Jonathan Clements and John Lim on bonds

[kevink]

I know many folks here share my admiration for the well-known former WSJ finance columnist Jonathan Clements and his "Humble Dollar" site.

I've recently been rereading two posts from that site. One is from Clements himself and is two years old:

https://humbledollar.com/2020/07/my-four-goals/?utm_source=mailpoet&utm_medium=email&utm_campaign=another-ses-test_7

The other by John Lim was written earlier this year and seems even more relevant now:

https://humbledollar.com/2022/04/ditching-bonds/

Clements made the decision at least two years ago to hold only short-term TIPS (as VTIP) and an ultra-short Treasury bond fund for his modest (~23%) fixed income allocation. Lim draws attention to just how catastrophic a long-term bond bear market can be. It's easy to forget this amidst all of the stock market carnage and freaking out about inflation - especially since only those whose peak investing years included the 1980's would be in a position to remember what a bond bear is like.

Acknowledging that forecasting interest rates is even more of a fool's errand than timing the stock market I do have to say I'm having a hard time seeing any significant downside to Clement's all-short term approach. Curious to hear other's thoughts.

 

[jebmke]

I've been short-term for most of our investing life except for a huge slug of long Tips that were too good to pass up in October, 2008. Average duration sans Tips probably around 2.5-3 (some intermediate term IG and munis but majority short).

Larry Swedroe used to recommend short nominals because they tend to adjust quickly to inflation - not perfectly but their adjustment is quick.

 

[jldavid47]

Acknowledging that forecasting interest rates is even more of a fool's errand than timing the stock market...

Interest rate trends tend to run in very long cycles. At least for the last 220 years or so.

1798-1835 Falling trend
1835-1860 Choppy rising trend
1860-1900 Falling trend
1900-1921 Rising trend
1921-1945 Falling trend
1945-1981 Rising trend
1981-2021 Falling trend
2021-?? Rising trend?

The average persistence of a rising trend in interest rates over the past 220+ years is 27 years. Is this time going to be different? I have no idea but I'd bet not. Odds are I'll be dead before this interest rate cycle peaks. That doesn't mean it will be straight up to 1981 levels. It could be as simple as a 25-30 year choppy grind up to, say, 8%.

Here's a link to a 230 year graph that displays this phenomenon:

https://advisor.visualcapitalist.com/us-interest-rates/

It's a couple of years old but gets the point across.

 

[njhowie]

It all depends what the investor is looking for.

Clement's lays out what he wants from his investments. He indicates how his holdings addresses it.

Lim ditched bonds. So what did he do - TIPS fund (down 15%-20% YTD even with inflation up), gold (down 15% past 6 months), and gold miner stocks (down about 30% past 6 months). He would have done better sitting in bonds rather than all of these.

 

[daylatedollarshort]

Annuities without inflation protection and any kind of bond funds don't seem like good ideas right now, haven't been all year and the foreseeable future isn't looking all that rosy for any of them either. Many members on this forum have already posted much better advice this year that has worked out great in our various threads on I bonds, TIPS and the Golden Period for individual bonds thread.

 

[VanWinkle]

It all depends what the investor is looking for.

Clement's lays out what he wants from his investments. He indicates how his holdings addresses it.

Lim ditched bonds. So what did he do - TIPS fund (down 15%-20% YTD even with inflation up), gold (down 15% past 6 months), and gold miner stocks (down about 30% past 6 months). He would have done better sitting in bonds rather than all of these.

I am sure his timing will be better next time.........

VW

 

[Freedom56]

It amazes me that there is no shortage of clowns that the WSJ manages to find. They weren't telling people not to buy treasuries, bonds, and CDs when rates were near zero. But now that rates have become attractive to savers, these clowns are telling people to avoid bonds. Does that make sense? One clown is invested in gold and gold mining stocks. Really? Has he looked at a long term chart for Barrick Gold or Newmont?

 

[jldavid47]

It amazes me that there is no shortage of clowns that the WSJ manages to find. They weren't telling not to buy treasuries, bonds, and CDs when rates were near zero. But now that rates have become attractive to savers, these clowns are telling people to avoid bonds. Does that make sense?

Yes, there are plenty of clowns that get qouted or get air time in financial media. However, in all fairness buying long dated bonds is still probably not a good idea in this environment. Short duration (<=2 years) is just fine.

One clown is invested in gold and gold mining stocks. Really? Has he looked at a long term chart for Barrick Gold or Newmont?

Apparently not.

 

[Montecfo]

Lim ditches bonds and replaces with...wait for it...international stocks? Which he later acknowledges to be a bad idea in the same column.

I have been using short term bonds, floating rate securities and CD's for s while, to combat poor price action/rate risk in bonds. Her mentions TIPS but those have not been a winner this year-interest rate risk has not been repealed.

Best ideas seem to be short-term bonds, CDs, and mid-term bonds held to maturity. and of course I-bonds are perfect for this environment, though volume limited.

 

[Freedom56]

As long has you keep your duration below no more than 6 years you will do well. The sweet spot in yields is 2-3 years right now. The average duration in my fixed income portfolio is 4.2 years and for the past 30 years it has hovered between 3.5-4.5 years. The vast majority of individual bond investors don't buy 15,20, 30 year bonds other than for a short term trade. Pension funds, insurance companies, and long duration bond funds buy those bonds. When you buy a treasury, CD, or corporate note, you are locking in your yield at the time of you purchase.

 

[Chuckanut]

It amazes me that there is no shortage of clowns that the WSJ manages to find. They weren't telling people not to buy treasuries, bonds, and CDs when rates were near zero. But now that rates have become attractive to savers, these clowns are telling people to avoid bonds. Does that make sense? One clown is invested in gold and gold mining stocks. Really? Has he looked at a long term chart for Barrick Gold or Newmont?

Yesterday's WSJ supplement on investing was, IMHO, a thinly veiled promotion for the professional investment and "wealth management" services offered by high cost brokerage houses and such. I bet some of the better WSJ personal finance" writers past and present just shook their head and kept as far away from it as possible. Clements is probably glad he had nothing to do with it.

My 2¢. Take what you wish and leave the rest.

 

[Chuckanut]

Her mentions TIPS but those have not been a winner this year-interest rate risk has not been repealed.

But, if one buys a new TIPS today from the FRB and keeps it for its duration, that would seem to be a winner or at least at good competitor from my point of view. Am I missing something?

 

[daylatedollarshort]

But, if one buys a new TIPS today from the FRB and keeps it for its duration, that would seem to be a winner or at least at good competitor from my point of view. Am I missing something?

No, you aren't missing anything. TIPS at 1.33% yield return a 4% safe withdrawal rate over 30 years with the safety of Treasuries. And rates are now bumping up to 2% and rising. Holding to maturity is the advantage of buying the individual bonds over the funds, because they don't lose principal if you buy at par and don't sell before they mature. You only lose money with TIPS in a fund or if you don't understand how they work buy them without planning to hold to maturity.

TIPS funds without maturity dates are subject to the same issue as other bond funds in a rising rate environment. I ditched all my bond funds early in the year. Even short term and floating rate funds have been money losers this year, and floating rates are especially dicey to own with a likely recession coming up.

 

[Montecfo]

But, if one buys a new TIPS today from the FRB and keeps it for its duration, that would seem to be a winner or at least at good competitor from my point of view. Am I missing something?

Could be good depending on inflation. My point is that even in times of rising inflation, such as now, TIPS have not performed well. They are rather complicated in terms of how they move with the market.

Example Ishares TIPS bond ETF down 18% YTD. Most people would not have expected that.

Even STIP (0-5 yr TIPS ETF) has a total return of -4% YTD.

So might be a rougher ride than some expect.

 

[daylatedollarshort]

Could be good depending on inflation. My point is that even in times of rising inflation, such as now, TIPS have not performed well. They are rather complicated in terms of how they move with the market.

Example Ishares TIPS bond ETF down 18% YTD. Most people would not have expected that.

Even STIP (0-5 yr TIPS ETF) has a total return of -4% YTD.

So might be a rougher ride than some expect.

Anyone who understand TIPS would have known their funds would go down this year in a rising rate environment. TIPS real yields have been negative for some time so of course the funds are going to go down. It is basic math. TIPS aren't exactly rocket science. Anyone who understands that bond prices go down when interest rates go up would know bond funds were going to tank when the Fed said they were going to raise interest rates 6 to 7 times early in the year.

Individual TIPS even bought at 0% real yields have returned the same as I Bonds this year. They have done great compared to almost all the alternatives. TIPS bought at positive real yields, say 2%, have returned over 10% this year.

Bond funds are not bonds. As Freedom56 points out often, bond funds introduce market risk into an asset class that normally has none. TIPS ETFs are not TIPS.

 

[jldavid47]

Bond funds are not bonds. As Freedom56 points out often, bond funds introduce market risk into an asset class that normally has none. TIPS ETFs are not TIPS.

+1

This cannot be emphasized enough. The vast majority of fixed income investors believe that bond funds are safer than individual bonds. Not in this environment. If you need any proof, go look at a chart of TLT over the past year.

 

[Montecfo]

Anyone who understand TIPS would have known their funds would go down this year in a rising rate environment. TIPS real yields have been negative for some time so of course the funds are going to go down. It is basic math. TIPS aren't exactly rocket science.

Individual TIPS even bought at 0% real yields have returned the same as I Bonds this year. They have done great compared to almost all the alternatives. TIPS bought at positive real yields, say 2%, have returned over 10% this year.

Bond funds are not bonds. As Freedom56 points out often, funds introduce market risk into an asset class that normally has none.

Well, in a rising inflationary environment, TIPS *should* rise in value. Because the coupon rises with inflation. So this cuts FOR higher TIPS value (it is why you buy the TIPS for example) and rising rates cut the other way. So the net effect depends on degree of change and market sentiment.

All securities are subject to market risk, by definition. Your premise is that you can beat that by holding to maturity but, fact is, the values of all securities (excluding I-Bonds I suppose) change daily. That is what market risk means. Funds go down as you said, but individual bonds ALSO go down. Your brokerage statements will clearly show that. Funds hold individual bonds, so this makes sense.

And I could not find any TIPS that "returned" 10 percent this year. But if you have a source for that I would be very interested. As far as I can tell, all TIPS held at start of year have a negative total return. Perhaps you can find an exception.

TIPS can be valuable in a rising rate environment, but they are more complicated to understand than regular treasuries, in my view.

I am linking a useful Investopedia article: 3 Reasons to Maybe Avoid Treasury Inflation-Protected Securities (TIPS)

Among the comments:

"Unfortunately, TIPS do not always live up to their billing, primarily because most people don't understand this investment as well as they should."

https://www.investopedia.com/articl...tile,safety and inflation protection features.

 

[daylatedollarshort]

Well, in a rising inflationary environment, TIPS *should* rise in value. Because the coupon rises with inflation. So this cuts FOR higher TIPS value (it is why you buy the TIPS for example) and rising rates cut the other way. So the net effect depends on degree of change and market sentiment.

All securities are subject to market risk, by definition. Your premise is that you can beat that by holding to maturity but, fact is, the values of all securities (excluding I-Bonds I suppose) change daily. That is what market risk means. Funds go down as you said, but individual bonds ALSO go down. Your brokerage statements will clearly show that. Funds hold individual bonds, so this makes sense.

And I could not find any TIPS that "returned" 10 percent this year. But if you have a source for that I would be very interested. As far as I can tell, all TIPS held at start of year have a negative total return. Perhaps you can find an exception.

TIPS can be valuable in a rising rate environment, but they are more complicated to understand than regular treasuries, in my view.

I am linking a useful Investopedia article: 3 Reasons to Maybe Avoid Treasury Inflation-Protected Securities (TIPS)

Among the comments:

"Unfortunately, TIPS do not always live up to their billing, primarily because most people don't understand this investment as well as they should."

https://www.investopedia.com/articles/investing/102215/3-reasons-stay-away-tips.asp#:~:text=TIPS%20Prices%20Are%20Volatile,safety%20and%20inflation%20protection%20features.

You have to look up the CUSIP in Treasury Direct and see what the inflation factor was at the beginning of the year and what it is now to find out how much they have gone up. That is pretty clearly explained on the Treasury Direct site - TIPS/CPI Data — TreasuryDirect. TIPS go up with CPI inflation on a 2 month lag. The inflation factors are in TD and can easily be looked up. The coupon rate does not rise with inflation. The coupon remains the same throughout the life of the bond. The principal is adjusted by CPI inflation.

[Mod Edit]


TIPS with a 2% real yield have gone up 10% because the yield is 2% plus the principal is adjusted by CPI inflation. That is the inflation protected part of Treasury Inflation Protected Securities. Recently bought I bonds are currently 0% real yield so they only go up by CPI inflation alone.

 

[daylatedollarshort]

TIPS principal will adjust downward in value with deflation. However, they are redeemed at maturity for par value or with the accumulated inflation factor, which ever is greater, so if you hold to maturity you at least always get your principal back, if you bought at par. If you buy on the secondary market with accumulated inflation, and there is deflation, you can lose principal.

TIPS aren't a good deflation hedge, but when there is deflation the yields usually go up so for the long term that can be a great buying opportunity. I'm hoping for 3% real yields in the next year or so.

 

[MichaelB]

Just to remind readers that comparing bond funds with individual holdings is a an apples vs oranges comparison. The fund (or etf) marks to market while the individual holding does not, which creates an illusion that the fund price is more volatile. A true comparison needs to adjust for duration and market price.

In addition, there are reports (unverified) that the Fed owns around 25% of all TIPs, which calls into question if the market price really reflects market demand.

No conclusion here, just a reminder that TIPs are not a simple Treasury bond,

 

[daylatedollarshort]

I looked up one of my TIPS by CUSIP in TD, 912810QP6. The value on 10/31/21 for a $1K par bond was $1,263 and on 10/31/22 the value is listed at $1,365. That comes out to an increase of 8.27% in the principal, plus the interest rate of 2.125%.

For those of you who say TIPS are losing value this past year, and that 2% (or higher) real yield TIPS have not earned more than 10%, please let me know where I have made a math error in my calculations.

 

[Freedom56]

Just to remind readers that comparing bond funds with individual holdings is a an apples vs oranges comparison. The fund (or etf) marks to market while the individual holding does not, which creates an illusion that the fund price is more volatile. A true comparison needs to adjust for duration and market price.

In addition, there are reports (unverified) that the Fed owns around 25% of all TIPs, which calls into question if the market price really reflects market demand.

No conclusion here, just a reminder that TIPs are not a simple Treasury bond,

Not true. Bonds do not trade every day. Some bonds only trade a few times per year. Brokerage firms use a "third party price" to estimate the value of individual bonds, GSEs, treasuries, or CDs after the market closes every day in your account. The prices are extremely conservative. For example I have a 6.75% 2023 note that has been called for 10/26/22 and the make whole call price is estimated to be about $102.75 plus accrued interest. The last trade price was $101.50. The third party prices has been fluctuating since the full call from $99 to 101.4. If anything it biases to the downside to the point where Fidelity recently issues a message to clients who have been buying CDs and corporate notes regarding the use of third part prices to estimate the value of the security and that the securities mature at par.

This is the definition from Fidelity:

"Third party pricing depicts a security's price formulated from a third-party vendor's proprietary pricing methodology; to establish this modeled price, a host of factors such as recent trade activity, size, timing, and yields of comparable bonds are used; in the case of a comparable bond, the vendor assigns a "fair market" yield to the security, then extrapolates a representative price based on the fair market yield assigned; in many cases, this modeled price provides price discovery and transparency for bonds that may not have traded for days, months, or even years; understandably, in scenarios where a security hasn't traded recently, attempting to accurately predict the "market price" can be a challenging endeavor; nevertheless, the vendor prices bonds on a daily basis

Note: Given the nature of the modeled pricing provided, it is not accurate to characterize such pricing as a "closing price" or to suggest that the price was based on specific recent (prior day's end of day) trading activity"

ETFs do not update every day all securities in their portolio and complaints have recently been made to the SEC as investors have no idea what the the real asset values are. Many don't use third part pricing for their portfolio and us a last traded price that may be from months ago. ETFs are now scrambling to update their NAV like the one below:


https://www.bakersfield.com/ap/news...cle_28101072-3375-5a35-891e-d3175dc00353.html

It should be noted that actively managed CEFs have started to mark down the value of their assets and have gone from trading at a discount to asset value to trading at a premium to asset value.

 

[pb4uski]

I looked up one of my TIPS by CUSIP in TD, 912810QP6. The value on 10/31/21 for a $1K par bond was $1,263 and on 10/31/22 the value is listed at $1,365. That comes out to an increase of 8.27% in the principal, plus the interest rate of 2.125%.

For those of you who say TIPS are losing value this past year, and that 2% (or higher) real yield TIPS have not earned more than 10%, please let me know where I have made a math error in my calculations.

Not arguing with you, but the values that you are quoting above are principal or par values, right? I forget the correct term but basically the $1k par value and inflation adjustments since issue. And for someone who intends to hold to maturity then that is a good value to use.

But what were the fair values of CUSIP 912810QP6 on 10/31/21 and on 10/31/22? Like it or not, investment returns are typically calculated based on fair values and cash flows .. so the XIRR of the fair value at 10/31/21 as a cash outflow, interest payments as inflows and the 10/31/22 value as an inflow.

 

[daylatedollarshort]

Not arguing with you, but the values that you are quoting above are principal or par values, right? I forget the correct term but basically the $1k par value and inflation adjustments since issue. And for someone who intends to hold to maturity then that is a good value to use.

But what were the fair values of CUSIP 912810QP6 on 10/31/21 and on 10/31/22? Like it or not, investment returns are typically calculated based on fair values and cash flows .. so the XIRR of the fair value at 10/31/21 as a cash outflow, interest payments as inflows and the 10/31/22 value as an inflow.

Holding to maturity and getting principal back is the whole point for most of us who buy individual bonds, inflation adjusted or not, but especially for TIPS. If you want to buy and sell any kind of bond prior to maturity, that is your choice, but then obviously you can't count on getting your principal back, especially in a rising rate environment. But if you decide to sell a bond a year from now or two years from now, the price today is largely irrelevant as well. If you want to buy an individual bond and then price it like a fund would be priced in your portfolio with day to day secondary market fluctuations, you can do that but I don't see what the logic would be if you plan to hold it to maturity.

Day to day price fluctuations on the secondary market have no impact on the coupon rate on a TIPS bond, the inflation factors in Treasury Direct or what TIPS will redeemed for at maturity. The formula for how TIPS current values are calculated by Treasury Direct is on their web site in the previous link.

If you check out the Golden Period thread for nominal bonds, the bonds being discussed there are all planned to be held to maturity, except for those who are buying to scoop up deals in the secondary market by funds being forced to sell bonds at deep discounts prior to maturity due to liquidations.

 

[pb4uski]

I looked up one of my TIPS by CUSIP in TD, 912810QP6. The value on 10/31/21 for a $1K par bond was $1,263 and on 10/31/22 the value is listed at $1,365. That comes out to an increase of 8.27% in the principal, plus the interest rate of 2.125%.

For those of you who say TIPS are losing value this past year, and that 2% (or higher) real yield TIPS have not earned more than 10%, please let me know where I have made a math error in my calculations.

You asked "For those of you who say TIPS are losing value this past year, and that 2% (or higher) real yield TIPS have not earned more than 10%, please let me know where I have made a math error in my calculations."

And while I don't really give a hoot, I'm just saying that those who are saying that TIPS lost value this past year are probably looking at fair values and what the bond trades for which is the generally accepted way of looking at economic returns, so the math error in your calculations is that you are not using fair value.

Under your approach to calculating returns a conventional UST bond could never have a negative return because the par is constant and the return would always equal the coupon rate using your approach. But we all know that is poppycock because the fair value of bonds fluctuate inversely to changes in interest rates.

If you own any TIPS in a brokerage account rather than through TD, your brokerage statement shows a fair value that is different from the inflation adjusted par value, right?

If you want to choose to ignore changes in fair value because you intend to hold to maturity then fine... I think that many here who invest for income have that mindset. But don't expect the rest of the world to look at it that way because it is unlikely to happen.