recommended bond portfolio

[AltaRed]

Quote:

Originally Posted by mathjak107 Only high quality bond funds carry a duration value as you cant have any market risk in order for the value to hold true and so you wont find a duration value on hi-yielld or lower quality corporate bond funds.

Maybe not, but Barclay's Corporate LQD does list a duration of 6.02 yrs.
http://www.ishares.com/fund_info/det...D50?symbol=LQD

As an aside, their AGG carries a current yield of 5%. Question is whether that is sufficient return over 5 years (5 yrs duration), or whether there is a bit of CG upside here in event Feds start dropping short term rates. I believe MMFs are already starting to show fractional decline.

Seems to me a mixture of CDs and AGG (or LQD) is not a bad way to hedge Fixed Income.

[mathjak107]

As long as there is default risk its hard to have a time on the duration value . Credit risk can change the effective interest rate big time.

remember a bond fund is nothing more than a big bunch of laddered bonds . they behave no different than if you bought individual bonds yourself and sold some early and kept some ..

Dont forget even individual bonds may cost you more than par or less than par if they arent newly issued. You can pay 1050.00 for a 1,000 dollar bond if it pays a higher rate of interest than the market is at giving you a higher interest rate but a loss in capital when you get 1,000 bucks for a bond at maturity thatyou paid 1050.00 for

CD or bonds?

a cd or money market is a bet that rates will stay the same or rise at maturity

bonds unless very short term are a bet rates will stay the same or fall

[saluki9]

Quote:

Originally Posted by mathjak107 Bond funds have a maturity too,its called duration. As long as you stay in the fund for the duration value you pretty much will get very close to the same deal. The interest rate varies on a bond fund unlike a fixed bond and as rates rise your rate rises too although a drop in nav will follow the increase in rate.

I would be careful about using duration as a measurement of time. It's best and most common use is as a measurement of sensitivity to changes in interest rates.

Holding a fund for the "length" of it's duration is no guarantee that you will not see a loss in the principal value.

[saluki9]

I also wanted to add per the discussion of using the Lehman Ag vs LQD or some other ETF for your fixed income portfolio.

I (along with some other more famous people) do not like corporate bonds. IMHO you are taking on all the the risk of stockholders and getting instead a limited and fixed return. In addition, for doing so you get much much less of the diversification benefit that you would from other fixed income sources.

To prove my point I just ran a correlation matrix of (Vanguard Funds) S&P 500, Total Stock market index, Total bonds market index, High yield Corporate, and Intermediate Treasury Fund. Sadly I'm having trouble now printing it to a pdf so I will Summarize.

Compared to the total SM index over the last 5 years, the correlations have run as follows. (For novices high correlations (closer to 1) are bad, negatives are good for asset allocation purposes)

High yield corporate = .56

Total Bond Mk Index = -.27

Intermed Treasury = -.45

You can now see why when I am constructing a portfolio I

1. Do not add corporate fixed income securities

2. Favor US treasury securities over broader indexes.

[magellan_nh]

Quote:

Originally Posted by saluki9 I (along with some other more famous people) do not like corporate bonds. IMHO you are taking on all the the risk of stockholders and getting instead a limited and fixed return. In addition, for doing so you get much much less of the diversification benefit that you would from other fixed income sources.

saluki9,

Thanks for working up this data. It is interesting indeed. However, I'm hesitant to change my thinking about asset allocation based on 5 years of correlation data.

To me, correlation data is a reasonable thing to consider in figuring out an asset allocation stratgey. However, I think we (the world!) place way too much stock in the recent correlation data in making allocation decisions. Making investment decisions based on 3-7 years worth of correlation data is a lot like making them based on 3-7 years worth of returns data. In short, recent correlations may not be a good predictor of future correlations.

So while I certainly pay attention to correlation data and the output of optimizers, I pay more attention to the underlying "return generating process" of each asset class (I got this phrase from indexinvestor.com)

The idea is to think about the forces that generate returns for each asset class in your portfolio. Are those forces similar or different between asset classes? Are the risks similar or different? Are there structural reasons to believe the relationships or the underlying return generating processes have changed or will change?

For example, IMHO corporate bonds are fundamentally different animals from government bonds in terms of the risks and the return opportunities that underly the two investments. They have different return generating processes and bacause of that are unlikely to be (or stay) correlated over the long haul.

Also, I would bet a large sum of money (in fact I guess I am) that corporate bond returns will not stay correlated to stocks over the next 30-40 years. For example, after a 25% market crash, if investor psychology fundamtentally shifts away from equities (which it does from time to time), demand for stocks is likely to fall vs demand for bonds, and hence their respective returns will be different.

So while I could accept (or at least consider) a market timing argument that the risk of corporate bonds is mispriced by the market right now, I'd disagree with an argument that corporate bonds and stocks have similar return generating processes and therefore are likely to move in lock-step.

I know this thinking is controversial and many respected people disagree with me, but hey, sometimes it's fun to buck the conventional wisdom...

Jim

[saluki9]

Quote:

Originally Posted by magellan saluki9, Thanks for working up this data. It is interesting indeed. However, I'm hesitant to change my thinking about asset allocation based on 5 years of correlation data. To me, correlation data is a reasonable thing to consider in figuring out an asset allocation stratgey. However, I think we (the world!) place way too much stock in the recent correlation data in making allocation decisions. Making investment decisions based on 3-7 years worth of correlation data is a lot like making them based on 3-7 years worth of returns data. In short, recent correlations may not be a good predictor of future correlations. So while I certainly pay attention to correlation data and the output of optimizers, I pay more attention to the underlying "return generating process" of each asset class (I got this phrase from indexinvestor.com) The idea is to think about the forces that generate returns for each asset class in your portfolio. Are those forces similar or different between asset classes? Are the risks similar or different? Are there structural reasons to believe the relationships or the underlying return generating processes have changed or will change? ... I know this thinking is controversial and many respected people disagree with me, but hey, sometimes it's fun to buck the conventional wisdom... Jim

I can list the factors that go into corporate bond returns. Why don't you try the same, and ten tell me how they aren't related to stocks.

There is bucking the trend, and then there is lacking common sense. I will hold back my opinion on yours.

BTW: The correlation between the S&P 500 and the High yield fund is EXACTLY THE SAME when you go out 15 years. In addition, correlations change every day. When doing research of asset classes most believe you are better served by looking at recent correlation data rather than older data because many of those factors don't even exist anymore.

Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

[magellan_nh]

Quote:

Originally Posted by saluki9 I can list the factors that go into corporate bond returns. Why don't you try the same, and ten tell me how they aren't related to stocks.

My thinking is that relative demand for equities vs stocks bonds has historically ebbed and flowed over the years driven largely by investor psychology. Following the 30s, the average investor considered equities a lot like betting at the race track and considered bonds as the more sensible investment. I'm not claiming that investor sentiment is about to change tomorrow, only suggesting that it may repeat patterns from the past and this may cause returns from the two asset classes to diverge.

Quote:

When doing research of asset classes most believe you are better served by looking at recent correlation data rather than older data because many of those factors don't even exist anymore.

Yeah, this is the challenge I commented on before. The short term correlations don't have enough history to them and the long term correlations don't hold anymore. The correlations are likely to stay the same until they change, and no one knows when that will happen.

Quote:

Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

Ouch! Looks like I struck a nerve, sorry. I didn't mean to challenge your belief system, only to ask you to consider another view.

Jim

[saluki9]

Quote:

Originally Posted by magellan Ouch! Looks like I struck a nerve, sorry. I didn't mean to challenge your belief system, only to ask you to consider another view. Jim

But what is there to consider?

Treasury securities are the safest, most liquid security the world has. The only risks that they run into are interest rate risk and inflation risk.

Corporate securities on the other hand are subject to interest rate risk + liquidity risk, downgrade risk, credit spread risk, event risk, and default risk.

To imply that somehow liquidity risk, credit risk, and default risk is going to provide you a correlation benefit as compared to the same issuers as the stocks is just plain silly.

[brewer12345]

Quote:

Originally Posted by saluki9 You can now see why when I am constructing a portfolio I 1. Do not add corporate fixed income securities 2. Favor US treasury securities over broader indexes.

Heh, so what do you think of SPIAs?

I don't think much of LQD as a bond allocation, in part because of the factors Saluki mentioned and in part because of the fact that credit spreads are at historically low levels.

[Nords]

Quote:

Originally Posted by saluki9 Arguing abuot whether corp bond returns are correlated with stock returns is like arguing whether the earth is round.

Aw, c'mon, I can't pass up a slow pitch.

Technically the earth isn't round, it's a skewed ellipsoid. And it's changing too, just like correlations!

[saluki9]

Quote:

Originally Posted by brewer12345 Heh, so what do you think of SPIAs?

I have mixed feelings about SPIAs.

I think that for people who aren't interested in leaving money to their children or who have limited resources they can be a very helpful solution. Yet, the fact remains that they purchaser is trading the risk of running out of money for the credit risk of the insurance company.

Concerning the previous posts...


I think the problem here is that we have two very different types of investors debating the same solutions. Whereas Nords and Brewer might be happy accepting very high volatility for higher returns, most investors have other worries than their terminal value. If all you care about is your portfolio at time X, then correlations don't mean much to you, you should just invest in the securities with the highest expected reutns. Whether LQD has higher expected returns than the Lehman Ag, I will leave to your own estimate

[mathjak107]

corporate bonds are to correlated to stocks for my taste.

they have most of the risk and little of the gain potential. I prefer treasuries and foreign.

[mathjak107]

Quote:

Originally Posted by saluki9 I would be careful about using duration as a measurement of time. It's best and most common use is as a measurement of sensitivity to changes in interest rates. Holding a fund for the "length" of it's duration is no guarantee that you will not see a loss in the principal value.

This is true but it still acts as guide. Remember too that reinvesting the dividends shortens up that duration time alot too

[magellan_nh]

Quote:

Originally Posted by saluki9 I think the problem here is that we have two very different types of investors debating the same solutions. Whereas Nords and Brewer might be happy accepting very high volatility for higher returns, most investors have other worries than their terminal value. If all you care about is your portfolio at time X, then correlations don't mean much to you, you should just invest in the securities with the highest expected reutns. Whether LQD has higher expected returns than the Lehman Ag, I will leave to your own estimate

I'm not sure if this was in response to my comments, but in case it was, I didn't mean to imply that I think correlations don't matter. I think they do and I'd like to optimize my portfolio around estimated future correlations rather than correlations from the last 5 years.

We could argue all day about what methods will best accomplish this, but I don't think it's silly or demonstrates a lack of common sense to think about the problem of how best to estimate future correlations between asset classes.

Finally, in the interest of full disclosure, you can see my complete asset allocation on the introductions board here:
http://early-retirement.org/forums/i...3931#msg173931

I don't think I'm talking about anything really radical here (well maybe the gold ). I'm saying that I've chosen NOT to tilt my strategic bond allocation away from a market allocation and toward treasuries only.

Jim

[AltaRed]

Quote:

Originally Posted by brewer12345 I don't think much of LQD as a bond allocation, in part because of the factors Saluki mentioned and in part because of the fact that credit spreads are at historically low levels.

That is where I landed as well.