skierincolorado wrote: ↑Fri Sep 23, 2022 1:05 pm
I would not say that hfea relies on a negative correlation. The correlation has not been negative historically it has been near zero. Low/negative correlation is nice and helps to reduce volatility and volatility decay of highly leveraged portfolios. But it is far more essential that the portfolio components simply have positive expected returns. The expected return for stocks and bonds is positive. The expected return is higher than it was a year ago. While I have some issues with hfea specifically (as outlined in some of my posts above), one should own at least as much stocks and bonds as a year ago - if not more due to the higher expected returns.
It's a slippery slope. As I outlined a few times in the mHFEA thread, I feel there is little to no theoretical justification that the term premium should be positive in the long run; and all models forecast a zero or negative term premium, and the models e.g. ACM didn't budge even when interest rates rose dramatically in 2022. I too feel that a 3.5% 10y looks "safer" for (m)HFEA than a 1.5y 10y yield. But is it true?
Copying from the long term bond thread
The CPI 1964 to ca. 1980 looks not much different from 2021-2022, despite the fact that interest rates were several percentage points above inflation during 1964 to ca. 1978. After 1964, rates did not fall below 4% again until ca. 2008 - that's 44 years! That would suggest to NOT go by the current yield when determining your treasury allocation, hoping for it to fall ("mean-revert") - because it may not.
Interesting, when 5y rates were at 5% in 2007, the estimated term premium was zero (probably because of the 44 year recent history of high short-term rates at that time). In 2009 after a significant drop of the 5y from ca. 5% to ca. 2%, the estimates were at ca. 2%. Because the short-term rates were even lower (0%) and I guess it was implied in the curve that they would stay that way for a while
EDIT: It was actually implied that they would rise again soon (see third image below) - so why was the expected term premium so high? (I guess the term structure implied higher rates, but that didn't affect expected returns of current bonds back then as the hikes were expected.) VGIT performance was about flat, see last image below. So ITT futures would probably have had negative returns in the 5-year period starting 2009 (chart performance + interest distributions from the fund - financing cost).
That would suggest going by the current yield, NOT by term premia model forecasts, wouldn't it?