using maturities and YTM formulations. So I'm not one to sell on that idea.
Investors who willingly choose not to match duration with investment horizon are taking on more interest rate risk without being compensated for it.

Actively choosing such a mismatch is market timing, pure and simple, and anyone wishing to engage in that behavior should at the very least understand that they are doing so. What they do with that information is, of course, up to them.
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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Sat Oct 12, 2019 8:01 am

vineviz wrote:
Sat Oct 12, 2019 6:06 am
patrick013 wrote:
Fri Oct 11, 2019 9:40 pm
This whole duration mindset is nauseating to me. It's like being on a sinking ship that hasn't sank yet. I can do everything I need using maturities and YTM formulations. So I'm not one to sell on that idea.
Investors who willingly choose not to match duration with investment horizon are taking on more interest rate risk without being compensated for it.

Actively choosing such a mismatch is market timing, pure and simple, and anyone wishing to engage in that behavior should at the very least understand that they are doing so. What they do with that information is, of course, up to them.
That's as weird as it gets. Strategic allocation is not really market timing. Matching duration to horizon will produce much lower yield. We can spend yield not duration. A weird idea unless rates stay low forever, locking in such low rates. Looks good short term however.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 8:56 am

patrick013 wrote:
Sat Oct 12, 2019 8:01 am
vineviz wrote:
Sat Oct 12, 2019 6:06 am
patrick013 wrote:
Fri Oct 11, 2019 9:40 pm
This whole duration mindset is nauseating to me. It's like being on a sinking ship that hasn't sank yet. I can do everything I need using maturities and YTM formulations. So I'm not one to sell on that idea.
Investors who willingly choose not to match duration with investment horizon are taking on more interest rate risk without being compensated for it.

Actively choosing such a mismatch is market timing, pure and simple, and anyone wishing to engage in that behavior should at the very least understand that they are doing so. What they do with that information is, of course, up to them.
That's as weird as it gets. Strategic allocation is not really market timing. Matching duration to horizon will produce much lower yield. We can spend yield not duration. A weird idea unless rates stay low forever, locking in such low rates. Looks good short term however.
The claim that “matching duration to horizon will produce much lower yield” depends on a belief that you can predict future behavior of markets. This is the opposite of strategic allocation: it’s a tactical allocation that relies on market signals. It is market timing, by any definition.
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Re: Bond Investing when Yield Curve is Flat

Post by JoMoney » Sat Oct 12, 2019 9:07 am

patrick013 wrote:
Sat Oct 12, 2019 8:01 am
... That's as weird as it gets. Strategic allocation is not really market timing. Matching duration to horizon will produce much lower yield. We can spend yield not duration. A weird idea unless rates stay low forever, locking in such low rates. Looks good short term however.
This statement, implies to me that you have no intention of ever spending the bond principal...??? If that's the case, the duration of your portfolio can be infinite if you like the yield well enough. That's a different situation than someone who expects their coupon interest and principal to be secure over a particular time frame. Interest rates may be low, but nobody has any idea how long they will remain low or if they'll go lower or higher (and how quickly rates might move).
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 9:55 am

This idea of matching duration to one's investment horizon needs better definition.

I'm going to die in 20 years so my entire FI allocation should be in a single 20 year zero coupon bond? Obviously not.

I would be able to do this because I am not going to spend the money from my bonds but rather spend the dividends and cap gains from the equity portion of my portfolio. Probably not.

We should think of our fixed income portfolio as a part of our entire portfolio not as a stand alone position. With that in mind I want my Treasury portfolio to act as a foil to my equity position with emphasis on stock market corrections. With a more normal yield curve this would mean a significant part of my Treasuries would be in intermediate and long term bonds. But with a flat yield curve would those longer term notes and bonds still provide more of a counter than short term notes and if that answer is yes am I willing to give up low FI returns for the next 10, 20 or 30 years?

Question: Do we have any data on the correlation of different maturity treasuries during stock market corrections when the yield curve is flat?
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 10:10 am

Doc wrote:
Sat Oct 12, 2019 9:55 am
This idea of matching duration to one's investment horizon needs better definition.

I'm going to die in 20 years so my entire FI allocation should be in a single 20 year zero coupon bond? Obviously not.
If you’re planning to die in exactly 20 years, your investment horizon likely isn’t 20 years.

But if your interest horizon IS 20 years, then yes: you can eliminate interest rate with a 20 year zero-coupon bond.

Doesn’t mean you SHOULD invest solely in such a bond: there are likely better strategies with the same duration.
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Re: Bond Investing when Yield Curve is Flat

Post by JoMoney » Sat Oct 12, 2019 10:19 am

On a side note, If you were looking to make a series of withdrawals every year over the next 20 years, the bond portfolios duration isn't 20 years, the duration would be more like 10 years.
A portfolio with a ladder of bonds maturing in (1,2,3, ..., 20) years would have a duration of about 10 years.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 11:28 am

JoMoney wrote:
Sat Oct 12, 2019 10:19 am
On a side note, If you were looking to make a series of withdrawals every year over the next 20 years, the bond portfolios duration isn't 20 years, the duration would be more like 10 years.
A portfolio with a ladder of bonds maturing in (1,2,3, ..., 20) years would have a duration of about 10 years.
We seem to have gotten on bonds in isolation. And the ideas presented have been informative.

But I'm concerned with overall portfolio performance.

With a "normal" yield curve I would like to have enough intermediate/long Treasuries to rebalnce in a 20% to 40% stock market decline. With an 80/20 AA I only need about 7% of my total portfolio or 35% of my bond portfolio in "long" T's. And in that case I don't really care if the yield curve is flat because there is not that much income from the T's to make much difference. But if I have a 50/50 AA that Treasury "insurance" part becomes 10% of my total portfolio 20% of my bond portfolio. Do I really want 20% of my bond portfolio to be in long T's with a flat yield curve?

A second question is with a flat yield curve are long T's still going to give us better insurance than short T's in that stock market crash? Does that data exist?
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 1:17 pm

Doc wrote:
Sat Oct 12, 2019 11:28 am
With a "normal" yield curve I would like to have enough intermediate/long Treasuries to rebalnce in a 20% to 40% stock market decline. With an 80/20 AA I only need about 7% of my total portfolio or 35% of my bond portfolio in "long" T's. And in that case I don't really care if the yield curve is flat because there is not that much income from the T's to make much difference. But if I have a 50/50 AA that Treasury "insurance" part becomes 10% of my total portfolio 20% of my bond portfolio. Do I really want 20% of my bond portfolio to be in long T's with a flat yield curve?
You want bond duration to match investment horizon, regardless of yield curve OR how much of the portfolio is allocated to bonds.

In practice, there is generally a correlation between investment horizon and the allocation to bonds. But there is no causal relationship between those two particular characteristics.

Doc wrote:
Sat Oct 12, 2019 11:28 am
A second question is with a flat yield curve are long T's still going to give us better insurance than short T's in that stock market crash? Does that data exist?
I’ve answered this already, I think. Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 2:32 pm

vineviz wrote:
Sat Oct 12, 2019 1:17 pm
You want bond duration to match investment horizon, regardless of yield curve OR how much of the portfolio is allocated to bonds.
I understand that but I don't have an investment horizon. (Unless you add 90 years to the age of my youngest grandchild. :D ) I'm trying to have some of my FI portfolio in a position to have a negative correlation to stocks in a stock market collapse. That could occur any time in the next year or so if we belive that an inverted yield curve is a harbinger of a depression. In that case my investment horizon is 12 months. So by your reasoning T-Bills are fine. And maybe you are right. If so I'm already in good shape since I've been replace rungs of my 7-3 ladder with T-Bills as they rolled off.
vineviz wrote:
Sat Oct 12, 2019 1:17 pm
I’ve answered this already, I think. Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve.
Yes you said that. And I agree with that under "normal" yield curve conditions. But do we have any data that shows that it is also true when the yield curve is inverted? In 2008 the yield curve was flattish (10-2 ~ 1.5%) but not inverted and longer term bonds did do better than shorter term bonds when the market tanked.

But in the fall of 1998 the 10-2 spread spiked from about 0.1 to 0.6 after it had been negative indicating that the price of the tens dropped . Not good for rebalancing.

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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Sat Oct 12, 2019 2:39 pm

vineviz wrote:
Sat Oct 12, 2019 8:56 am


The claim that “matching duration to horizon will produce much lower yield” depends on a belief that you can predict future behavior of markets. This is the opposite of strategic allocation: it’s a tactical allocation that relies on market signals. It is market timing, by any definition.

Well there you go predicting rates will stay ultra low so your plan would work.

So I guess we'll just have strategic allocations for secular trends and the higher yields
that will return when economically feasible.
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Re: Bond Investing when Yield Curve is Flat

Post by patrick013 » Sat Oct 12, 2019 2:41 pm

JoMoney wrote:
Sat Oct 12, 2019 9:07 am
patrick013 wrote:
Sat Oct 12, 2019 8:01 am
... That's as weird as it gets. Strategic allocation is not really market timing. Matching duration to horizon will produce much lower yield. We can spend yield not duration. A weird idea unless rates stay low forever, locking in such low rates. Looks good short term however.
This statement, implies to me that you have no intention of ever spending the bond principal...??? If that's the case, the duration of your portfolio can be infinite if you like the yield well enough. That's a different situation than someone who expects their coupon interest and principal to be secure over a particular time frame. Interest rates may be low, but nobody has any idea how long they will remain low or if they'll go lower or higher (and how quickly rates might move).
Ultra low rates aren't economically feasible. Neither are ultra high rates. I wouldn't expect either to last very long. So why worry about it.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 2:46 pm

Doc wrote:
Sat Oct 12, 2019 2:32 pm
I understand that but I don't have an investment horizon. (Unless you add 90 years to the age of my youngest grandchild. :D )
Everyone has an investment horizon, and yours sounds like it is well over 30 years. There’s no reason to own anything but the longest term bonds you can find.
Doc wrote:
Sat Oct 12, 2019 2:32 pm
vineviz wrote:
Sat Oct 12, 2019 1:17 pm
I’ve answered this already, I think. Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve.
Yes you said that. And I agree with that under "normal" yield curve conditions. But do we have any data that shows that it is also true when the yield curve is inverted? I
Yes, we have this data and this is why I keep repeating it: Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 2:57 pm

vineviz wrote:
Sat Oct 12, 2019 2:46 pm
Yes, we have this data and this is what I keep repeating it: Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve
Please show me some data. I would like to belive you.

The 1998 data does not seem to support that. In 1998 the stock market tanked and the 10-2 spread rose sharply which indicates I think that means the ten price decreased. And what we want is for the price to increase.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 3:24 pm

Doc wrote:
Sat Oct 12, 2019 2:57 pm
vineviz wrote:
Sat Oct 12, 2019 2:46 pm
Yes, we have this data and this is what I keep repeating it: Long-term Treasuries are the best diversifier among bond types REGARDLESS of the shape of the yield curve
Please show me some data. I would like to belive you.

The 1998 data does not seem to support that. In 1998 the stock market tanked and the 10-2 spread rose sharply which indicates I think that means the ten price decreased. And what we want is for the price to increase.
We don’t always get what we want, do we? The question is, what’s the best strategy given what is knowable before the crash?

Long-term Treasuries are the best diversification strategy, and the shape of the yield curve doesn’t change the decision.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 4:12 pm

vineviz wrote:
Sat Oct 12, 2019 3:24 pm
Long-term Treasuries are the best diversification strategy, and the shape of the yield curve doesn’t change the decision.
1) Show us some data where the curve was inverted and long term Treasuries were a better diversifier. The spike in the 10-2 spread concurrently with the stock market crash in '98 seems to infer the opposite.

2) Even if long-term Treasuries is the best strategy is it worth locking in a low return for a long time if the stock market crash does not occur for the duration of your long T''s.

I want you to be right. I don't like to be in the position I'm in right now with a Treasury portfolio duration of only 1.5 years. But I'm reluctant to extend the duration and accept a low return for many years when the anticipated stock market crash may not occur.
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Re: Bond Investing when Yield Curve is Flat

Post by 305pelusa » Sat Oct 12, 2019 4:52 pm

Doc wrote:
Sat Oct 12, 2019 4:12 pm
I want you to be right. I don't like to be in the position I'm in right now with a Treasury portfolio duration of only 1.5 years. But I'm reluctant to extend the duration and accept a low return for many years when the anticipated stock market crash may not occur.
I understand your view here. Here's a thought: You don't have to extend your duration to your true horizon (say 20 years+) if you feel really uncomfortable holding such a return for that long. Specially if you'll end up feeling really upset, dumb, angry, etc if you follow this advice and rates do go up. "Why did I listen to a bunch of Internet posters instead of my gut?". There's a very real psychological weight here.

But 1.5 years is pretty short too. What if rates continue to dip? Won't you feel really upset if in 3 years, bonds begin to yield negative rates and you'll have to reinvest at that? The 2% 30Y treasury bonds of 2019 will look awesome when looking back.

So maybe split the difference? Extend your duration to, say, 7-8 years (like the 3-Fund Portfolio) and just relax. That might be a reasonable compromise between the technically rational answer of matching duration=horizon, and your own personal psychological feelings on the topic (which definitely matter too).

Again, just a thought.

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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 5:19 pm

Doc wrote:
Sat Oct 12, 2019 4:12 pm
vineviz wrote:
Sat Oct 12, 2019 3:24 pm
Long-term Treasuries are the best diversification strategy, and the shape of the yield curve doesn’t change the decision.
1) Show us some data where the curve was inverted and long term Treasuries were a better diversifier. The spike in the 10-2 spread concurrently with the stock market crash in '98 seems to infer the opposite.

2) Even if long-term Treasuries is the best strategy is it worth locking in a low return for a long time if the stock market crash does not occur for the duration of your long T''s.

I want you to be right. I don't like to be in the position I'm in right now with a Treasury portfolio duration of only 1.5 years. But I'm reluctant to extend the duration and accept a low return for many years when the anticipated stock market crash may not occur.
1) I’ve already provided the data. Go back and look.

2) if the only reason you are holding any bonds is because you’re waiting for an equity crash, don’t hold any bonds. That’s a terrible reason to allocate to bonds. If you’re going to hold bonds anyway, long-term Treasuries check the two most important boxes: best diversification and lowest interest rate risk.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sat Oct 12, 2019 5:21 pm

Doc wrote:
Sat Oct 12, 2019 9:55 am
With that in mind I want my Treasury portfolio to act as a foil to my equity position with emphasis on stock market corrections. With a more normal yield curve this would mean a significant part of my Treasuries would be in intermediate and long term bonds. But with a flat yield curve would those longer term notes and bonds still provide more of a counter than short term notes and if that answer is yes am I willing to give up low FI returns for the next 10, 20 or 30 years?
Obviously bond yields do not always drop during market corrections, but often they do. My long treasurys have performed very well over the last few months of volatility and have done a nice job evening things out for me. My gold has been performing well also.
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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sat Oct 12, 2019 5:25 pm

vineviz wrote:
Sat Oct 12, 2019 5:19 pm
long-term Treasuries check the two most important boxes: best diversification and lowest interest rate risk.
Not sure I agree with the latter point. I like LT Treasurys but they are generally considered of high interest rate risk...Duration of a 30 year treasury is usually in the 20ish year range (depending on coupon issued).
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 5:37 pm

welderwannabe wrote:
Sat Oct 12, 2019 5:25 pm
vineviz wrote:
Sat Oct 12, 2019 5:19 pm
long-term Treasuries check the two most important boxes: best diversification and lowest interest rate risk.
Not sure I agree with the latter point. Long Treasuries are generally considered of high interest rate risk...Duration of a 30 year treasury is usually in the 20ish year range (depending on coupon issued).
I was speaking direct about the case of the OP, who acknowledged a very long investment horizon (90+ years, if they were not being facetious). For an investor with such a long horizon, long-term bonds do in fact present the least interest rate risk.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sat Oct 12, 2019 6:08 pm

vineviz wrote:
Sat Oct 12, 2019 5:37 pm
I was speaking direct about the case of the OP, who acknowledged a very long investment horizon (90+ years, if they were not being facetious). For an investor with such a long horizon, long-term bonds do in fact present the least interest rate risk.
There is still risk because one's horizon may end up being different than hoped/desired forcing an early sale. Just because you think your horizon is 90 years does not make the risk disappear. Its still there, you are just telling yourself it isn't.

I could see making this case about reinvestment risk, but not interest rate risk.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sat Oct 12, 2019 6:36 pm

welderwannabe wrote:
Sat Oct 12, 2019 6:08 pm
There is still risk because one's horizon may end up being different than hoped/desired forcing an early sale.
That is a risk, for sure, but it’s not interest rate risk.

Duration matching can not eliminate ALL risks faced by an investor, just interest rate risk.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sat Oct 12, 2019 7:00 pm

vineviz wrote:
Sat Oct 12, 2019 6:36 pm
That is a risk, for sure, but it’s not interest rate risk.
Duration matching can not eliminate ALL risks faced by an investor, just interest rate risk.
Again, the interest rate risk is still there. If interest rates shoot up, the value of the long bond has fallen at that point in time. The value of a bond falling in response to rising rates is the definition of interest rate risk. Lots of people plan to hold things to term and then don't for whatever reason. You can call needing to sell an asset before you had hoped a different type of risk, but the fact is that if the interest rate risk wasnt there then selling the bond early wouldn't matter.

Having fire insurance and good smoke detectors does not mean that my home no longer has a risk of having a fire.
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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sat Oct 12, 2019 7:11 pm

welderwannabe wrote:
Sat Oct 12, 2019 5:21 pm
Obviously bond yields do not always drop during market corrections, but often they do.
Going back to the Schwab paper referenced in the OP. Of the last 6 periods when stocks have fallen sharply intermediate T's have out performed T-Bills 3 times, T-Bills have outperformed 2 times and the other was essentially a wash. My question is does the yield curve give us a head's up as which will happen next time?

FWIW 3 intermediate winners, 2 T-Bill winners and 1 draw is not a conclusive result that one is "best". Going long based on this data is questionable.
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sun Oct 13, 2019 6:14 am

welderwannabe wrote:
Sat Oct 12, 2019 7:00 pm
Again, the interest rate risk is still there. If interest rates shoot up, the value of the long bond has fallen at that point in time. The value of a bond falling in response to rising rates is the definition of interest rate risk.
You’re misdefining interest rate risk. What you’re describing is price risk, which is only one piece of interest rate risk. Reinvestment risk is the other piece, and it has an opposite sign from price risk.

When duration of the asset matches the investment horizon, these two components of interest rate risk exactly offset each other. At that point, interest rate risk (but not all other risks) is zero.
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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sun Oct 13, 2019 7:33 am

vineviz wrote:
Sun Oct 13, 2019 6:14 am
You’re misdefining interest rate risk. What you’re describing is price risk, which is only one piece of interest rate risk. Reinvestment risk is the other piece, and it has an opposite sign from price risk.

When duration of the asset matches the investment horizon, these two components of interest rate risk exactly offset each other. At that point, interest rate risk (but not all other risks) is zero.
Uhm, I would say using a different definition than you. As a voracious reader of various financial texts I can tell you that in many of them (if not most of them) Interest Rate Risk is defined exactly as I stated. In those, reinvestment risk is viewed as related to interest rate risk (moving in the opposite direction) but a separate type of risk all together.

However, even using the definition you are using I still find you concept to be invalid as it makes the assumption that an investor has 100% control over their timeline and therefore the risk can be completely eliminated. I still believe the risk is there, you just tell yourself that it isn't. There are very very few situations where you can guarantee 100% that your investment horizon is what you say it is.

A stable value failing because of a mass layoff at a company causing redemptions are examples where the investment horizon was perceived to be one thing until it wasn't and CFAs were hand wringing saying "but interest rate risk was zero because we matched our durations to the investment horizon".

So maybe this is one of those things like Physics formulas where they only work in a vacuum and we are an standard temp and pressure.
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Re: Bond Investing when Yield Curve is Flat

Post by welderwannabe » Sun Oct 13, 2019 7:42 am

Doc wrote:
Sat Oct 12, 2019 7:11 pm
Going back to the Schwab paper referenced in the OP. Of the last 6 periods when stocks have fallen sharply intermediate T's have out performed T-Bills 3 times, T-Bills have outperformed 2 times and the other was essentially a wash. My question is does the yield curve give us a head's up as which will happen next time?

FWIW 3 intermediate winners, 2 T-Bill winners and 1 draw is not a conclusive result that one is "best". Going long based on this data is questionable.
I certainly don't know for sure! Wish I did, I could quit my day job.

I would say an inverted/flat yield curve would indicate that the short-end could perform better during some corrections, but unless you can tell the future and know the reason for the correction in advance its hard do say. If the market is predicting the fed will have to make a major cut (that wasn't previously priced in) you could see a drop in short term interest rates with the longer end staying put. In other words, a steepening of the curve. In those cases I would expect the short end to outperform.

However, in a case where the market drops because they feel the Fed *should* cut but thinks that they won't for political or other reasons then I would expect yields to drop intermediate/long and short to stay high, causing performance to be better at the mid and long end of the curve.

Regardless its all guesses, but I think one thing we can learn from a flat/inverted yield curve is that there is a larger chance of it not performing to the normal mantra of "intermediate bond prices rise when stocks fall". In other words, the relationship is less correlated and more volatile during those times.

Taking off my Great Carnac hat now.
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Re: Bond Investing when Yield Curve is Flat

Post by jeffyscott » Sun Oct 13, 2019 8:09 am

welderwannabe wrote:
Sun Oct 13, 2019 7:42 am
Regardless its all guesses, but I think one thing we can learn from a flat/inverted yield curve is that there is a larger chance of it not performing to the normal mantra of "intermediate bond prices rise when stocks fall". In other words, the relationship is less correlated and more volatile during those times.

Taking off my Great Carnac hat now.
With a 1 year return of 10% based on Vanguard intermediate treasury, if stocks were to fall now, perhaps you've already gotten your rise in bond prices in advance? That 10% return happened with yields falling from about 3.1% to 1.7% for the 7 year bond.

Not sure what it would take to get another 10%, perhaps the 7 year going to 0.3%?
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Re: Bond Investing when Yield Curve is Flat

Post by Nowizard » Sun Oct 13, 2019 8:18 am

This may not be the thread for this, but to complete a bond discussion, it would be helpful for those of us who find bonds more confusing than stocks to discuss the advantages of investing in bond funds vs. individual bonds when the yield curve is flat.

Tim

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Sun Oct 13, 2019 9:36 am

jeffyscott wrote:
Sun Oct 13, 2019 8:09 am
With a 1 year return of 10% based on Vanguard intermediate treasury, if stocks were to fall now, perhaps you've already gotten your rise in bond prices in advance?
Yeh! The price increase over the past year is 7.4%. Just slightly more than the S&P 500.

http://quotes.morningstar.com/chart/fun ... 0L8W%22%7D
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Re: Bond Investing when Yield Curve is Flat

Post by vineviz » Sun Oct 13, 2019 12:42 pm

welderwannabe wrote:
Sun Oct 13, 2019 7:33 am
Uhm, I would say using a different definition than you. As a voracious reader of various financial texts I can tell you that in many of them (if not most of them) Interest Rate Risk is defined exactly as I stated. In those, reinvestment risk is viewed as related to interest rate risk (moving in the opposite direction) but a separate type of risk all together.
Treating price risk and interest rate risk as equivalent is a common mistake, so it certainly doesn't surprise me that you've seen this error in print. The full and proper definition of interest rate risk, and the one taught in the CFA curriculum, is the one I presented earlier in which interest rate risk has two components, price risk and reinvestment risk.

See here for some references: viewtopic.php?t=288043#p4700173
welderwannabe wrote:
Sun Oct 13, 2019 7:33 am
However, even using the definition you are using I still find you concept to be invalid as it makes the assumption that an investor has 100% control over their timeline and therefore the risk can be completely eliminated. I still believe the risk is there, you just tell yourself that it isn't. There are very very few situations where you can guarantee 100% that your investment horizon is what you say it is.
I'll say it again, interest rate risk is certainly not the only type of risk an investor faces. Those other risks may be significant, and possibly significant enough that controlling interest rate risk might seem like an unworthy goal, but that doesn't mean that interest rate risk isn't distinct from those risks. Each distinct risk will require distinct strategies for managing those risks, which is why it's important not to confuse them.
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Re: Bond Investing when Yield Curve is Flat

Post by Hector » Thu Oct 17, 2019 6:25 pm

I have read that since no one knows tomorrow, it is a good idea to assume that tomorrow's rate would be similar to today's rate. Article seems to emphasis that today's rate on short term securities is not going to last for long.

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Re: Bond Investing when Yield Curve is Flat

Post by Doc » Fri Oct 18, 2019 3:48 pm

Hector wrote:
Thu Oct 17, 2019 6:25 pm
I have read that since no one knows tomorrow, it is a good idea to assume that tomorrow's rate would be similar to today's rate. Article seems to emphasis that today's rate on short term securities is not going to last for long.
I think the idea was "The best predictor of the future yield curve is today's yield curve. Just not a very good one."
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