Bond Allocation - Mixing in Preferred Stocks, High Yield Bonds, & Foriegn Bonds

[DawgMan]

Like many/most here, I oversee my own investments and spend time talking to and researching what the "experts" suggest (as well as many of you) in an effort to create the best "mouse trap" for me. While about 2 years out from RE, with last years run up, I have effectively "won the game", but continue to battle my logical/conservative nature with my ever present "greed glands" looking for a little more juice. While in the last few years I finally convinced myself to ratchet down to a more conservative 60/40 AA (which I suspect I will stay with thru RE), I cannot help but feel there are some better ways to turbo charge my "40". Yes, logically, I know that a big part of my bond allocation is there for stability and to counter the more volatile "60" over time, but I cant help with being discontent with a measly 2% + yield. So at the beginning of last year, after meeting with my financial executive committee (that's me), I made the decision to split my "40" as follows (and note their 2017 total returns which include reinvesting distributions and the approximate yield)...

- 25% Intermediate Bond Funds/ETFs (3.5% & 2%+) Previously, all my "40" here.
- 7% Preferred Stock Funds/ETFs (10.5% & 5.5%)
- 5% High Yield Bond Funds/ETFs (9%+ & 5%)
- 3% Foreign Bond Funds/ETFs (10% & 4%+)

While I am no expert, in simple terms, my research tells me Preferred Stocks will act more like Bonds with a little bit of stock momentum, High Yield Bond movement will generally run closer to stock performance, and Foreign Bonds will be affected more by currency changes. Again, putting it all simply.


So while last years performance for this 15% alternative bond allocation looks great compared to my sleepy Intermediate Bond performance, is the risk/reward model over time really worth it? Am I kidding myself with my 5% High Yield Bonds... is this effectively as if I am really holding a 65% Stock allocation? I love the extra juice in 2017, just wondering if this is a sustainable or really needed "40" allocation model?

 

[audreyh1]

Just look at how those asset classes behaved in 2008.

The point of bonds is to diversify away from stocks. Use the lower correlation high quality bonds/cash.

What is the point of taking equity like risks in your fixed income allocation?

 

[REWahoo]

What is the point of taking equity like risks in your fixed income allocation?

+1

Would you cut a few panels out of your parachute to make it lighter?

 

[Blueskies123]

Bonds (especially treasuries) are the life vest you hold onto when the stock market is crashing. You are turning your bonds portfolio into a proxy for the stock market. If you are 25 this might be OK but if you are older than 40 then you should remember 2008 and run from this idea.
“The investor’s chief problem and even his worst enemy is likely to be himself.” – Benjamin Graham

 

[OldShooter]

To turbo charge your fixed income yield, simply stop paying fund management fees. Learn to buy individual bonds and to buy govvies on the auction. Your Schwab/Fido bond guys are a great resource. People seem to think that this is hard to do. It is not.

 

[JustCurious]

Stocks are not bonds.

 

[hesperus]

To turbo charge your fixed income yield, simply stop paying fund management fees. Learn to buy individual bonds and to buy govvies on the auction. Your Schwab/Fido bond guys are a great resource. People seem to think that this is hard to do. It is not.

+1 very much a fan of individual bonds. It's not that hard...

 

[Winemaker]

I treat my preferred stock portion of my 7 figure portfolio as part of my fixed income/ bond allocation. My allocation is 55/30/15, and preferreds make up 10% of my total portfolio. The other 20% is half Blackrock TIPS, and half Vanguard Total Bonds. My preferred rate of return for last year was 6.65%, TIPS 3.09%, and Total Bonds 3.57%. I sleep well at night.

 

[redduck]

I treat my preferred stock portion of my 7 figure portfolio as part of my fixed income/ bond allocation. My allocation is 55/30/15, and preferreds make up 10% of my total portfolio. The other 20% is half Blackrock TIPS, and half Vanguard Total Bonds. My preferred rate of return for last year was 6.65%, TIPS 3.09%, and Total Bonds 3.57%. I sleep well at night.

Must be the wine.

 

[GravitySucks]

I had about 5% in high yeild until I saw how close it tracked equities. Doesn't do the job that my bonds are meant to do - stay stable when everything else goes south.
http://quotes.morningstar.com/chart/etf/chart.action?t=JNK&region=usa&culture=en_US

Thought of changing AA to to 65/35 but decided to move it over to a bond fund instead. Still have 1% in HY, but will sell this year for living expenses.

 

[redduck]

+1

Would you cut a few panels out of your parachute to make it lighter?

Well, if it were a race to the bottom...

 

[ESRwannabe]

DawgMan,

Splitting up your bonds makes sense to me. Going by your yields I'm guessing you are using CEFs.

My investments are in a taxable account so I use muni bonds and preferred stocks (qualified divs). Around 70% of all pref stocks are qualified, so even if the CEF/etf/fund is not specifically tax-managed you will do ok.

Now is a good time to start adding to fixed income CEFs with everyone worried about inflation.

Here is one CEF that I like which is 50/50 stocks (mostly utility) and preferred stocks. Ticker is HTD.

 

[gcgang]

http://mebfaber.com/wp-content/uploads/2016/05/SSRN-id2724737.pdf

You might want more foreign bonds.

Above link to Meb Faber from January 2016. If you wanted a "neutral", global market cap weighted portfolio, you'd have 30%, not 3%, in foreign governments.

Not saying to put 30% there, just sayin...

 

[DawgMan]

http://mebfaber.com/wp-content/uploads/2016/05/SSRN-id2724737.pdf

You might want more foreign bonds.

Above link to Meb Faber from January 2016. If you wanted a "neutral", global market cap weighted portfolio, you'd have 30%, not 3%, in foreign governments.

Not saying to put 30% there, just sayin...

Interesting. Thanks for sharing. This is why I like this site... always something to learn. I need to dig deeper, but would be curious if many here have subscribed to a significant foreign bond allocation over the last say 10 yrs, what fund/etf they used, and how it performed?

 

[KenZ71]

Where would REITs land in this discussion?

 

[Senator]

You must first ask yourself "What is my bond allocation for?".

If the bonds are for cash flow, and not stability, maybe an increase in preferred stocks or other cash flowing investment may be OK.

If the bonds are for stability, and not necessarily cash flow, do not do it. The most stable bond fund is a US Treasury. Your own mortgage bond is probably the only better bond fund than a treasury.

If you have enough money coming in from pensions, SS, rentals, etc., you can get by with a bit more volatility. If you have excess dividends, you can probably weather the volatility storm a bit better too.

If you need to sell something every year to live, you may want more stability.

 

[pb4uski]

To turbo charge your fixed income yield, simply stop paying fund management fees. Learn to buy individual bonds and to buy govvies on the auction. Your Schwab/Fido bond guys are a great resource. People seem to think that this is hard to do. It is not.

I'm skeptical. Vanguard recently did a piece on bond investing vs bond funds. They state:

The bid-ask spread tends to vary by trade size and bond
sector, and the size of the spread is typically larger for
small transactions. Mutual funds buy and sell large
quantities of bonds, with trades routinely exceeding $1
million. The larger transactions can command higher prices
for sales and lower prices for buys. So long as bid-ask
spreads are inversely related to purchase lot size, mutual
funds are likely to have an advantage over individuals
or other small-scale buyers. The benefits of scale are
most significant in sectors of the bond market other
than Treasuries, although they are important there, too.

A table following that paragraph suggests that in terms of bid asked spread that small investors in individual bonds are at a 51 bps disadvantage to mutual funds due to trade size... and in most cases that 51 bps advantage overwhelms the bond fund expense ratio.


https://personal.vanguard.com/pdf/ICRIBI.pdf

 

[audreyh1]

Where would REITs land in this discussion?

Equities.

 

[ERD50]

.... While I am no expert, in simple terms, my research tells me Preferred Stocks will act more like Bonds with a little bit of stock momentum, ....

What research is that? Actual data, or a lot of opinion? Can you provide some links?

I found two Preferred Stock funds that go back to FEB2008 (PFF, PGX), so we can get a sense of how they did in the big drop. Like the high-div=payers, they really didn't perform as some people expected.

Here's 5 years, FEB2008-FEB2013. Port #1 Total Market, #2 is a group if high-div-funds, #3 are the 2 Preferred Stock funds:

https://www.portfoliovisualizer.com..._3=50&symbol13=PSK&symbol14=VRP&symbol15=PFXF

What do you see?

-ERD50

 

[FIRE'd@51]

What research is that?

I suspect he's thinking in terms of interest-rate sensitivity, which is bond-like. Since they don't have a maturity date, their duration is equal to the reciprocal of yield.

 

[redduck]

... Like the high-div=payers, they really didn't perform as some people expected.
-ERD50

Hey, hey, was that necessary?

 

[DawgMan]

What research is that? Actual data, or a lot of opinion? Can you provide some links?

I found two Preferred Stock funds that go back to FEB2008 (PFF, PGX), so we can get a sense of how they did in the big drop. Like the high-div=payers, they really didn't perform as some people expected.

Here's 5 years, FEB2008-FEB2013. Port #1 Total Market, #2 is a group if high-div-funds, #3 are the 2 Preferred Stock funds:

https://www.portfoliovisualizer.com..._3=50&symbol13=PSK&symbol14=VRP&symbol15=PFXF

What do you see?

-ERD50

Tuff Crowd!

As I stated, I am no expert...

I was primarily trying to suggest 2 of my observations. 1) My research tells me most experts put preferreds in the fixed income bucket as they tend to see their share price adjust like bonds due to interest rate sensitivity which is why Schwab, as an example, categorizes them as "fixed income", and 2) I noted in my own comparison using PGX (which I own) and comparing the total returns to both Vanguard Total Stock market fund (VTSAX) and Vanguard Total Bond fund (VTSAX) from 2008 (really 2009 since I could not find a PGX return for 2008) that interestingly, PGX seemed to perform somewhere between both stocks & bonds for the most part with the exception of 2016 (slightly below bonds) and 2014/15 where PGX outperformed both stocks and bonds (see comparison chart below).

Annual Total Return (%) History

PGX VBTLX VTSAX



2017 10.84% 3.56 21.17
2016 1.20% 2.6 12.66
2015 8.08% .4 .39
2014 15.29% 5.89 12.56
2013 -1.83% -2.15 33.52
2012 14.51% 4.15 16.38
2011 3.26% 7.69 1.08
2010 12.23% 6.54 17.26
2009 19.28% 6.04 28.83
2008 NA 5.15 -36.99

Hence, my comment... ".... While I am no expert, in simple terms, my research tells me Preferred Stocks will act more like Bonds with a little bit of stock momentum, ...."

I am not making a sales pitch for preferreds, I am just serving it up for conversation as it relates to having a seat at the bond allocation table.

There... you now have my "data"!

 

[ERD50]

Tuff Crowd!

As I stated, I am no expert...

I was primarily trying to suggest 2 of my observations. 1) My research tells me most experts put preferreds in the fixed income bucket as they tend to see their share price adjust like bonds due to interest rate sensitivity which is why Schwab, as an example, categorizes them as "fixed income", and 2) I noted in my own comparison using PGX (which I own) and comparing the total returns to both Vanguard Total Stock market fund (VTSAX) and Vanguard Total Bond fund (VTSAX) from 2008 (really 2009 since I could not find a PGX return for 2008) that interestingly, PGX seemed to perform somewhere between both stocks & bonds for the most part with the exception of 2016 (slightly below bonds) and 2014/15 where PGX outperformed both stocks and bonds (see comparison chart below).

Annual Total Return (%) History

PGX VBTLX VTSAX



2017 10.84% 3.56 21.17
2016 1.20% 2.6 12.66
2015 8.08% .4 .39
2014 15.29% 5.89 12.56
2013 -1.83% -2.15 33.52
2012 14.51% 4.15 16.38
2011 3.26% 7.69 1.08
2010 12.23% 6.54 17.26
2009 19.28% 6.04 28.83
2008 NA 5.15 -36.99

Hence, my comment... ".... While I am no expert, in simple terms, my research tells me Preferred Stocks will act more like Bonds with a little bit of stock momentum, ...."

I am not making a sales pitch for preferreds, I am just serving it up for conversation as it relates to having a seat at the bond allocation table.

There... you now have my "data"!

Thanks, not trying to be "tough", but I do think it's helpful to back up statements. I find (in all walks of life), that a lot of "conventional wisdom" is just wrong, or at least unfounded.

Here's a graph to help visualize the data - P#1 is PGX (preferred fund), #2 is Total Bond, and #3 is Total stock. The preferred fund sure seems to act like stocks in the downturn and recovery, then acts more like bond from 2010 on. Volatility in a Bear and stability in a Bull? That's not attractive to me.

I'm not sure what to say about the interest rate sensitivity. To my eye, they act so much like stocks, that I'm not sure it matters?

https://www.portfoliovisualizer.com...ion12_2=100&symbol13=VTSAX&allocation13_3=100

-ERD50

 

[FlaGator]

When I have done things like this in past, time showed I only outsmarted myself

If you're unhappy with the return on 40% of your portfolio, maybe you should take your equity allocation up to 65-70% and go vanilla on the bonds (treasuries).

 

[DawgMan]

When I have done things like this in past, time showed I only outsmarted myself

If you're unhappy with the return on 40% of your portfolio, maybe you should take your equity allocation up to 65-70% and go vanilla on the bonds (treasuries).

Fair statement.

Wrestling with all the different ideas/strategies I have picked up over the years from places like this site. I think its helpful for me (and hopefully others) to sound out some of these different strategies and then make hopefully the best informed decision from there.