Do long-term bonds belong in one's portfolio?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
patrick013
Posts: 2425
Joined: Mon Jul 13, 2015 7:49 pm

Re: Do long-term bonds belong in one's portfolio?

Post by patrick013 » Sat Dec 08, 2018 6:41 pm

JackoC wrote:
Sat Dec 08, 2018 5:45 pm

This is the model's output of *expected* term premium at each of those dates, not the realized premium. Bond investors imposed a huge expected premium in '80's-90's after they got more and more severely burned by unexpected inflation from the late 60's to early 80's. That big premium went back to previous levels as investors became more confident inflation was anchored. But now the premium is negative, again per the Fed's model. This might be a result of global central bank 'QE' among other factors. Note that even though the Fed's QE is gradually unwinding, US long rates are also influenced by extraordinarily low Euro and Yen long rates, which in all likelihood have their own central bank manipulation induced negative term premiums.
It's a common observation when stock prices go up bond prices go down, and when stock prices go down bond prices go up. And when interest rates fall money moves into long term bonds and vice versa. But how often does supply and demand have it's effect. Sure there is exchange rate pressures in global markets affecting bond prices but more often I read about increased foreign demand for US bonds. The increased volume buys up the higher yielding bonds for sale leaving the yield curve with lower yielding offerings for future buyers. It's not really an economic valuation or paradigm as much of an expectation of lower spreads due to higher sales volume. When the foreign buyers show up any US AAA bond can experience a noticeable price rise. So US TRSY's may have lower spreads expected.
age in bonds, buy-and-hold, 10 year business cycle

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 6:42 pm

longinvest wrote:
Sat Dec 08, 2018 6:36 pm
vineviz wrote:
Sat Dec 08, 2018 6:18 pm
longinvest wrote:
Sat Dec 08, 2018 6:05 pm
It must be noted that Vanguard's Extended-Duration Treasury ETF (EDV) isn't a typical long-term bond ETF. It seeks to to track the performance of the Bloomberg Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. It's not a capitalization weighted index ETF. In other words, it invests into zero-coupon bonds with a maturity varying between 20 and 30 years. Its average duration is a little over 24 years. It only contains 81 strip coupons and principals. According to Vanguard, "[EDV] is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions." (link)

In contrast, a typical long-term bond fund like Vanguard's Long-Term Bond Index Fund (VBLTX) provides broad exposure to U.S. investment-grade bonds with maturities of more than ten years. Its average duration is a little below 15 years. It contains 2141 bonds.
Good caveats, possibly except for the implication that the number of bonds is a reasonable measure of diversification in a Treasury index fund.
These aren't normal bonds. They're Separate Trading of Registered Interest and Principal of Securities (STRIPS). They aren't sold by the Federal Reserve or a governmental agency. They are derivatives built from the principals and coupons after a "stripping process" which removes coupons from a bond and then sells the separate parts as a zero coupon bonds. Obviously, the stripping process has embedded hidden fees, otherwise nobody would take the time to strip Treasuries if there was no opportunity to make a profit in the process.

EDV isn't a Bogleheads investment. It's pure speculation (a hope of making a profit by selling it to a greater fool).
The Treasury appears to disagree with your assessment:

https://www.treasurydirect.gov/instit/m ... strips.htm

“STRIPS are attractive investments for tax-deferred accounts, such as individual retirement accounts and 401(k) plans, and for non-taxable accounts, which include pension funds.”

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 6:45 pm

staythecourse wrote:
Sat Dec 08, 2018 9:10 am
The key to analyze this would be to look at the period of 1940-s-1970's. That was a period that started with low inflation (thus low coupon rate) and inflation slowly increased.

One can NOT look at the most recent period of 1970's to up to recent as it started with HIGH inflation (high interest rates) and slowly decreased causing folks to put a premium on the far end of the maturity curve when it came to fixed income.

I remember peeking at the difference a while ago and some other random sites and during these times and others cash was a better diversifier then LT bonds. So just because they have been doesn't mean they have to and likely if they are or not is more due to the slope of inflation going forward. Who knows what will happen with inflation and thus interest rates, but have a hard time seeing interest rates staying down forever vs. slowly going up. I would bet on a repeat of 1940's to 1970's vs. the last 30-40 years which would require a starting point of REALLY high interest rates (doubt in the political climate anyone even has the guts to suggest it).

Good luck.
:thumbsup

The notions of 'bonds are for safety' and 'you don't really need stocks at all' seem to me to me greatly impacted by U.S. bonds' impressive 30 run from 1982-2012. Many are seemingly ignorant of 1977-1981 or the 1940s, both of which were very tough on nominal bonds.

And even if LT bonds do turn out to be a marginally better diversifying asset than something else, the question then becomes whether you'll have the intestinal fortitude to hold it if their real return over the next decade is 0% or even worse (which I believe is a distinct possibility), in addition to being very volatile (by bond standards).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

User avatar
vineviz
Posts: 2277
Joined: Tue May 15, 2018 1:55 pm

Re: Do long-term bonds belong in one's portfolio?

Post by vineviz » Sat Dec 08, 2018 6:50 pm

longinvest wrote:
Sat Dec 08, 2018 6:36 pm

EDV isn't a Bogleheads investment. It's pure speculation (a hope of making a profit by selling it to a greater fool).
You’re entitled to your opinion, obviously.

But you’re wrong.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

stlutz
Posts: 4835
Joined: Fri Jan 02, 2009 1:08 am

Re: Do long-term bonds belong in one's portfolio?

Post by stlutz » Sat Dec 08, 2018 6:51 pm

The answer to this question really depends on the answer to the question of why you even want bonds in your portfolio.

Two "risk parity" constructions are often discussed here:

a) The "bonds are for safety" approach. For these investors, they are seeking returns from domestic and international stocks and using bonds to lever down their exposure. With this approach, short term bonds are most appropriate.

b) The "non-correlated investments" approach. For these investors, they are looking for multiple sources of risk/volatility in their portfolio. Stocks and long-term bonds are both volatile. Sometimes they correlate positively; sometimes they don't. If you can't handle the drawdown that could result from the two having positively correlation, then the portfolio should be levered down using short-term bonds.

Then there are people who are looking for bonds to generate income. In this case, the duration of the portfolio should be one-half of the period you need the income to be spread over.

a) So, if you retire at 65 and are looking for bonds to provide a fixed amount of income until age 95, your portfolio duration should be 30/2 = 15. That means this investor should have a lot of long-term bonds at age 65. As they get older their average duration will shrink.

b) If you are younger than retirement but you have a portion of your portfolio that you want to set aside now for income when you are 65, then that money belongs in long-term bonds.

For the income investor, fluctuation in principal value is irrelevant. What matters is stability of income. This is achieved by matching duration with when you need the money.

Finally there are the people who just want to hold a balanced portfolio of assets and don't want to think about it any further. In that case, a total bond market fund probably makes sense. It will provide some portfolio stability, possibly some negative correlation, and hopefully some modest positive return. But none of these is viewed as being mutually exclusive of the other. In this case, you might as well go with the default option.

longinvest
Posts: 3108
Joined: Sat Aug 11, 2012 8:44 am

Re: Do long-term bonds belong in one's portfolio?

Post by longinvest » Sat Dec 08, 2018 6:56 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 6:42 pm
longinvest wrote:
Sat Dec 08, 2018 6:36 pm
vineviz wrote:
Sat Dec 08, 2018 6:18 pm
longinvest wrote:
Sat Dec 08, 2018 6:05 pm
It must be noted that Vanguard's Extended-Duration Treasury ETF (EDV) isn't a typical long-term bond ETF. It seeks to to track the performance of the Bloomberg Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. It's not a capitalization weighted index ETF. In other words, it invests into zero-coupon bonds with a maturity varying between 20 and 30 years. Its average duration is a little over 24 years. It only contains 81 strip coupons and principals. According to Vanguard, "[EDV] is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions." (link)

In contrast, a typical long-term bond fund like Vanguard's Long-Term Bond Index Fund (VBLTX) provides broad exposure to U.S. investment-grade bonds with maturities of more than ten years. Its average duration is a little below 15 years. It contains 2141 bonds.
Good caveats, possibly except for the implication that the number of bonds is a reasonable measure of diversification in a Treasury index fund.
These aren't normal bonds. They're Separate Trading of Registered Interest and Principal of Securities (STRIPS). They aren't sold by the Federal Reserve or a governmental agency. They are derivatives built from the principals and coupons after a "stripping process" which removes coupons from a bond and then sells the separate parts as a zero coupon bonds. Obviously, the stripping process has embedded hidden fees, otherwise nobody would take the time to strip Treasuries if there was no opportunity to make a profit in the process.

EDV isn't a Bogleheads investment. It's pure speculation (a hope of making a profit by selling it to a greater fool).
The Treasury appears to disagree with your assessment:

https://www.treasurydirect.gov/instit/m ... strips.htm

“STRIPS are attractive investments for tax-deferred accounts, such as individual retirement accounts and 401(k) plans, and for non-taxable accounts, which include pension funds.”
Of course, STRIPS aren't speculation for a pension fund with nominal liabilities! You're changing the context of my statement.

I have yet to hear a retail investor tell me of a nominal liability of his in 20 to 30 years that would be best covered by investing the money into an ETF of "equal-weighted par" STRIPS that doesn't go down in duration over time.

Are you such a retail investor? What's the amount and date of your nominal liability? How does EDV help you with with covering it?
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

stlutz
Posts: 4835
Joined: Fri Jan 02, 2009 1:08 am

Re: Do long-term bonds belong in one's portfolio?

Post by stlutz » Sat Dec 08, 2018 6:58 pm

On the matter of negative correlation, for me the key fact is that we seem to have shifted between regimes of positive and negative correlation historically. The relationship hasn't really been random; positive and negative periods have been long-lasting.

Shifting between positive and negative can provide very costly for investors who are "invested" in the pattern staying the same for their lifetime. Going with long-term bonds in 1960 didn't work out well. Going with short term bonds in the early 80s also didn't work out well.

My favorite line from a poster who has long since moved on: "A reminder to anyone investing based on historical data - the market doesn't consult the history books when deciding where to stick tomorrow's free lunch."

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 7:01 pm

longinvest wrote:
Sat Dec 08, 2018 6:56 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 6:42 pm
longinvest wrote:
Sat Dec 08, 2018 6:36 pm
vineviz wrote:
Sat Dec 08, 2018 6:18 pm
longinvest wrote:
Sat Dec 08, 2018 6:05 pm
It must be noted that Vanguard's Extended-Duration Treasury ETF (EDV) isn't a typical long-term bond ETF. It seeks to to track the performance of the Bloomberg Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. It's not a capitalization weighted index ETF. In other words, it invests into zero-coupon bonds with a maturity varying between 20 and 30 years. Its average duration is a little over 24 years. It only contains 81 strip coupons and principals. According to Vanguard, "[EDV] is primarily intended for institutional investors with extremely long-term liabilities—20 years or more. Prospective individual investors are urged to consult with their own advisors to determine if the fund is suitable for their overall investment programs and financial positions." (link)

In contrast, a typical long-term bond fund like Vanguard's Long-Term Bond Index Fund (VBLTX) provides broad exposure to U.S. investment-grade bonds with maturities of more than ten years. Its average duration is a little below 15 years. It contains 2141 bonds.
Good caveats, possibly except for the implication that the number of bonds is a reasonable measure of diversification in a Treasury index fund.
These aren't normal bonds. They're Separate Trading of Registered Interest and Principal of Securities (STRIPS). They aren't sold by the Federal Reserve or a governmental agency. They are derivatives built from the principals and coupons after a "stripping process" which removes coupons from a bond and then sells the separate parts as a zero coupon bonds. Obviously, the stripping process has embedded hidden fees, otherwise nobody would take the time to strip Treasuries if there was no opportunity to make a profit in the process.

EDV isn't a Bogleheads investment. It's pure speculation (a hope of making a profit by selling it to a greater fool).
The Treasury appears to disagree with your assessment:

https://www.treasurydirect.gov/instit/m ... strips.htm

“STRIPS are attractive investments for tax-deferred accounts, such as individual retirement accounts and 401(k) plans, and for non-taxable accounts, which include pension funds.”
Of course, STRIPS aren't speculation for a pension fund with nominal liabilities! You're changing the context of my statement.

I have yet to hear a retail investor tell me of a nominal liability of his in 20 to 30 years that would be best covered by investing the money into an ETF of "equal-weighted par" STRIPS that doesn't go down in duration over time.

Are you such a retail investor? What's the amount and date of your nominal liability? How does EDV help you with with covering it?
Literally ten words before “pension funds” are the words “individual retirement accounts and 401ks”.

You’re telling me average retail investors have no nominal liabilities that are 20 to 30 years out? You want to try thinking that one through again?

longinvest
Posts: 3108
Joined: Sat Aug 11, 2012 8:44 am

Re: Do long-term bonds belong in one's portfolio?

Post by longinvest » Sat Dec 08, 2018 7:05 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 7:01 pm
longinvest wrote:
Sat Dec 08, 2018 6:56 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 6:42 pm
longinvest wrote:
Sat Dec 08, 2018 6:36 pm
vineviz wrote:
Sat Dec 08, 2018 6:18 pm

Good caveats, possibly except for the implication that the number of bonds is a reasonable measure of diversification in a Treasury index fund.
These aren't normal bonds. They're Separate Trading of Registered Interest and Principal of Securities (STRIPS). They aren't sold by the Federal Reserve or a governmental agency. They are derivatives built from the principals and coupons after a "stripping process" which removes coupons from a bond and then sells the separate parts as a zero coupon bonds. Obviously, the stripping process has embedded hidden fees, otherwise nobody would take the time to strip Treasuries if there was no opportunity to make a profit in the process.

EDV isn't a Bogleheads investment. It's pure speculation (a hope of making a profit by selling it to a greater fool).
The Treasury appears to disagree with your assessment:

https://www.treasurydirect.gov/instit/m ... strips.htm

“STRIPS are attractive investments for tax-deferred accounts, such as individual retirement accounts and 401(k) plans, and for non-taxable accounts, which include pension funds.”
Of course, STRIPS aren't speculation for a pension fund with nominal liabilities! You're changing the context of my statement.

I have yet to hear a retail investor tell me of a nominal liability of his in 20 to 30 years that would be best covered by investing the money into an ETF of "equal-weighted par" STRIPS that doesn't go down in duration over time.

Are you such a retail investor? What's the amount and date of your nominal liability? How does EDV help you with with covering it?
Literally ten words before “pension funds” are the words “individual retirement accounts and 401ks”.

You’re telling me average retail investors have no nominal liabilities that are 20 to 30 years out? You want to try thinking that one through again?
I've asked my questions first, and you didn't answer. Let me repeat them: Are you such a retail investor? What's the amount and date of your nominal liability? How does EDV help you with with covering it?
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

User avatar
vineviz
Posts: 2277
Joined: Tue May 15, 2018 1:55 pm

Re: Do long-term bonds belong in one's portfolio?

Post by vineviz » Sat Dec 08, 2018 7:06 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 7:01 pm
longinvest wrote:
Sat Dec 08, 2018 6:56 pm

Of course, STRIPS aren't speculation for a pension fund with nominal liabilities! You're changing the context of my statement.

I have yet to hear a retail investor tell me of a nominal liability of his in 20 to 30 years that would be best covered by investing the money into an ETF of "equal-weighted par" STRIPS that doesn't go down in duration over time.

Are you such a retail investor? What's the amount and date of your nominal liability? How does EDV help you with with covering it?
Literally ten words before “pension funds” are the words “individual retirement accounts and 401ks”.

You’re telling me average retail investors have no nominal liabilities that are 20 to 30 years out? You want to try thinking that one through again?
Also, the idea that the only POSSIBLE reason anyone might own bonds is to precisely match a particular known liability is . . . something.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

pdavi21
Posts: 195
Joined: Sat Jan 30, 2016 4:04 pm

Re: Do long-term bonds belong in one's portfolio?

Post by pdavi21 » Sat Dec 08, 2018 7:15 pm

If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.

A medium horizon investor should have more diversified bonds for reduced risk. (And should definitely hold bonds).

A short term investor can go without long term bonds, but should consider reducing equity exposure instead of removing longterm bonds.

aristotelian
Posts: 4875
Joined: Wed Jan 11, 2017 8:05 pm

Re: Do long-term bonds belong in one's portfolio?

Post by aristotelian » Sat Dec 08, 2018 7:46 pm

pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.

A medium horizon investor should have more diversified bonds for reduced risk. (And should definitely hold bonds).

A short term investor can go without long term bonds, but should consider reducing equity exposure instead of removing longterm bonds.
That would be too reasonable!

By the way, BND has 12% long bonds (20+ years).

longinvest
Posts: 3108
Joined: Sat Aug 11, 2012 8:44 am

Re: Do long-term bonds belong in one's portfolio?

Post by longinvest » Sat Dec 08, 2018 8:01 pm

aristotelian wrote:
Sat Dec 08, 2018 7:46 pm
By the way, BND has 12% long bonds (20+ years).
Vanguard Total Bond Market ETF (BND) has 19.1% long-term bonds (maturity of 10 years or more). See my previous post for Vanguard's definition of short-term, intermediate-term, and long-term bonds.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic / international) stocks / domestic (nominal / inflation-indexed) long-term bonds | VCN/VXC/VLB/ZRR

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 8:29 pm

pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

pdavi21
Posts: 195
Joined: Sat Jan 30, 2016 4:04 pm

Re: Do long-term bonds belong in one's portfolio?

Post by pdavi21 » Sat Dec 08, 2018 9:08 pm

willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
True and fair. My post is my own opinion based on the idea of a perfectly rational investor who will not make withdrawals for 30-40 years, 10-20 years, or 0-10 years. I don't believe I defined very long, medium, and short well either. My opinion differs from many others.

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 9:27 pm

willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 9:30 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:27 pm
willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20
Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
Last edited by willthrill81 on Sat Dec 08, 2018 9:32 pm, edited 2 times in total.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 9:41 pm

willthrill81 wrote:
Sat Dec 08, 2018 9:30 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:27 pm
willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20
Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 9:47 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:41 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:30 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:27 pm
willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
pdavi21 wrote:
Sat Dec 08, 2018 7:15 pm
If a very long horizon investor wants ANY bonds, they should be long term only (maybe treasuries only for re-balancing but lower yield). If not, 100% stocks.
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20
Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html
Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.

Now could long-term bonds have similar performance in spite of the tailwind of decreasing interest rates? It's possible, but it seems very unlikely to virtually all of the bond investors out there.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 9:52 pm

willthrill81 wrote:
Sat Dec 08, 2018 9:47 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:41 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:30 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:27 pm
willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm


You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds. For such people, total bond, intermediate, or short-term bonds are fine.
Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20
Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html
Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.
It’s absolutely a prediction. You’re predicting that:

1. The Fed will continue to raise interest rates,
2. And that will hurt long term total return on long term Treasuries, and
3. That the equity markets will continue its meteoric rise, leading to
4. An increase in the equity risk premium.

Did I miss anything?

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 10:01 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:47 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:41 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:30 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:27 pm


Such investors should be taught that long bonds are a way of having your cake and eating it too:

https://www.portfoliovisualizer.com/bac ... tion2_1=20
Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html
Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.
It’s absolutely a prediction. You’re predicting that:

1. The Fed will continue to raise interest rates,
No, I'm not. But it's impossible for them to drop interest rates as much going forward as they did from 1982-2012. Even if interest rates stay flat for a long time, bonds won't have the tailwind of declining interest rates.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
2. And that will hurt long term total return on long term Treasuries, and
If interest rates did increase, it's a mathematical fact that that will have a negative impact on existing nominal bonds.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
3. That the equity markets will continue its meteoric rise, leading to
I'm not saying anything about equities' performance.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
4. An increase in the equity risk premium.
I'm not saying anything about equities' performance.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 10:17 pm

willthrill81 wrote:
Sat Dec 08, 2018 10:01 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:47 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:41 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:30 pm


Long-term bonds did very well over almost that entire period because interest rates fell from double-digits to near zero. Do you expect long-term bonds to perform similarly over the next 30 years?

For instance, from 2012 through last month, long-term Treasuries had a real annual return .18%. U.S. stocks had a real annual return of 12.22% over the same period.
I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html
Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.
It’s absolutely a prediction. You’re predicting that:

1. The Fed will continue to raise interest rates,
No, I'm not. But it's impossible for them to drop interest rates as much going forward as they did from 1982-2012. Even if interest rates stay flat for a long time, bonds won't have the tailwind of declining interest rates.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
2. And that will hurt long term total return on long term Treasuries, and
If interest rates did increase, it's a mathematical fact that that will have a negative impact on existing nominal bonds.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
3. That the equity markets will continue its meteoric rise, leading to
I'm not saying anything about equities' performance.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
4. An increase in the equity risk premium.
I'm not saying anything about equities' performance.
Between 2004 and 2006 the Fed raised interest rates from 1% to 5.25%. Long treasuries returned 5% CAGR over those two years, higher than intermediate 3%. Shouldn’t long bonds have taken a hit, according to your macroeconomic theory? 1993 to 1995, same story, Fed raises rates from 3% to 6%, long treasuries returned 12%, intermediate returned 9%.

Your prediction is that bonds will not perform as well going forward as in the past. That includes an implicit prediction that equities will continue to outshine bonds. Otherwise, bonds would still be an attractive investment, even if they are less attractive than before (which I am disputing).

User avatar
willthrill81
Posts: 6418
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

Re: Do long-term bonds belong in one's portfolio?

Post by willthrill81 » Sat Dec 08, 2018 10:23 pm

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:17 pm
willthrill81 wrote:
Sat Dec 08, 2018 10:01 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:47 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:41 pm


I was referring to the volatility of the two portfolios. 20% lower volatility for not much lower return.

And if you’re going to predict the future of bond returns, you should at least keep up with the news:

https://www.cnbc.com/amp/2018/11/28/fed ... utral.html

https://www.cnbc.com/amp/2018/12/06/fed ... utral.html
Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.
It’s absolutely a prediction. You’re predicting that:

1. The Fed will continue to raise interest rates,
No, I'm not. But it's impossible for them to drop interest rates as much going forward as they did from 1982-2012. Even if interest rates stay flat for a long time, bonds won't have the tailwind of declining interest rates.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
2. And that will hurt long term total return on long term Treasuries, and
If interest rates did increase, it's a mathematical fact that that will have a negative impact on existing nominal bonds.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
3. That the equity markets will continue its meteoric rise, leading to
I'm not saying anything about equities' performance.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
4. An increase in the equity risk premium.
I'm not saying anything about equities' performance.
Between 2004 and 2006 the Fed raised interest rates from 1% to 5.25%. Long treasuries returned 5% CAGR over those two years, higher than intermediate 3%. Shouldn’t long bonds have taken a hit, according to your macroeconomic theory? 1993 to 1995, same story, Fed raises rates from 3% to 6%, long treasuries returned 12%, intermediate returned 9%.

Your prediction is that bonds will not perform as well going forward as in the past. That includes an implicit prediction that equities will continue to outshine bonds. Otherwise, bonds would still be an attractive investment, even if they are less attractive than before (which I am disputing).
Current interest rates are not the only factor impacting bonds' performance, regardless of the term. Clearly, other factors beyond rising rates were at work in the two period you cite.

However, if you're trying to argue that rising interest rates do not represent a headwind for nominal bonds, there's no point in continuing this discussion, because that's Bond Theory 101.

And saying that bonds are unlikely to perform as well in absolute returns going forward as they did from 1982-2012 has nothing to do with stocks. I'm saying that in a flat or rising interest rate environment, the returns of bonds are unlikely to be as good as they were in that period. How they compare to stocks' performance is a completely separate issue.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sat Dec 08, 2018 10:26 pm

willthrill81 wrote:
Sat Dec 08, 2018 10:23 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:17 pm
willthrill81 wrote:
Sat Dec 08, 2018 10:01 pm
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
willthrill81 wrote:
Sat Dec 08, 2018 9:47 pm


Saying that bonds aren't going to have the same tailwind any time soon that they had from 1982-2012 is not a prediction: it's a mathematical fact because we aren't starting at double-digit interest rates right now. And if we suddenly did see that kind of spike, nominal bonds would take an absolute bath.
It’s absolutely a prediction. You’re predicting that:

1. The Fed will continue to raise interest rates,
No, I'm not. But it's impossible for them to drop interest rates as much going forward as they did from 1982-2012. Even if interest rates stay flat for a long time, bonds won't have the tailwind of declining interest rates.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
2. And that will hurt long term total return on long term Treasuries, and
If interest rates did increase, it's a mathematical fact that that will have a negative impact on existing nominal bonds.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
3. That the equity markets will continue its meteoric rise, leading to
I'm not saying anything about equities' performance.
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 9:52 pm
4. An increase in the equity risk premium.
I'm not saying anything about equities' performance.
Between 2004 and 2006 the Fed raised interest rates from 1% to 5.25%. Long treasuries returned 5% CAGR over those two years, higher than intermediate 3%. Shouldn’t long bonds have taken a hit, according to your macroeconomic theory? 1993 to 1995, same story, Fed raises rates from 3% to 6%, long treasuries returned 12%, intermediate returned 9%.

Your prediction is that bonds will not perform as well going forward as in the past. That includes an implicit prediction that equities will continue to outshine bonds. Otherwise, bonds would still be an attractive investment, even if they are less attractive than before (which I am disputing).
Current interest rates are not the only factor impacting bonds' performance, regardless of the term. Clearly, other factors beyond rising rates were at work in the two period you cite.

However, if you're trying to argue that rising interest rates do not represent a headwind for nominal bonds, there's no point in continuing this discussion, because that's Bond Theory 101.
Actually Bond Theory 101 is that rising rates hurts prices on existing bonds but raises prices on new issues. If you invest in a bond fund, and you have a sufficiently long investment horizon, the two effects cancel out, and you are left with the term premium, the premium you earn for lending out your money for a longer period of time.

Circling all the way back to your original point, this is why investors should choose long bonds, because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.

MJW
Posts: 641
Joined: Sun Jul 03, 2016 7:40 pm
Location: Pacific Northwest

Re: Do long-term bonds belong in one's portfolio?

Post by MJW » Sun Dec 09, 2018 1:53 am

willthrill81 wrote:
Sat Dec 08, 2018 8:29 pm
You're overlooking that many investors do not have the emotional risk tolerance needed for a 100% stock portfolio, but they don't want the volatility of long-term bonds.
Weenies.

8-)

fennewaldaj
Posts: 371
Joined: Sun Oct 22, 2017 11:30 pm

Re: Do long-term bonds belong in one's portfolio?

Post by fennewaldaj » Sun Dec 09, 2018 2:15 am

stlutz wrote:
Sat Dec 08, 2018 6:51 pm
The answer to this question really depends on the answer to the question of why you even want bonds in your portfolio.

Two "risk parity" constructions are often discussed here:

a) The "bonds are for safety" approach. For these investors, they are seeking returns from domestic and international stocks and using bonds to lever down their exposure. With this approach, short term bonds are most appropriate.

b) The "non-correlated investments" approach. For these investors, they are looking for multiple sources of risk/volatility in their portfolio. Stocks and long-term bonds are both volatile. Sometimes they correlate positively; sometimes they don't. If you can't handle the drawdown that could result from the two having positively correlation, then the portfolio should be levered down using short-term bonds.
Right these two sides end up talking past each other because the bonds are for safety group likely does not care that most of the standard deviation of the portfolio comes from stocks. The bonds are diluting that risk in a way that is meaningful to them.

I suppose there is one more group of us bond investors that hold things such as high yield corporate and EM bonds. Not sure how exactly to categorize this group.

User avatar
vineviz
Posts: 2277
Joined: Tue May 15, 2018 1:55 pm

Re: Do long-term bonds belong in one's portfolio?

Post by vineviz » Sun Dec 09, 2018 2:44 am

JackoC wrote:
Sat Dec 08, 2018 5:45 pm

But, here's the real problem IMO in justifying lots of duration based on history. Besides the general fall in bond rates in all maturities since the 80's (since the 60's there's more up and down), the term premium was also typically much more positive all the way from the 1960's to recently than it is now. It's now as negative as it's ever been, according to the NY Fed's ACM term structure model which is not an outlier apparently. The average term premiums were:
60's-70's: 5 yr .66% 10 yr 1.03%
80's-90's: 1.90%, 2.76%
00's-'18: .57%, 1.00%
But now (Dec 6), per the model, 5yr -.55%, 10yr -.60%

This is the model's output of *expected* term premium at each of those dates, not the realized premium.
I just wanted to circle back and note that the ACM is prone, like many econometric models, be be sensitive to the inputs used to estimate its parameters.

The confidence interval for the so-called “ term premium “ in this model is rarely reported but is very wide. Wide enough that the reported sign is often suspect.

In this case, the model likely is overestimating the future short term rates by 50 bps or so and therefore underestimating the term premium.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

All Seasons
Posts: 86
Joined: Sun Dec 10, 2017 4:14 pm

Re: Do long-term bonds belong in one's portfolio?

Post by All Seasons » Sun Dec 09, 2018 3:00 am

Do long-term bonds belong in one's portfolio?
Yes. :beer
The market portfolio is always a legitimate portfolio.

Valuethinker
Posts: 36620
Joined: Fri May 11, 2007 11:07 am

Re: Do long-term bonds belong in one's portfolio?

Post by Valuethinker » Sun Dec 09, 2018 7:44 am

JackoC wrote:
Sat Dec 08, 2018 5:45 pm


Long term bonds don't belong in my portfolio to any significant degree IMO, now. That's in part because of particular other investments I have that are more interest rate sensitive than US stocks have been, but also the totality of the picture painted above on a forward looking basis.
Thank you for a very interesting and insightful post.

Are you able to say anything more about investments that are more interest rate sensitive than US stocks have been - e.g. for example residential housing investments (rental not owner occupied) or commercial property?

Valuethinker
Posts: 36620
Joined: Fri May 11, 2007 11:07 am

Re: Do long-term bonds belong in one's portfolio?

Post by Valuethinker » Sun Dec 09, 2018 8:03 am

fennewaldaj wrote:
Sun Dec 09, 2018 2:15 am


I suppose there is one more group of us bond investors that hold things such as high yield corporate and EM bonds. Not sure how exactly to categorize this group.
Orthogonal risk

There are a number of risk axes in bonds (in all investments) if we use a multi-factor model (ie think of an n-dimensional hyperplane) :

- term risk (duration risk)
- reinvestment risk (which I think is really a form of term risk, but I'd have to think about that)
- credit risk
- currency risk
- inflation risk
- call risk
- equity risk (for convertible bonds)

The question is to what extent they are orthogonal i.e. work uncorrelated with each other and therefore improve portfolio efficiency (risk-return tradeoff moves closer to the Efficient Frontier).

HY corporate bonds have credit risk. They also normally have call risk (they can be called and refinanced if the issuer moves to an Investment Grade credit rating).

The question is whether that credit risk is simply another form of equity risk or that the 2 factors are so correlated that you cannot separate them out (an institutional investor could buy Credit Default Swaps but as we know from The Big Short there are all kinds of issues wrt same). Larry Swedroe certainly argues that it is and therefore from a portfolio point of view there's no point in entering into it.

William Bernstein wrote a piece about when to buy HY bonds - a number of posters (against my advice ;-)) here followed that advice bought HY in Q1 2009 and did very well. I don't have Anti Illmanen's books on asset allocation to hand but I think of them as the bible for such things.

EM bonds

There's clearly default risk (credit risk).

If you buy EM bonds that pay in USD at the face of it there is no currency risk *but* any EM crisis is usually resolved by massive devaluation of the currency, exchange controls and emergency borrowing from the IMF. Thus no currency risk but in fact higher default risk (that's the impolite word for "restructuring" ;-)). The IMF insists bondholders take pain, and now admits the big failure in Greece's first restructuring was not to write down the bondholders sufficiently - in effect, the IMF saved the German and French governments (maybe Italian) from having to bail out their own banks. Now the Greek debt is mostly held by European supranational funds (the bailout fund) and thus a further writedown (which is inevitable) will hit the Eurozone taxpayer directly, and given the AfD was founded as an opposition party to subsidizing Greek bailout (asylum seekers came later as an issue) it ain't gonna happen - rock and hard place meet together.

One minute Argentina, a country that never gets out of the default cycle, is issuing 100 year bonds at 8% yield and they are snapped up. Next minute, Argentina is headed straight into its (8th?, 9th?) default in the history of the Republic.

If you buy EM "locals" govt debt that pays in their own currency, then your default risk becomes currency risk as the currency is devalued by printing money.

At this point, I shrug. For me, equity risk is paramount, the decision to hold bonds is about avoiding that risk. Others may feel their are unique return factors there worth grabbing onto (Rick Ferri certainly thought so and debated Larry Swedroe about it).

For reasons which are not about risk-return, 70% of my pension accounts are in short term government bonds. Unfortunately I can only do that hedged into GBP, which means I take full currency risk. The UK has very specific event risk which could send the pound plummeting towards $1 US (c. $1.27 now) - -Brexit ("hard Brexit" ie with no agreement) and the (not uncorrelated) risk of a very left wing government coming to power.

Valuethinker
Posts: 36620
Joined: Fri May 11, 2007 11:07 am

Re: Do long-term bonds belong in one's portfolio?

Post by Valuethinker » Sun Dec 09, 2018 9:24 am

CULater wrote:
Sat Dec 08, 2018 8:57 am
Here are some arguments for holding long term bonds, especially long treasuries, in one's portfolio as a component of the bond allocation.

1. Long bonds are better diversifiers for equities, as in lower correlations and because long bonds (treasuries) usually produce stronger gains if stocks tank.

2. Long bonds produce higher returns over time if you can ride out the greater fluctuations in principal value. Similar argument to holding stocks.

3. Holding short term bonds is often an attempt to time the bond market. Avoiding long bonds is effectively saying that long rates are wrong and it is irrational to hold long bonds.
These are good lessons to remember. I like to think of the stock market as a 25 year high quality bond that will pay us about 7% per year if we wait it out. But you have to be willing to wait several decades to see that come to fruition with any certainty. Diversifying our portfolios across the bond market is how we reduce our average waiting time (and uncertainty) without reducing it to nothing (cash) and earning nothing. So, just as it never makes sense to own an all-or-nothing position in stocks it also makes no sense to own an all-or-nothing position in the bond market.
https://www.pragcap.com/3-reasons-hold- ... tes-rise/

I've wrestled with this a long time. What scares me about long bonds is the term risk if we experience unexpected inflation. But the arguments above seem to make a case for having an allocation to them. The other thing that I think about is that if you split your fixed-income allocation between the long end and the short end, you end up with an effective intermediate-term bond allocation, so why bother with the long end and just hold intermediate? Wondering what other people are thinking about this.
Swensen basically says yes:

- a long term US Treasury bond is a deflation hedge

- long term TIPS are inflation hedges

I think the data shows that the most diversifying bond to an S&P 500 (lowest correlation) equity portfolio is the 30 year US Treasury (nominal) bond.

The 30 year zero coupon US Treasury bond is more volatile than the S&P 500, though (that number is old, but I have no reason to believe it is no longer true). That's something to be wary of.

There isn't really a market for stripped TIPS - I think Barclays tried to create one before the Great Financial Crisis, but it never got liquidity. Despite the theoretical and practical advantages of such a security (exact matching of future real CPI liabilities).

3funder
Posts: 781
Joined: Sun Oct 15, 2017 9:35 pm

Re: Do long-term bonds belong in one's portfolio?

Post by 3funder » Sun Dec 09, 2018 9:36 am

sillysaver wrote:
Sat Dec 08, 2018 9:05 am
Diversifying across different asset classes and sources of return makes sense. Having some long term bonds allows one to capture the term premium, and LT bonds do well in deflation. So, you own some long term, some intermediate and short duration, and of course, assets like equities that do well in inflation / rising markets.
+1, although I think it's worth pointing out that intermediate-term bonds should do fine on their own, assuming one's time horizon is longer than the duration.

CULater
Posts: 1569
Joined: Sun Nov 13, 2016 10:59 am

Re: Do long-term bonds belong in one's portfolio?

Post by CULater » Sun Dec 09, 2018 9:51 am

It's interesting that there are so many posts in which people are recommending whether to own long bonds, how much to allocate, etc. based on analyses about future interest rates, duration and holding period and so on. Basically, bond market timing. But when it comes to equities all such arguments that imply timing are verboten. The equivalent duration of stocks is even longer than long term treasuries right now, for example, but who ever points that out?

Using Portfolio Visualizer, we can see that since 1978, portfolios that included long term treasuries increased portfolio efficiency. Here we have an asset that has acted as perhaps the best diversifier of equity risk but there's a great deal of skepticism about owning it. (I"m talking to myself here). Is it any more complicated than that? Not advocating but I find the inconsistency in thinking about equities and long bonds interesting, myself included.
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

User avatar
JoMoney
Posts: 6261
Joined: Tue Jul 23, 2013 5:31 am

Re: Do long-term bonds belong in one's portfolio?

Post by JoMoney » Sun Dec 09, 2018 10:00 am

... and from 1940 to 1980 Long Bonds DECREASED "efficiency" (Sharpe ratio)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sun Dec 09, 2018 10:08 am

Valuethinker wrote:
Sun Dec 09, 2018 9:24 am
I think the data shows that the most diversifying bond to an S&P 500 (lowest correlation) equity portfolio is the 30 year US Treasury (nominal) bond.

The 30 year zero coupon US Treasury bond is more volatile than the S&P 500, though (that number is old, but I have no reason to believe it is no longer true). That's something to be wary of.
Let’s say there are two bonds with the following characteristics:

1. Correlation to equities of -0.4 and annual StdDev of 10%

2. Correlation to equities of -0.4 and annual StdDev of 20%

Which one would you rather hold when equities crash 50%? So which one is the better diversifier?

hdas
Posts: 378
Joined: Thu Jun 11, 2015 8:24 am

Re: Do long-term bonds belong in one's portfolio?

Post by hdas » Sun Dec 09, 2018 10:19 am

This is a good discussion. Allow introduce the concept of leverage on fixed income (something I'm currently looking into). Not recommendation. The market place of funds doesn't have optimal choices, but let's work with what we have:

Portfolio #1 EDV Vanguard Extended Duration Trs ETF
Portfolio #2 TYD Daily 7-10 Year Treasury Bull 3X Shares
Portfolio #3 TMF Daily 20+ Year Treasury Bull 3X Shares

Code: Select all

Portfolio	Initial Balance	Final Balance	CAGR	Stdev	Best Year	Worst Year	Max. Drawdown	Sharpe Ratio	Sortino Ratio	US Mkt Correlation
Portfolio 1	$10,000	$20,051 	8.11% 	19.47%	56.08%	-19.86%	-26.75% 	0.48	0.88	-0.51
Portfolio 2	$10,000	$21,179 	8.78% 	18.06%	51.54%	-18.43%	-23.87% 	0.54	0.93	-0.45
Portfolio 3	$10,000	$22,918 	9.75% 	38.12%	109.14%	-39.01%	-49.74% 	0.42	0.75	-0.49
Image

Notice the diff between portfolios and imagine if they offered a 5x 3-5 year duration.
Stay the course and buy some more.

rich126
Posts: 173
Joined: Thu Mar 01, 2018 4:56 pm

Re: Do long-term bonds belong in one's portfolio?

Post by rich126 » Sun Dec 09, 2018 10:26 am

hdas wrote:
Sun Dec 09, 2018 10:19 am
This is a good discussion. Allow introduce the concept of leverage on fixed income (something I'm currently looking into). Not recommendation. The market place of funds doesn't have optimal choices, but let's work with what we have:

Portfolio #1 EDV Vanguard Extended Duration Trs ETF
Portfolio #2 TYD Daily 7-10 Year Treasury Bull 3X Shares
Portfolio #3 TMF Daily 20+ Year Treasury Bull 3X Shares

Code: Select all

Portfolio	Initial Balance	Final Balance	CAGR	Stdev	Best Year	Worst Year	Max. Drawdown	Sharpe Ratio	Sortino Ratio	US Mkt Correlation
Portfolio 1	$10,000	$20,051 	8.11% 	19.47%	56.08%	-19.86%	-26.75% 	0.48	0.88	-0.51
Portfolio 2	$10,000	$21,179 	8.78% 	18.06%	51.54%	-18.43%	-23.87% 	0.54	0.93	-0.45
Portfolio 3	$10,000	$22,918 	9.75% 	38.12%	109.14%	-39.01%	-49.74% 	0.42	0.75	-0.49
Image

Notice the diff between portfolios and imagine if they offered a 5x 3-5 year duration.
Unfortunately that chart only goes back to 2010.

Elysium
Posts: 1365
Joined: Mon Apr 02, 2007 6:22 pm

Re: Do long-term bonds belong in one's portfolio?

Post by Elysium » Sun Dec 09, 2018 10:33 am

HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:26 pm
Because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.
That depends on where the term premiums are. As of now:

30 YR: 3.14
10 YR: 2.88
5 YR: 2.75

Take your pick. 26 bps to 39 bps premium for lending out 20-25 years extra.

1-2 YR CD available 2.75 and 5 YR available at 3.15, no term risk.

When 30 YR hits 5% and/or 200 bps gap with 2-10 yr notes, it starts becoming interesting, until then no reward.
Last edited by Elysium on Sun Dec 09, 2018 10:39 am, edited 3 times in total.

hdas
Posts: 378
Joined: Thu Jun 11, 2015 8:24 am

Re: Do long-term bonds belong in one's portfolio?

Post by hdas » Sun Dec 09, 2018 10:35 am

rich126 wrote:
Sun Dec 09, 2018 10:26 am
Unfortunately that chart only goes back to 2010.
True, however I think is sufficient to at least introduce the hypothesis that it's better to leverage a shorter maturity than to extend duration, the idea is that you get equal or more of the upside with less of the downside....However, I think this is highly dependent on the implementation. It's also quite possible that this might not be a permanent condition but dependent on the specific context of the yield curve.

For people that have more investing ideas than liquid capital, this is potentially very useful tool. (look into portable alpha). Perhaps useless for the typical holder of bonds.
Stay the course and buy some more.

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sun Dec 09, 2018 10:45 am

Elysium wrote:
Sun Dec 09, 2018 10:33 am
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:26 pm
Because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.
That depends on where the term premiums are. As of now:

30 YR: 3.14
10 YR: 2.88
5 YR: 2.75

Take your pick. 26 bps to 39 bps premium for lending out 20-25 years extra.

1-2 YR CD available 2.75 and 5 YR available at 3.15, no term risk.

When 30 YR hits 5% and/or 200 bps gap with 2-10 yr notes, it starts becoming interesting, until then no reward.
Is 3.14 not a higher number than 2.88 and 2.75? Then how does holding 30 yr Treasuries provide “no reward”?

Are you telling me that a 10% higher return is meaningless to a long term investor? Are you familiar with the tortuous games people play on this site to squeeze out an extra few basis points of return from expense ratios or tax efficiency?

Also, CDs are taxed at state & local level but Treasuries are not. CDs are also illiquid, unlike Treasuries which constitute the most liquid trading market that exists.

User avatar
JoMoney
Posts: 6261
Joined: Tue Jul 23, 2013 5:31 am

Re: Do long-term bonds belong in one's portfolio?

Post by JoMoney » Sun Dec 09, 2018 10:48 am

HEDGEFUNDIE wrote:
Sun Dec 09, 2018 10:08 am
Valuethinker wrote:
Sun Dec 09, 2018 9:24 am
I think the data shows that the most diversifying bond to an S&P 500 (lowest correlation) equity portfolio is the 30 year US Treasury (nominal) bond.

The 30 year zero coupon US Treasury bond is more volatile than the S&P 500, though (that number is old, but I have no reason to believe it is no longer true). That's something to be wary of.
Let’s say there are two bonds with the following characteristics:

1. Correlation to equities of -0.4 and annual StdDev of 10%

2. Correlation to equities of -0.4 and annual StdDev of 20%

Which one would you rather hold when equities crash 50%? So which one is the better diversifier?
The correlation isn't a static reliable characteristic. It's not a covenant of any bond I ever heard of that the market price of it will respond in any particular fashion (or that a market to sell it too will even exist). I would want cash to meet near term liabilities.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
vineviz
Posts: 2277
Joined: Tue May 15, 2018 1:55 pm

Re: Do long-term bonds belong in one's portfolio?

Post by vineviz » Sun Dec 09, 2018 10:55 am

hdas wrote:
Sun Dec 09, 2018 10:19 am
This is a good discussion. Allow introduce the concept of leverage on fixed income (something I'm currently looking into). Not recommendation. The market place of funds doesn't have optimal choices, but let's work with what we have:

Portfolio #1 EDV Vanguard Extended Duration Trs ETF
Portfolio #2 TYD Daily 7-10 Year Treasury Bull 3X Shares
Portfolio #3 TMF Daily 20+ Year Treasury Bull 3X Shares
I've also been intrigued by these leveraged funds, and could possibly see some use for them in a constrained portfolio.

My view, though, is that they aren't terribly cost-efficient ways to gain exposure to duration or the term factor.

In a Fama-French regression, TMF does indeed have more than twice the term factor of exposure of EDV per dollar of capital invested.

https://www.portfoliovisualizer.com/fac ... ssion=true

What puts me off is that TMF has an expense ratio that is nearly 16x that of EDV.

That expense, and the normal drag of volatility and the cost of rolling over the contracts, has meant that pretty much every year since inception you'd have been much better off allocating 20% to EDV than allocating 10% to TMF.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Elysium
Posts: 1365
Joined: Mon Apr 02, 2007 6:22 pm

Re: Do long-term bonds belong in one's portfolio?

Post by Elysium » Sun Dec 09, 2018 10:59 am

HEDGEFUNDIE wrote:
Sun Dec 09, 2018 10:45 am
Elysium wrote:
Sun Dec 09, 2018 10:33 am
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:26 pm
Because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.
That depends on where the term premiums are. As of now:

30 YR: 3.14
10 YR: 2.88
5 YR: 2.75

Take your pick. 26 bps to 39 bps premium for lending out 20-25 years extra.

1-2 YR CD available 2.75 and 5 YR available at 3.15, no term risk.

When 30 YR hits 5% and/or 200 bps gap with 2-10 yr notes, it starts becoming interesting, until then no reward.
Is 3.14 not a higher number than 2.88 and 2.75? Then how does holding 30 yr Treasuries provide “no reward”?

Are you telling me that a 10% higher return is meaningless to a long term investor? Are you familiar with the tortuous games people play on this site to squeeze out an extra few basis points of return from expense ratios or tax efficiency?

Also, CDs are taxed at state & local level but Treasuries are not. CDs are also illiquid, unlike Treasuries which constitute the most liquid trading market that exists.
Data speaks for itself. If 26 bps to 39 bps reward is enough for taking on an extra 20-25 years of term risk, then go for it. Most investors would demand better.

HEDGEFUNDIE
Posts: 1189
Joined: Sun Oct 22, 2017 2:06 pm

Re: Do long-term bonds belong in one's portfolio?

Post by HEDGEFUNDIE » Sun Dec 09, 2018 11:03 am

Elysium wrote:
Sun Dec 09, 2018 10:59 am
HEDGEFUNDIE wrote:
Sun Dec 09, 2018 10:45 am
Elysium wrote:
Sun Dec 09, 2018 10:33 am
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:26 pm
Because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.
That depends on where the term premiums are. As of now:

30 YR: 3.14
10 YR: 2.88
5 YR: 2.75

Take your pick. 26 bps to 39 bps premium for lending out 20-25 years extra.

1-2 YR CD available 2.75 and 5 YR available at 3.15, no term risk.

When 30 YR hits 5% and/or 200 bps gap with 2-10 yr notes, it starts becoming interesting, until then no reward.
Is 3.14 not a higher number than 2.88 and 2.75? Then how does holding 30 yr Treasuries provide “no reward”?

Are you telling me that a 10% higher return is meaningless to a long term investor? Are you familiar with the tortuous games people play on this site to squeeze out an extra few basis points of return from expense ratios or tax efficiency?

Also, CDs are taxed at state & local level but Treasuries are not. CDs are also illiquid, unlike Treasuries which constitute the most liquid trading market that exists.
Data speaks for itself. If 26 bps to 39 bps reward is enough for taking on an extra 20-25 years of term risk, then go for it. Most investors would demand better.
If that is the market spread, then by definition that’s what “most investors” are demanding.

Elysium
Posts: 1365
Joined: Mon Apr 02, 2007 6:22 pm

Re: Do long-term bonds belong in one's portfolio?

Post by Elysium » Sun Dec 09, 2018 11:16 am

HEDGEFUNDIE wrote:
Sun Dec 09, 2018 11:03 am
Elysium wrote:
Sun Dec 09, 2018 10:59 am
HEDGEFUNDIE wrote:
Sun Dec 09, 2018 10:45 am
Elysium wrote:
Sun Dec 09, 2018 10:33 am
HEDGEFUNDIE wrote:
Sat Dec 08, 2018 10:26 pm
Because in the end, the term premium generally wins out. Just as how over time, the equity risk premium generally wins out over bonds.
That depends on where the term premiums are. As of now:

30 YR: 3.14
10 YR: 2.88
5 YR: 2.75

Take your pick. 26 bps to 39 bps premium for lending out 20-25 years extra.

1-2 YR CD available 2.75 and 5 YR available at 3.15, no term risk.

When 30 YR hits 5% and/or 200 bps gap with 2-10 yr notes, it starts becoming interesting, until then no reward.
Is 3.14 not a higher number than 2.88 and 2.75? Then how does holding 30 yr Treasuries provide “no reward”?

Are you telling me that a 10% higher return is meaningless to a long term investor? Are you familiar with the tortuous games people play on this site to squeeze out an extra few basis points of return from expense ratios or tax efficiency?

Also, CDs are taxed at state & local level but Treasuries are not. CDs are also illiquid, unlike Treasuries which constitute the most liquid trading market that exists.
Data speaks for itself. If 26 bps to 39 bps reward is enough for taking on an extra 20-25 years of term risk, then go for it. Most investors would demand better.
If that is the market spread, then by definition that’s what “most investors” are demanding.
There are several other factors at play in the bond market which makes the rates what they are. Institutonal investors including pension funds and insurance companies have liability matching needs. Those aren't applicable to retail investors who do not set the price in the bond market or any other market for that matter. The question is whether such low premiums by historical standards are worthwhile for retail investors, the answer is pretty clear, it is not given the spread. That said, the current spread could be pointing to an increased chance of recession, in that event long term treasury can rewarding, although intermediate term treasury will do the same. Current spreads in any event is not very attractive for retail investors to take on 20-25 year term risk. That said, it's your money and you can do what you feel like with it, no one is questioning that. But to argue there is a case for long term treasury for all investors is absurd.

2pedals
Posts: 645
Joined: Wed Dec 31, 2014 12:31 pm

Re: Do long-term bonds belong in one's portfolio?

Post by 2pedals » Sun Dec 09, 2018 12:05 pm

If you are 60+ yo retired with significant savings, pension and social security that covers all expenses. Discretionary and lumpy will come from the savings. The added risks are not worth it to me. I will take my risks on the equity side of my allocation with savings. Having said that I am not against using a total bond fund that contains some long bonds for simplicity/diversity in the bond portion of your allocation.

A longer-term bond carries greater risk that higher inflation could reduce the value of payments, as well as greater risk that higher overall interest rates could cause the bond's price to fall. This is something I am trying to avoid at this stage.

JackoC
Posts: 349
Joined: Sun Aug 12, 2018 11:14 am

Re: Do long-term bonds belong in one's portfolio?

Post by JackoC » Sun Dec 09, 2018 12:22 pm

patrick013 wrote:
Sat Dec 08, 2018 6:41 pm
JackoC wrote:
Sat Dec 08, 2018 5:45 pm

This is the model's output of *expected* term premium at each of those dates, not the realized premium. Bond investors imposed a huge expected premium in '80's-90's after they got more and more severely burned by unexpected inflation from the late 60's to early 80's. That big premium went back to previous levels as investors became more confident inflation was anchored. But now the premium is negative, again per the Fed's model. This might be a result of global central bank 'QE' among other factors. Note that even though the Fed's QE is gradually unwinding, US long rates are also influenced by extraordinarily low Euro and Yen long rates, which in all likelihood have their own central bank manipulation induced negative term premiums.
It's a common observation when stock prices go up bond prices go down, and when stock prices go down bond prices go up.
I would stop you right there though if I may. It's a common *belief* that stock and US treasury bond prices are negatively correlated. It's not actually a historically strong relationship at all. The rest of what you said I confess I don't understand. But the premise is not correct so probably better to focus on that basic disagreement.

JackoC
Posts: 349
Joined: Sun Aug 12, 2018 11:14 am

Re: Do long-term bonds belong in one's portfolio?

Post by JackoC » Sun Dec 09, 2018 12:24 pm

vineviz wrote:
Sun Dec 09, 2018 2:44 am
JackoC wrote:
Sat Dec 08, 2018 5:45 pm

But, here's the real problem IMO in justifying lots of duration based on history. Besides the general fall in bond rates in all maturities since the 80's (since the 60's there's more up and down), the term premium was also typically much more positive all the way from the 1960's to recently than it is now. It's now as negative as it's ever been, according to the NY Fed's ACM term structure model which is not an outlier apparently. The average term premiums were:
60's-70's: 5 yr .66% 10 yr 1.03%
80's-90's: 1.90%, 2.76%
00's-'18: .57%, 1.00%
But now (Dec 6), per the model, 5yr -.55%, 10yr -.60%

This is the model's output of *expected* term premium at each of those dates, not the realized premium.
I just wanted to circle back and note that the ACM is prone, like many econometric models, be be sensitive to the inputs used to estimate its parameters.

The confidence interval for the so-called “ term premium “ in this model is rarely reported but is very wide. Wide enough that the reported sign is often suspect.

In this case, the model likely is overestimating the future short term rates by 50 bps or so and therefore underestimating the term premium.
I think you need to provide more support for those statements. Look at the output of that model over 50 yrs. How often has the sign flipped? Very rarely. It's certainly not indicative of a confidence interval on the order of the current answer of -60 bps.

JackoC
Posts: 349
Joined: Sun Aug 12, 2018 11:14 am

Re: Do long-term bonds belong in one's portfolio?

Post by JackoC » Sun Dec 09, 2018 12:39 pm

Valuethinker wrote:
Sun Dec 09, 2018 7:44 am
JackoC wrote:
Sat Dec 08, 2018 5:45 pm


Long term bonds don't belong in my portfolio to any significant degree IMO, now. That's in part because of particular other investments I have that are more interest rate sensitive than US stocks have been, but also the totality of the picture painted above on a forward looking basis.
Thank you for a very interesting and insightful post.

Are you able to say anything more about investments that are more interest rate sensitive than US stocks have been - e.g. for example residential housing investments (rental not owner occupied) or commercial property?
Around 20% allocation to real estate besides ~50% stocks, and I also think stocks now but particularly EM are probably more sensitive to a big move up in rates than historically, given how long they (and corp balance sheets) have had to get used to low rates.

So that's the risk side besides bonds. Then for bonds a flat curve with term structure models saying that's because of a negative term premium. 10yr doesn't seem very attractive given all that and at 30 yrs I think credit issues begin to enter in for highly indebted rich country govt debt so no interest in that as 'safe' counterweight in largely risky portfolio.

stlutz
Posts: 4835
Joined: Fri Jan 02, 2009 1:08 am

Re: Do long-term bonds belong in one's portfolio?

Post by stlutz » Sun Dec 09, 2018 12:53 pm

2pedals wrote:
Sun Dec 09, 2018 12:05 pm
A longer-term bond carries greater risk that higher inflation could reduce the value of payments, as well as greater risk that higher overall interest rates could cause the bond's price to fall. This is something I am trying to avoid at this stage.
For the moment let me keep the inflation piece out of the equation and consider longer-term TIPS vs. shorter-term TIPS.

The shorter-term TIPS face reinvestment risk. That is, when your current bond matures you may not be able to replace it with a bond that yields as much. For example, right now 5 year TIPS yield 1.02%; five years ago they yielded -.13%. With short-term bonds, you face the risk of having to reinvest at lower real rates in the future.

The longer-term TIPS face interest-rate risk. That is, if I buy a 30 year TIPS now at 1.17%, they might yield 2% in the future and I'm stuck with my current rate for 30 years. If I sell before the 30 years are up, I have to accept a loss in principal value.

It seems fairly common to view the former risk as not that big of the deal and the later as a big problem. I don't see why--shouldn't they balance against one another?

Post Reply