Why I have a portion of long term bonds

[OrcasIslandBound]

Today is turning into a microcosm of why I like to have a chunk of long term bonds in my portfolio. Notice BLV moving opposite the stock market direction. See the picture.

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[ESRwannabe]

I would eventually like to have some money in a long term treasury fund on par with what I like to keep in cash for emergencies (i.e. one year living expenses).

 

[OrcasIslandBound]

I tried to upload this earlier.

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[Mulligan]

That has been my essential strategy for past 18 months or so. About 70% (another 10% not investment grade) of what I own is investment grade preferred stocks which are essentially indefinite length "bonds". Four issues very modestly down today, two up, and the other 10 or so unchanged today. I see no reason to change with markets in flux, little growth and inflation on the horizon.


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[sengsational]

I'm thinking of going short on long term bonds by doing a cash-out refinance at 3.75%.

 

[audreyh1]

Today is turning into a microcosm of why I like to have a chunk of long term bonds in my portfolio. Notice BLV moving opposite the stock market direction. See the picture.

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I don't keep long term bonds. But intermediate bonds help also, and even short-term. Bonds need to be high quality to trade up during "rush to quality" events. You won't get as much help from a purely corporate bond fund, and a high yield fund is very likely sell off during "rush to quality" events.

2008 is a good model of how important quality is in bond funds if you are trying to counterbalance equity risk.

 

[Mulligan]

I'm thinking of going short on long term bonds by doing a cash-out refinance at 3.75%.[/

I have zero interest in true long bonds. But I certainly have no stones for a short bet in that, or anything I guess.


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[DrRoy]

I favor short to medium term myself. In munis if a taxable account.

 

[OrcasIslandBound]

Bonds are a subtle investment. Everyone seems to be aware of the rough estimate of how much long term bonds can go up or down. You simply multiply the change in interest rate times the duration and the result is the amount of gain or loss. BLV has a 15 year duration, so if it's interest rate changes by 1% it can change value by 15%, a seemingly scary figure. The subtle part is that it already is somewhat closer to historical rates and so I think will see somewhat smaller interest rate changes. Plus it earns 4.1% instead of 2.3% BND return, a 5 year duration bond. Both are solid bonds with high % treasuries and no junk. I use about a third long term and two thirds medium term bonds. I'll let you all know in a few years if this was a good move or a bad move.

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[24601NoMore]

I've been thinking of increasing our bond position but have been concerned about the Fed raising rates - possibly 3X more in 2016.

Curious what everyone thinks about increasing bond positions with Fed increases on the horizon. I know how to look at bond fund duration and even ST bond funds concern me with likely .75 bp or greater increases coming this year..

 

[Mulligan]

I've been thinking of increasing our bond position but have been concerned about the Fed raising rates - possibly 3X more in 2016.

Curious what everyone thinks about increasing bond positions with Fed increases on the horizon. I know how to look at bond fund duration and even ST bond funds concern me with likely .75 bp or greater increases coming this year..

Bill Gross cant predict the bond market, so neither can I. But, just because the Funds rate is increased does not mean the long end will move appreciably. Other factors are more pressing for the long end. Inflation, economic growth, other countries bond yields, world events, etc.
Banks were all excited about Funds rate hike and now it may backfire. Yield spreads are compressing and they could flatten out if Fed is intent on pressing too quick. No rate hiking program has ever been tried this late in a (weak) recovery cycle and could lead to actually lower rates if recession occurs.


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[24601NoMore]

Bill Gross cant predict the bond market, so neither can I. But, just because the Funds rate is increased does not mean the long end will move appreciably. Other factors are more pressing for the long end. Inflation, economic growth, other countries bond yields, world events, etc.
Banks were all excited about Funds rate hike and now it may backfire. Yield spreads are compressing and they could flatten out if Fed is intent on pressing too quick. No rate hiking program has ever been tried this late in a (weak) recovery cycle and could lead to actually lower rates if recession occurs.


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Right - but Bill Gross is buying individual bonds, while many of us are buying bond funds. Funds are my concern. You know - the old "Duration % down in NAV for every 1% increase in rates" ratio.

Buying individual bonds (if I could figure out how to do it well) is not as much of a concern. But the funds worry me for NAV impact reasons..

 

[Chuckanut]

Buying individual bonds (if I could figure out how to do it well) is not as much of a concern. But the funds worry me for NAV impact reasons..

Bonds go up and down in value also, thus their NAV varies.

 

[Mulligan]

Right - but Bill Gross is buying individual bonds, while many of us are buying bond funds. Funds are my concern. You know - the old "Duration % down in NAV for every 1% increase in rates" ratio.

Buying individual bonds (if I could figure out how to do it well) is not as much of a concern. But the funds worry me for NAV impact reasons..

There gets to be a lot of debate on other forums over bonds vs. bond funds and how each responds in your question. But ultimately a bond fund is full of individual bonds. "Panic" selling bringing forced bond redemptions in an illiquid market is an example of funds dropping more than an individual bond. Whether that would happen, who knows....Concerning short end, even if the Fed raised 75bp's, it would be so slow, I wouldn't worry about losing any appreciable amount money in a short term bond fund as they pick up the immediate yield gain to compensate for the rate hike adjustment.


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[Ed_The_Gypsy]

I don't keep long term bonds. But intermediate bonds help also, and even short-term. Bonds need to be high quality to trade up during "rush to quality" events. You won't get as much help from a purely corporate bond fund, and a high yield fund is very likely sell off during "rush to quality" events.

2008 is a good model of how important quality is in bond funds if you are trying to counterbalance equity risk.

Just for grins, here is a fascinating presentation which shows the yield curve vs the S&P 500 on any day since 1999. Talk about a wild ride!
StockCharts.com - Free Charts - Dynamic Yield Curve

I went to check on an old statement that the 30-year yield doesn't get you much more than the 10-year yield. Judge for yourselves.

You can watch the yield curve flatten then invert just before the S&P crashes. (The yield curve is not even flat today. Cause for optimism?)

It gives an early warning, though. It flattened out in 2006, two years before the S&P dropped.

 

[Lsbcal]

Bonds are a subtle investment. Everyone seems to be aware of the rough estimate of how much long term bonds can go up or down. You simply multiply the change in interest rate times the duration and the result is the amount of gain or loss. BLV has a 15 year duration, so if it's interest rate changes by 1% it can change value by 15%, a seemingly scary figure. The subtle part is that it already is somewhat closer to historical rates and so I think will see somewhat smaller interest rate changes. Plus it earns 4.1% instead of 2.3% BND return, a 5 year duration bond. Both are solid bonds with high % treasuries and no junk. I use about a third long term and two thirds medium term bonds. I'll let you all know in a few years if this was a good move or a bad move.

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I do not think the statement about historical rates is correct. I was really curious, could I be missing an opportunity? If you look up BLV it has a lot of 20 to 30 year bonds, see maturity breakdown here: http://portfolios.morningstar.com/fund/summary?t=BLV®ion=usa&culture=en-US

The history on the 20 year bond is here: https://research.stlouisfed.org/fred2/series/GS20

Basically you are taking a lot of interest rate risk.

 

[audreyh1]

Just for grins, here is a fascinating presentation which shows the yield curve vs the S&P 500 on any day since 1999. Talk about a wild ride!
StockCharts.com - Free Charts - Dynamic Yield Curve

I went to check on an old statement that the 30-year yield doesn't get you much more than the 10-year yield. Judge for yourselves.

You can watch the yield curve flatten then invert just before the S&P crashes. (The yield curve is not even flat today. Cause for optimism?)

It gives an early warning, though. It flattened out in 2006, two years before the S&P dropped.

I stumbled across that chart a few days ago. It's handy. Reminds me of an old Smart Money "living yield curve" interactive graphic that I'm not sure works anymore.

When short term bonds yield the same or more than long, I tend to move more to short duration. Why take the interest rate risk when you get higher yield on the short end?

Yes, inverted yield curve does seem like an pretty good early warning system. To me it indicates that the Fed has overdone it on the interest rate rises.

But it's still steep now. Not warning yet. It will be interesting to see how it changes as the Fed raises rates.

 

[Mulligan]

I stumbled across that chart a few days ago. It's handy. Reminds me of an old Smart Money "living yield curve" interactive graphic that I'm not sure works anymore.

When short term bonds yield the same or more than long, I tend to move more to short duration. Why take the interest rate risk when you get higher yield on the short end?

Yes, inverted yield curve does seem like an pretty good early warning system. To me it indicates that the Fed has overdone it on the interest rate rises.

But it's still steep now. Not warning yet. It will be interesting to see how it changes as the Fed raises rates.

I agree with what you are saying in todays rate environment of low interest rates. I did extensive research on historical impacts on rates to see how yield movement would impact their prices. Interestingly though when rates are very high (as opposed to todays environment) it worked the opposite way. Some preferred stocks were issued with lower yields than the 10 year treasury back in the 70s. The assumption I would assume is high rates for short issues cant last for long, so locking in the indefinite term yield would be lower because market assumed real high rates couldn't last forever.


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[OrcasIslandBound]

Hi Lsbcal, what I was really trying to say was the the yield curve will likely go from what it is today (0 to 4ish. % as the time goes from a few months to many years) to something more flatter. So the interest rate increases will likely be bigger for shorter duration bonds, slightly lessening the risk that I have chosen to accept in the long bonds. The key word is slightly. Unfortunately, all sectors, stocks, bonds, oil, perhaps even real estate, are very risky right now. So I'm deliberately attempting to create an extremely diverse portfolio whose elements of risk are unlikely to fall simultaneously. I hope the long bond, specifically the long treasury component will offset the potential stock major sell-off risk. This recipe usually works, but fails if inflation kicks up hard and interest rates are pulled up to counteract inflation. I reluctantly accept that risk as the whole system solution is the lesser of risk imo.

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[Lsbcal]

I guess what you are saying OrcasIslandBound is that you view this in a whole portfolio context and over an extended time frame. Sounds OK to me. I've never really considered the long bond but do have intermediate bonds (like 5 year duration). If I were to consider this, I'd do a several decades study with all the components to see if adding the long bonds helped or not.

Some investment advisors have stated quite frequently on Bogleheads that you are not paid sufficiently to extend out to the longer bonds and the sweet spot appears to be intermediate bonds historically. I've never really studied this myself. Right now the yield curve is steep in the intermediate range and the slopes are:
1) 10yr - 3mo Treasury = (2.25 - 0.19%)/9.75yrs = 21 basis points/year
2) 30yr - 10yr = (3.01 - 2.25)/20yrs = 3.8 basis points/year

So it looks like the extension out from 10 years to 30 years is pretty poor reward. I recall that these same advisors (like Swedroe on Bogleheads) say the longer maturity bonds are used by institutions like insurance companies to lock in obligations. There may be better info on the Bogleheads site or in Swedroe's bond book.

 

[OrcasIslandBound]

Thank you Lsbcal, keep in mind that I'm only using long term bonds in a third of my bonds portfolio, or 18% of my total portfolio. It doesn't really dominate the investments.

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[mathjak107]

long term treasury's can be very volatile right on par with stocks .

my opinion is odds are pretty good rates will trend up on bonds , they have already over the year wiping away all interest and barely staying positive on intermediate term bonds while long term bonds were down.

with equity's being the likely lead horse as it usually is i would not want any other assets with the weight of my stocks that could hold back my equity's if equity gains are weak..

i would not hold any long term bonds at this point , only intermediate and short .

 

[OrcasIslandBound]

Many here have missed the whole point. Long term bonds (BLV) are usually negatively correlated with stocks. Negative correlation means when one goes up the other goes down. That is what I'm talking about when I say the overall "system" is less volatile then the individual components.

The beauty of being in charge of one's own finances is that we can all have the investments our own way. I will enjoy a lesser volatility because I'm using both long term bonds and stock indexes in my portfolio, and those who are largely invested in stocks will get a better return if they wait long enough, just a greater short term loss as well during sharp downturns.


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[mathjak107]

negative correlated assets count on strong trends in one of them to eeek out gains .

no problem using long term bonds to fly fighter cover when we have stable interest rates and a raging stock market or falling interest rates when we have poor markets .

but when rates are more likely to rise and have been and the stock market returns weak there is no powerful trend and that is the danger now .

every time stocks get traction in a nice up day usually long term bonds take an equally large hit .


that has been the problem with the permanent portfolio .

it just has not been able to get traction since every time an asset has a run up an opposing asset is strong enough to grab it by the collar and yank it back .

low rates and high valuations are not the best time in my opinion to play assets against each other . they more need to support each other and help the asset that makes it in to the clear able to run with the ball .

not every point in time has a strategy that is best .

 

[Lsbcal]

Many here have missed the whole point. Long term bonds (BLV) are usually negatively correlated with stocks. Negative correlation means when one goes up the other goes down. That is what I'm talking about when I say the overall "system" is less volatile then the individual components.
...

I'm not convinced the long bonds together with equities are a smoother ride then intermediate bonds with equities. I'd like to see the data.

There is some indirect evidence. When I look at Vanguard's Wellesley it has 20% of 20-30 year bonds in the bond part of the portfolio. But they do have a larger portion of intermediates. I guess this is termed a bar bell strategy? See: http://portfolios.morningstar.com/fund/summary?t=VWELX®ion=USA&culture=en-US