why do investors/Bogleheads love GNMAs so much

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

why do investors/Bogleheads love GNMAs so much

Post by larryswedroe »

thought you might find my latest look of interest

http://moneywatch.bnet.com/investing/bl ... blog-river

Note IMO owning them is not a serious crime like a felony, more like a misdemeanor (:-))

Best wishes
Larry
deerhunter
Posts: 424
Joined: Sat Jan 03, 2009 6:12 pm
Location: Central Ohio

Post by deerhunter »

I have held Fidelity gnma's since the early 1980's. I went to 80 per cent gnma's in January of 2000 when I decided I didn't need the risk of stock market exposure anymore.

Since then my IRA has averaged over 6 per cent per year and I have slept better. Last week I sold a 10 per cent chunk of them since they were at an all time high. At age 69 and 65 my wife and I feel comfortable with them and will continue with our asset allocation which is 70 percent gnma's, 10 percent short term bonds and money market and 20 percent stock index funds.
Living off the land is a family tradition.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

deerhunter

Post by larryswedroe »

What you describe is the issue of absolute performance vs relative performance of what would have been a more efficient way to accomplish the objective.

Say for example from 1980-1999 you owned an actively managed large cap fund that returned 15%. And you were happy. But you should not have been because Vanguard's S&P 500 Index fund returns almost 18%.

Also you are looking at the fund in isolation, the wrong way to look at funds, as I have pointed out many times.

Also note the period you are looking at is one of basically falling rates over time. No real long period of extension risk. The one thing we can pretty much say for certain is that that type period will not be repeated and risk of extension is now quite high

Best wishes
Larry
deerhunter
Posts: 424
Joined: Sat Jan 03, 2009 6:12 pm
Location: Central Ohio

Post by deerhunter »

Between 1980 and 1999 I was heavily invested in Fidelity's hot mutual funds like Magellan. I made lots of money, sometimes 30 per cent per year. I just had a small investment in gnma's. In 2000, I got out at DOW 11000 plus, what is it today?
Living off the land is a family tradition.
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Post by richard »

The reason to hold GNMAs is that diversification is a good idea and GNMAs are a large part of the bond market. Stretching for yield or overweighting GNMAs (compared to market weights) would be a mistake,

As Ken French said in a related context, diversification means putting your eggs in a lot of baskets and throwing out a large market segment is the opposite of diversification.
http://www.dimensional.com/famafrench/2 ... ssion.html
Van
Posts: 904
Joined: Wed Oct 27, 2010 9:24 am

Post by Van »

If you go to Vanguard and compare VFIIX with VFITX with regard to growth of $10,000, they are almost identical for 1, 3, 5 and 10 years.

However, to my eye, there are fewer little peaks and valleys with the GNMA fund (VFIIX).

Therefore, despite the theoretical and no doubt accurate analysis of the OP, an admittedly simple minded bottom line guy like me loves the GNMA fund.
User avatar
Munir
Posts: 2998
Joined: Mon Feb 26, 2007 4:39 pm
Location: Oregon

Post by Munir »

richard wrote:The reason to hold GNMAs is that diversification is a good idea and GNMAs are a large part of the bond market. Stretching for yield or overweighting GNMAs (compared to market weights) would be a mistake,

As Ken French said in a related context, diversification means putting your eggs in a lot of baskets and throwing out a large market segment is the opposite of diversification.
http://www.dimensional.com/famafrench/2 ... ssion.html
Richard,
I don't understand your concluding sentence as constructed.

Here is the text of your quote:

"Diversification by OmissionCan investors build a better portfolio by combining asset classes that have low correlations? It is possible, explains Ken French, but not in the way that most investors attempt it. Some think they can enhance diversification by eliminating mid caps and concentrating on only large and small cap stocks because these asset classes are less correlated. Ken explains that portfolio variance is determined not only by correlation, but also by variance of the individual asset classes and, critically, by their weighting in the portfolio. He emphasizes that throwing out mid caps is equivalent to doubling up on the risk of large and small caps, which is the opposite of diversification."

Have F & F been eavesdropping on Mel or the other way around? :)
Rob't
Posts: 197
Joined: Thu Apr 19, 2007 8:33 pm

Richard wrote:

Post by Rob't »

The reason to hold GNMAs is that diversification is a good idea and GNMAs are a large part of the bond market. Stretching for yield or overweighting GNMAs (compared to market weights) would be a mistake,
That (total bond market investing) seems a reasonable approach; Larry might even consider it less than a misdemeanor; perhaps a warning ticket. I think he is warning against GNMAs as the sole fixed investment in the current climate.
jginseattle
Posts: 987
Joined: Fri Jul 01, 2011 7:33 pm

Post by jginseattle »

I am coming around to the belief that there may be better choices than GNMAs. However, you don't eliminate them entirely by owning Vanguard's Treasury funds. Those funds do hold GNMAs from time to time.
Rob't
Posts: 197
Joined: Thu Apr 19, 2007 8:33 pm

Post by Rob't »

Deerhunter wrote:
Between 1980 and 1999 I was heavily invested in Fidelity's hot mutual funds like Magellan. I made lots of money, sometimes 30 per cent per year. I just had a small investment in gnma's. In 2000, I got out at DOW 11000 plus, what is it today?
Congratulations. That worked very well for you. I think, however, that as a strategy market timing and chasing hot performance will not be beneficial for the average Boglehead. Larry has another saying along the line of "Don't confuse strategy with outcome."
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Post by richard »

Munir wrote:
richard wrote:The reason to hold GNMAs is that diversification is a good idea and GNMAs are a large part of the bond market. Stretching for yield or overweighting GNMAs (compared to market weights) would be a mistake,

As Ken French said in a related context, diversification means putting your eggs in a lot of baskets and throwing out a large market segment is the opposite of diversification.
http://www.dimensional.com/famafrench/2 ... ssion.html
Richard,
I don't understand your concluding sentence as constructed.
What don't you understand?

In the audio at the link, he says diversification means putting your eggs in a lot of baskets.

The text at the link includes, "He emphasizes that throwing out mid caps is equivalent to doubling up on the risk of large and small caps, which is the opposite of diversification." In other words, throwing out a large segment of the market (midcaps or GNMAs or whatever) is the opposite of diversification.

What Mel is doing is also the opposite of diversification - he's throwing out significant segments of the market (large and small) and concentrating all his equity eggs in midcaps. Ken is not saying midcaps are great, he's saying diversification means not ignoring large parts of the market.
User avatar
Taylor Larimore
Advisory Board
Posts: 31474
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

100% equity in midcaps?

Post by Taylor Larimore »

What Mel is doing is also the opposite of diversification - he's throwing out significant segments of the market (large and small) and concentrating all his equity eggs in midcaps.
Richard:

I am sure that Mel would never own or recommend a portfolio with "all his equity eggs in midcaps."
"Simplicity is the master key to financial success." -- Jack Bogle
User avatar
Munir
Posts: 2998
Joined: Mon Feb 26, 2007 4:39 pm
Location: Oregon

Post by Munir »

richard wrote:
Munir wrote:
richard wrote:The reason to hold GNMAs is that diversification is a good idea and GNMAs are a large part of the bond market. Stretching for yield or overweighting GNMAs (compared to market weights) would be a mistake,

As Ken French said in a related context, diversification means putting your eggs in a lot of baskets and throwing out a large market segment is the opposite of diversification.
http://www.dimensional.com/famafrench/2 ... ssion.html
Richard,
I don't understand your concluding sentence as constructed.
What don't you understand?

In the audio at the link, he says diversification means putting your eggs in a lot of baskets.

The text at the link includes, "He emphasizes that throwing out mid caps is equivalent to doubling up on the risk of large and small caps, which is the opposite of diversification." In other words, throwing out a large segment of the market (midcaps or GNMAs or whatever) is the opposite of diversification.

What Mel is doing is also the opposite of diversification - he's throwing out significant segments of the market (large and small) and concentrating all his equity eggs in midcaps. Ken is not saying midcaps are great, he's saying diversification means not ignoring large parts of the market.
Richard,

Sorry for not being clear. Your sentence as constructed could be misunderstood (in my opinion). It would have been more clear if you had a period after "in a lot of baskets" and starting a new sentence with "Throwing out a large market segment...". Of course that is only my opinion for whatever it's worth.

I don't remember Mel saying that all one's equities should be in midcaps. He was agreeing with you, and with F & F, by saying the midcaps have been neglected by many investors, and should be inlcluded in one's portfolio for diversification. Taylor is correct.

I don't want to stear the conversation away from the discussion about GNMAs, so I'll quit here.
deerhunter
Posts: 424
Joined: Sat Jan 03, 2009 6:12 pm
Location: Central Ohio

Post by deerhunter »

R'bt said
Congratulations. That worked very well for you. I think, however, that as a strategy market timing and chasing hot performance will not be beneficial for the average Boglehead. Larry has another saying along the line of "Don't confuse strategy with outcome."
I wasn't timing the market, I was 59 years old and didn't want to risk what I had made. If I was 40, I would have stayed in equities, in fact, if I was 40 now I would be in stocks.

In the 80's and 90's you could chase any hot performance and make money. We need another 20 years like that. :)
Living off the land is a family tradition.
beardsworth
Posts: 2135
Joined: Fri Jun 15, 2007 4:02 pm

Re: 100% equity in midcaps?

Post by beardsworth »

Taylor Larimore wrote:I am sure that Mel would never own or recommend a portfolio with "all his equity eggs in midcaps."
Actually, once upon a time he did. I was quite surprised to read the statement, but his belief in mid–caps as the market's "sweet spot" must have been quite firm.

http://www.bogleheads.org/forum/viewtop ... ae#1118954

Marc
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Re: 100% equity in midcaps?

Post by richard »

marc beat me to it
Last edited by richard on Mon Aug 22, 2011 6:53 pm, edited 1 time in total.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

richard

Post by larryswedroe »

If going to quote French then should state that French would not buy GNMAs. Or any MBS.They will not buy any bond without a fixed or known maturity. No call risk, let alone put risk And while I don't want to put words in his mouth, IMO French would say that he looks at the evidence and avoids recommending buying assets that history has shown have not delivered appropriate returns, avoiding these anomalies.
Best
Larry
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Van

Post by larryswedroe »

First, even if the results were similar ALONE, that is the wrong way to look at things
Second, the period does not include a period when rates were rising sharply--which if it had occurred then the returns would have been quite different
Third, the results alone are irrelevant--only thing that matters is how the asset mixes with portfolio---unless it is only asset you own.

Best wishes
Larry
Beagler
Posts: 3442
Joined: Sun Dec 21, 2008 7:39 pm

Post by Beagler »

Anyone holding a VG Target Retirement fund, or holding VG's Total Bond Fund had better like GNMA's a lot:

Image
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
User avatar
BigD53
Posts: 1042
Joined: Sat Jul 21, 2007 7:47 pm

Post by BigD53 »

Well, I guess if GNMAs are so bad, then Vanguard had better remove them from the Total Bond Market Index fund!? Shall we start a letter-writing campaign??? :shock: :roll:

In 30 years, VFIIX has had ONE minor down year. It lost -0.95%, in 1994. It's almost as if Larry hopes the GNMA fund will crash, so he can say a big "I Told You So!"

I just don't buy it, and I don't understand this seemingly constant reminder that GNMAs are so bad. There are certainly much more worrisome areas of finance to worry about! But if his theories turn out to be correct someday, I will be the first to congratulate him. Until then, I think we all got much bigger fish to fry. :lol:
User avatar
Taylor Larimore
Advisory Board
Posts: 31474
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

It's a mistake to be "sure."

Post by Taylor Larimore »

Marc:

Thank you for the correction about Mel's earlier portfolio.
"Simplicity is the master key to financial success." -- Jack Bogle
User avatar
nisiprius
Advisory Board
Posts: 47218
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

Image

Larry's probably right, but if that 0.3% difference in return were someone's claimed difference between an actively managed fund and a passively managed fund I'd shrug it off as unproven and inconsequential. Hey, I have to shrug off a lot more than that to stick with Vanguard Total Bond instead of PIMCO Total Return.

In a week when we've had two posters contemplating 100% stocks and one contemplating 100% bonds, I think it's really important to hold both in a sensible allocation, and not so important which intermediate-term investment-grade bond fund to old.

And, yes, I can compound 0.3% for thirty years as well as the next man.*

*9.4%
Last edited by nisiprius on Mon Aug 22, 2011 9:40 pm, edited 9 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
beardsworth
Posts: 2135
Joined: Fri Jun 15, 2007 4:02 pm

Post by beardsworth »

Beagler wrote:Anyone holding a VG Target Retirement fund, or holding VG's Total Bond Fund had better like GNMA's a lot:

Image
This kind of nomenclature–related confusion seems to come up every time there's a thread about GNMAs. The "government mortgage–backed" securities in Total Bond Market Index Fund include both GNMAs and mortgage pass–throughs arising out of other government agencies. In other words, a percentage in "government mortgage–backed" does not automatically translate into the same percentage specifically in GNMAs.

Or, to put it another way, all GNMAs are government mortgage–backed securities, but not all government mortgage–backed securities are GNMAs. :)

You can download the most recent (12–31–2010) Total Bond Market Index list of holdings here:

https://personal.vanguard.com/us/funds/ ... IntExt=INT

Marc
Last edited by beardsworth on Tue Aug 23, 2011 8:13 am, edited 1 time in total.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

BigD

Post by larryswedroe »

If you read my posts you will note that I have said this is relatively minor problem in the big scheme of things. I call it a minor misdemeanor and not felony.

But that is not the point of the posts. The point is to educate investors so they actually understand what they own. Most who invest in GNMAs or MBS have no clue of the risks they are taking. And they certainly don't know how the asset mixes

Even after many posts on the subject and the articles explicitly discussing how one should not look at things in isolation you still get people looking at things the wrong way, in isolation

And you also get people thinking in RELATIVE terms. Relatively my GNMA did well. They don't look at the risks and how they mixed and to see if there were better alternatives. IMO there are better alternatives.

BTW_I sure do hope that GNMAs perform poorly because of rising rates--but not for reason you think. If we don't get rising rates then we are in serious economic trouble. With real growth of say 3% and inflation of say 2.5% we should see rates several hundred points higher which would cause extension risk. I would assume you too are rooting for that to happen.
beardsworth
Posts: 2135
Joined: Fri Jun 15, 2007 4:02 pm

Post by beardsworth »

Hi Larry,

(Please read with a smile and good humor, as this post is made by a reader who looks forward to your posts here and always finds in them something to think about:)

Perhaps the problem was your original thread title, which asked "Why do investors/Bogleheads love GNMAs so much?"

Several people then answered the question and said, "Here's why I love my GNMAs." . . . And then you told them why they were (in a non–felony, misdemeanor way) wrong.

So maybe the thread title should just have been: "Investors/Bogleheads shouldn't love GNMAs so much."

:)

Cheers (from one who does not currently own GNMAs),

Marc
Van
Posts: 904
Joined: Wed Oct 27, 2010 9:24 am

Post by Van »

Mr. Swedroe,

Do you feel the same way about individual GNMAs bought and held to maturity as you do about GNMAs held in a mutual fund?

Does the former have any advantages over the later?
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Re: richard

Post by richard »

larryswedroe wrote:If going to quote French then should state that French would not buy GNMAs. Or any MBS.They will not buy any bond without a fixed or known maturity. No call risk, let alone put risk And while I don't want to put words in his mouth, IMO French would say that he looks at the evidence and avoids recommending buying assets that history has shown have not delivered appropriate returns, avoiding these anomalies.
French says that if you omit a large segment of a market you are not diversified. By normal definitions of diversification, including French's, omitting GNMAs results in a less diversified portfolio.

The next question is whether this is a good thing. The standard efficient market starting point is the cap weighted market portfolio. As Cochrane says
Do not forget, the average investor holds the
market. If you’re pretty much average, all this thought
will lead you right back to holding the market index.
To rationalize anything but the market portfolio, you
have to be different from the average investor in some
identifiable way
http://papers.ssrn.com/sol3/papers.cfm? ... _id=218871

It's not the case that everyone can move away from the market in the same direction.

Given the limited amount of general history available (e.g. four independent 25 year periods) and the shorter amount of history of GNMAs, relying on history to repeat may not be the best course. Given a belief in market efficiency, if you have a diversified portfolio, higher risk implies higher expected returns, such that the additional expected return compensates for the higher risk (ex ante if not ex post).

Are there any published docs in which French says owning the bonds you list is a bad idea, and if so, how does he reconcile that view with his general efficient market outlook and preference for diversification?
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Van

Post by larryswedroe »

Cannot change the nature of the security by the form in which you hold it.
Doesn't matter at all. The risks are the same.

Best wishes
Larry
User avatar
LH
Posts: 5490
Joined: Wed Mar 14, 2007 2:54 am

Post by LH »

While the GNMA fund will always have a higher yield than the similar Treasury fund, that doesn’t mean its return will be higher. In fact, for the past five years ending August 19, VFITX outperformed VFIIX 7.9 percent versus 7.1 percent, and in the past 10-year period it outperformed 6.3 percent versus 5.9 percent. In addition, over the 12 months ending August 19, VFITX outperformed VFIIX 8.5 percent versus 6.5 percent. This is a time when the stability of fixed income was especially valuable, given that the Vanguard 500 Index Fund (VFINX) lost 8.2 percent.

There are a couple time periods quoted where GNMA underperforms.

But clear something up for me:

In General, expectantly, barring defaults, if the yields are higher, the return should be higher on average, if market is efficient, or even near efficient?

1) GNMA, there can be early repayment due to refinance, so that is a similiar mechanism for higher yields but lower returns than expected.

2)There can be times when funds are valued higher and such just due to "hot" (emotional?) money flows in/out.

Anything else? Per the other poster, who said that really the two funds returns are essentially equal on average, it must be reasons 1 and 2 that the yields are higher but the return equal on average and lower at times?

Thanks,

LH
User avatar
Doc
Posts: 10393
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc »

Beagler wrote:Anyone holding a VG Target Retirement fund, or holding VG's Total Bond Fund had better like GNMA's a lot:

Image
Note that the 26% Government Mortgage Backed has a lot of Freddie and Fannie in it. It is not all GNMA. Also I believe that the corporate MBS is quite lower than historical norms in the index itself because of the mortgage meltdown.

I usually think of TBM as 1/3 each Treasury, MBS, Corporate. One third is a lot of floating maturity notes in my opinion. Not much you can do about it if you use a TBM fund. But if you have reason not to use TBM say becasue of limited space in tax advantaged I think it makes sense to follow Larry's "how does it fit with the rest of the portfolio" advice. My IPS called for about 10% MBS and I went to zero a few months ago because of the renewed extension risk Larry opened this thread with and becasue I didn't want any "risky" (in terms of volatility) instruments during the debt crisis debate.
Last edited by Doc on Tue Aug 23, 2011 9:28 am, edited 1 time in total.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Richard

Post by larryswedroe »

First, there are different ways to look at diversification, this is one of the focuses of what might be called Post Modern Portfolio Theory. If have not read Illmanen's new book I urge you to do so. Lots of work coming out of University of Chicago and guys like Moskowitz and others (Asness) on this type stuff.

Second if you own TSM you have exposure to only one risk factor, beta. If you tilt you gain exposure to three risk factors, beta, size and value. IMO done right that is more effective diversification, and the evidence clearly shows that, as I have shown over and over again. The evidence is why many really smart people I know believe the most efficient portfolios are low beta and high tilt. (pretty sure Bill Bernstein would agree for example) Especially if you are risk averse , and even more so if you are in capital preservation game. Certainly all the behavioralists would agree as they think value tilt is free lunch.

Third, as I said there is no such thing as an average investor, doesn't exist. It's theoretical idea, not reality. The market is made up of people who have big negative tilts and big positive tilts and no tilts. So who are you supposed to be different from exactly? You can drown in river with average depth of 6 inches. The right answer IMO is to consider the issues I have tried to address--your marginal utility of wealth, risk aversion, diversification across risk factors, potential dispersion of returns from portfolios, anomalies in market, etc. Not be blindly adherent to an idea of perfect efficiency which we know is not correct.

Finally, as to French on bonds, while no published papers the answer is right in front of your nose. French directs research at DFA, along with Fama. Does any DFA fund own any callable bonds? Do they own any MBS? If the answer is no they do not, that tells you exactly what French's views are. They don't believe you should own a security that you don't know the maturity of. And I have I am sure stated this before here.

What I don't get is the blind adherence to if the market creates a product you should buy it. That to me is nonsensical. Just try this idea for moment--the exact same thing if I suggested on equity side almost no one would do yet on bond side you advocate it because it exists? And explain to me why when rates go down (and by definition extension risk goes up) you should buy more GNMAs, which is exactly what happens in a TBM fund because the amount of GNMAs tends to increase. That makes no sense to me either. But what do I know.

So now take your equity portfolio and right puts and calls on it. How do you feel about that idea? That is the same thing as an MBS in effect and have never heard you or any Boglehead advocate any such thing. Nor have I heard anyone advocate taking their Treasuries and writing puts and calls --again same thing as owning MBS.

I hope that is helpful

Larry
User avatar
nisiprius
Advisory Board
Posts: 47218
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

Larry, something I'm not clear on. Is the problem you see with GNMAs something that has been there all along and is illustrated by your 1992-2011 example, or is it something that has not actually shown up yet?

Do you see that time period as a reasonably representative sample of the true nature of GNMAs? One might, for example, say, without claiming any quantitative accuracy, that neither the 1990s nor the 2000's are a true sample of the stock market, but that the two decades taken together are, and show pretty much the best and the worst that the stock market does. Does 1992-2011 show the best and the worst behavior of GNMAs?

Or is the problem you see in GNMAs a risk that has not shown up yet? Is the issue the possibility of a future, let's call it a microcrash in GNMA values?

As an analogy, people who invested in GE Enhanced Cash thinking it was just like a money market fund only better, ended up with $0.97 on the dollar. Not a crushing blow, but enough to wipe any smile off their faces. Is that the sort of risk you foresee with GNMAs?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Beagler
Posts: 3442
Joined: Sun Dec 21, 2008 7:39 pm

Post by Beagler »

Larry wrote: "The market is made up of people who have big negative tilts and big positive tilts and no tilts. So who are you supposed to be different from exactly? You can drown in river with average depth of 6 inches...Not be blindly adherent to an idea of perfect efficiency which we know is not correct."

I'm assuming this is an opinion that TSM is not perfectly efficient.
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Re: Richard

Post by richard »

Larry,

Most of your post is a disagreement with the Fama, French, Cochrane efficient market view. The numbered points are mostly direct disagreements with things they've written, both in general and the French statement on diversification (http://www.dimensional.com/famafrench/2 ... ssion.html, both text and video) and the Cochrane statement on average investors in particular (quoted above).

DFA is in business to sell products, presumably non-generic products. I don't draw any particular implication from their product mix beyond a profit motive.

"What I don't get is the blind adherence to if the market creates a product you should buy it."

It's not just the market creating a product, it's also market participants buying the product. If I create a nonsensical product and no one buys it, then it won't be a significant part of the market portfolio. It's only if there is sufficient supply and sufficient demand that it becomes a significant part of the whole.

As Fama says, the market portfolio is always efficient. If everyone should tilt in one direction (less GNMA, more SV, whatever), then the market is not efficient. That may be the case, but it's contrary to the whole Fama, French, Cochrane, DFA published view.

"And explain to me why when rates go down (and by definition extension risk goes up) you should buy more GNMAs"

You're confusing cause and effect. Bond rates go down because there's increased demand. Interest rates are not an exogenous variable. As a market participant who believes markets are efficient and who can't identify any reason that he's different than others, you should too. If you identify a reason that applies to everyone, you're just disagreeing with market efficiency. Which is fine, but should give some pause in citing Fama, et al.


Is my memory going or have we been having this same general discussion for over a decade?
richard
Posts: 7961
Joined: Tue Feb 20, 2007 3:38 pm
Contact:

Post by richard »

Beagler wrote:Larry wrote: "The market is made up of people who have big negative tilts and big positive tilts and no tilts. So who are you supposed to be different from exactly? You can drown in river with average depth of 6 inches...Not be blindly adherent to an idea of perfect efficiency which we know is not correct."

I'm assuming this is an opinion that TSM is not perfectly efficient.
Perfect is a loaded term. It's an opinion that the market portfolio (TSM is just the US equity portion) is not sufficiently efficient, such that you're better at determining values than the market is. Put another way, it's a belief you have a better feel for risk-adjusted pricing.

Identifying the average or representative can be a complex issue. The main point is that if you believe everyone should tilt in one direction or another, then you must believe the market is not efficient.
User avatar
BigD53
Posts: 1042
Joined: Sat Jul 21, 2007 7:47 pm

Post by BigD53 »

Have we not had a period of rising rates in the past? And how did the Vanguard GNMA fund perform during that time?

I think seeing those real figures would answer a lot of questions for folks. And if putting money in VFIIX is the worst investing mistake I ever make, I think I'm doing pretty darn well.
User avatar
TrustNoOne
Posts: 787
Joined: Thu Oct 30, 2008 7:09 am

Post by TrustNoOne »

This raises a sort of interesting question - if owning GNMA's is not a very good strategy, is the converese true - i.e. is it good to short a GNMA by having a conventional mortgage. I've always thought no, its better not to have a mortgage. I'm guessing the layers of fees embedded in the mortgage are worth avoiding. A GNMA fund yields about 3%, while the cheapest mortgage seems to be around 4%+. I'm thinking the servicing fees, etc are the missing 1%. However, you lose the benefit of reverse "negative convexity" (hope I got that right - if interest rates go up, I'm a winner, if they go down I refinance. )

Same question with junk bonds. Larry has shown pretty well that investors aren't compensated for the risk of owning junk bonds. My assumption is therefore, that the winners in the junk bond market are the firms that issue them (and of course, thier underwriters.)
natureexplorer
Posts: 4204
Joined: Thu Sep 03, 2009 10:52 am
Location: Houston

Post by natureexplorer »

Judge Larry :)

What is the bigger misdemeanor? GNMAs or nominal corporate bonds?
User avatar
LH
Posts: 5490
Joined: Wed Mar 14, 2007 2:54 am

Post by LH »

One of the more interesting threads recently.
deerhunter
Posts: 424
Joined: Sat Jan 03, 2009 6:12 pm
Location: Central Ohio

Post by deerhunter »

Still love my GNMA's :)
Living off the land is a family tradition.
User avatar
Doc
Posts: 10393
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Post by Doc »

BigD53 wrote:Have we not had a period of rising rates in the past? And how did the Vanguard GNMA fund perform during that time?

I think seeing those real figures would answer a lot of questions for folks. And if putting money in VFIIX is the worst investing mistake I ever make, I think I'm doing pretty darn well.
No. Not since the GNMA fund inception. We've basically had 30 years of falling interest rates and in that environment you don't get the extension risk.

http://research.stlouisfed.org/fredgraph.png?g=1L6

.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
beardsworth
Posts: 2135
Joined: Fri Jun 15, 2007 4:02 pm

Post by beardsworth »

Doc wrote:
BigD53 wrote:Have we not had a period of rising rates in the past? . . .
No. Not since the GNMA fund inception. We've basically had 30 years of falling interest rates and in that environment you don't get the extension risk.
Vanguard's online fund performance information goes back 15 years, and there was not a year between 1996 and 2010 when the GNMA fund showed a whole–year loss:

https://personal.vanguard.com/us/funds/ ... t=tab%3A1a

I used to follow this fund more regularly and have the recollection that in 1994––a year when the Fed was raising rates––the GNMA Fund lost 0.94% (a whole–year figure which "masks" the amount of volatility while the year was in progress). This was somewhat less than Total Bond Market Index's net loss in the same rising–rates year.

But as Doc observes, interest rates have trended downward for decades and the isolated Fed–induced bumps were "the exceptions that prove the rule."

Marc
User avatar
Taylor Larimore
Advisory Board
Posts: 31474
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

TBM; GNMA & Inflation

Post by Taylor Larimore »

Hi Bogleheads:

It is informative to review the recent history of Vanguard's Total Bond Market Index Fund, GNMA Fund and Inflation

YEAR...TBM...GNMA.INFLATION
1996......3.6%....5.2%.......3.3%
1997......9.4%....9.5%.......1.7%
1998......8.6%....7.1%.......1.6%
1999.....-0.8%....0.8%.......2.7%
2000.....11.4%...11.2%......3.4%
2001......8.4%....7.9%.......2.8%
2002......8.3%....9.7%.......1.6%
2003......4.0%....2.5%.......2.3%
2004......4.2%....4.1%.......2.7%
2005......2.4%....3.3%.......3.4%
2006......4.3%....4.3%.......3.2%
2007......5.9%....7.0%.......2.8%
2008......5.1%....7.2%.......0.1%
2009......5.9%....5.3%.......2.7%
2010......6.5%....6.9%.......1.5%

* Mr. Bogle, who started both TBM, GNMA, and most Vanguard bond funds, recommends Total Bond Market Index Fund with its GNMA bonds for diversification, simplicity, safety, and income.

* Total Bond Market has been in our portfolio for nearly 25 years. Thank you, Jack!

Past performance does not guarantee future performance.
"Simplicity is the master key to financial success." -- Jack Bogle
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

few thoughts

Post by larryswedroe »

LH--you buy a GNMA today with 3% yield and it prepays and you reinvest at 2%. Or you buy it at 3% yield and you get extension risk and instead of getting paid back in 5 years you get paid back in 10 and thus stuck with the now below market yield for an extra 5 years. That is how higher yield becomes lower return.

Nisprius, even the period cited which was very favorable for GNMA did not show it was the most efficient. In other words the big risks did not show up--the extension risk. That would have happened from late 60s through around 1980 when rates kept going up and you kept getting extension risk showing up. You buy a GNMA say with a 6% yield and rates go to 15% and you are now holding it not for say 5 years as you thought at 6% but 12 years.

Nature explorer

Tough call, if stay with high investment grade and ST I would say GNMA, otherwise corporate. I would rather in general take term than credit risk. At least with term risk you know you get return of principal. With credit risk you don't know if you get return OF principal, let alone return on principal.

Trust No ONe
I would not short GNMA.

Richard, whatever you think I KNOW WITH CERTAINTY that what I said about French and DFAs view on bonds is accurate. For very long time DFA was purely research driven. Today IMO they would be more likely to come out with product that they get demand for if they believe they can add value, even if they are not necessarily in complete agreement (commodities good example). But for the FI funds from long ago, it was pure research. The newer funds like ST extended credit and now extended credit were more market driven perhaps but still they will not buy any bond with optionality, period. And that is driven by research team. And that is Fama and French

BTW- Fama I believe would completely disagree that the market is always efficient. If he actually believed that then DFA would not screen out certain securities, would buy callable bonds, would not include momentum strategies,etc. His actions speak volumes

And I did not say everyone should tilt. Obviously not all can, but as long as most won't I can and will.

On bonds I am not confusing cause and effect. Rates go down so there is more demand for mortgage debt. That means all of a sudden there is more supply of mortgages. Now why should I want all of a sudden more optionality in my bonds because people decided to borrow more? That makes no sense, at least to me.

IMO you are stuck in the theoretical world of perfect efficiency when even the people at DFA left that world long ago.

Best wishes
Larry
tripleb
Posts: 203
Joined: Mon Mar 07, 2011 10:30 am
Contact:

Post by tripleb »

I agree with everything Larry said. Let's assume I didn't. There's still virtually no reason to own GMNAs, ever.

If you subscribe to standard Bogleheads logic, then you look at your bond fund as:

(a) a diversifier from stocks. it zigs when stocks zag.
(b) a safe-haven such that within this one asset, there is minimal movement so you have "safe money"

For this person, you want short to intermediate term treasuries. Nothing safer than 100% backed by the US Treasury. Nothing has less correlation within the subset of all bonds than treasuries. When stocks go down, treasuries respond more strongly than non-treasuries.

If you subscribe to the Permanent Portfolio, there's no need for GMNAs at all anyway.

If you are using a system other than traditional Boglehead or PP then I think you're system is not good.

So even if you disagree with Larry about why GMNAs are bad, there's still no reason to own them.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Richard

Post by larryswedroe »

FWIW Anti Illmanen is one of the leading lights in modern finance. And IMO his book Expected Returns is must read for any SERIOUS STUDENT of investing theory.

Here is quotation from his book, which is highly readable

“A fair conclusion is that recent events have undermined the validity of the EMH’s main idea — that market prices are always ‘right’ (near the fair value) — but have underlined the validity of its main implication for most investors — that beating the market is extremely difficult (no free lunches).”

Among his findings from the research are that both MBS and corporate bonds have been poorly rewarded because of their optionality. Exception is the fallen angels I have mentioned previously.

So either one can "stop banging their head against the wall of market efficiency and leaving returns on the table," or look at the research and adapt, which IMO is what smart people do when they learn their beliefs were mistaken (even Fama and French did that, as all smart people do). Even Keynes said that (at least he got that one right (:-))

Best wishes
Larry
User avatar
nisiprius
Advisory Board
Posts: 47218
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius »

MarcMyWord wrote:Vanguard's online fund performance information goes back 15 years, and there was not a year between 1996 and 2010 when the GNMA fund showed a whole–year loss
Morningstar has the chart back to 1980--this is a pretty venerable fund--and there certainly seem to be years with losses. It looks like it moved very similarly to the BarCap Aggregate (do you still call it the BarCap Aggregate when you're talking about years when it was the Lehman Brothers Aggregate?) and, let's see, there were... nope, those notches happened in the middle of calendar years.

1994 shows a very small whole-year loss. I think that's the only one.

Live chart

Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Beagler
Posts: 3442
Joined: Sun Dec 21, 2008 7:39 pm

Post by Beagler »

VG's GNMA fund is actively managed (Wellington Management) , so perhaps this is a situation where competent active management has been rewarded.
“The only place where success come before work is in the dictionary.” Abraham Lincoln. This post does not provide advice for specific individual situations and should not be construed as doing so.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 8:28 am
Location: St Louis MO

Beagler

Post by larryswedroe »

The big losses would have showed up in late 70s when rates went through roof. After that we have been pretty much in downward trend wtih few small hiccups. And even in this very favorable period GNMAs did worse than a simple Treasury fund in a portfolio, even though had less yield by a lot. Again, why do people love them? I cannot figure it out for life of me.
deerhunter
Posts: 424
Joined: Sat Jan 03, 2009 6:12 pm
Location: Central Ohio

Post by deerhunter »

Do treasury funds and intermediate bond funds pay dividends each month like GNMA's.
Living off the land is a family tradition.
Post Reply