Why I have a portion of long term bonds

[OrcasIslandBound]

Very interesting that Wellesley 20% of its bonds in longer term bonds. I have about 33% of my bonds in longer term, so a little more than Wellesley but comparable. The longer term bonds are 18% of my total investments.

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[audreyh1]

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

I remember the Frank Armstrong efficient frontier (and other) curves that showed short-term and intermediate actually behaved better than long bonds for risk-adjusted returns. He concluded that the long bond rates didn't compensate sufficiently for volatility/slow response to inflation rises.

I have an AMT-free muni bond fund has an average duration of around 7 years. Other than that I hold only intermediate and short-term bonds.

 

[Lsbcal]

I remember the Frank Armstrong efficient frontier (and other) curves that showed short-term and intermediate actually behaved better than long bonds for risk-adjusted returns. He concluded that the long bond rates didn't compensate sufficiently for volatility/slow response to inflation rises.

I have an AMT-free muni bond fund has an average duration of around 7 years. Other than that I hold only intermediate and short-term bonds.

Yes that is my understanding too and why I've avoided long term bonds.

I don't know what Wellesley's strategy is with a 20% holding of long bonds in their bond portfolio and I'm not sure if it is a static strategy or dynamic. Would be interesting to know just for educational purposes.

 

[Ed_The_Gypsy]

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.

Yes, I remember this.

I have recently been looking at the data for a 50/50 combination of SCV/LTB as far back as the early '70s. They are inversely correlated and produced an impressive and surprisingly not very volatile growth over time. Only problem is frequent rebalancing (twice a year or so, when they get far out of balance).

This may require more attention than I want to commit to and I am not completely comfortable with it, but it can't be worse than my O&G stock adventure lately. Can it?


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[OrcasIslandBound]

What's O&G? The only thing I can think of is Oh God stock. Forgive me.

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[samclem]

What's O&G? The only thing I can think of is Oh God stock. Forgive me.

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"Oil and Gas'--which has probably been a wild ride of late. IIRC, it's the industry that Ed is/was in, so if >he< is finding it to be an adventure, there's no way that I would wade into it.

 

[Ed_The_Gypsy]

What's O&G? The only thing I can think of is Oh God stock. Forgive me.

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You ain't far off the mark.

Wild ride means straight down.

I bet more than I should have (but only a part of the pot) on Oil and Gas including pipelines, which should have been immune to the collapse in oil prices--but weren't. I reviewed the companies I held/hold and most of them still look good to me but I sold those I had converted to Roths for recharacterisation. Too clever by half, as the Brits say.

I am back to funds and ETFs (and I have some trepidations about ETFs). No more individual stocks. Not even XOM.

Back to our original program: 50/50 SCV/LTB. Any comments?

I used Simba's updated program (Boggleheads and referenced on this forum) as referred to me to eye-ball this mix. I went back as far as I could to the '70s, when interest rates last went up (make that UP!) dramatically. Performance of the equivalent of LTB funds that far back is uncertain to me but as far as I can tell, Simba's data is consistent with recent data.

 

[samclem]

Back to our original program: 50/50 SCV/LTB. Any comments?

Sounds similar to Larry Swedrow's recent idea ("Reducing the Risk of Black Swans"), he wrote a book on it. We batted it around in this thread and some more here. I am not a fan of it--it just relies too much on the future being like the past, and it can lead to some very heavy portfolio concentration in a few sectors. I'd much prefer to spread my bets. But take a look at his book and see what you think.

 

[Ed_The_Gypsy]

I'd focus on a portfolio I could hold with some confidence in wild markets.

Hmmm? Your suggestions would be most welcome.

BTW, I am not talking about the whole pot. For example, I have a chunk in VWELX, a broad 60/40. I also have a chunk in international (WDIV and an O&G stock--don't wince, this one,EDPFY, has done well for me).

My interest was piqued by Paul Merriman here: When it pays to go all-in on small-cap value - MarketWatch combined with the significant non-correlation (or inverse correlation) with LTB, which also have a long-term return. I insist that non-correlated assets have a positive return. Refer back to Simba's spreadsheet.

 

[Lsbcal]

What about that long rise in rates from 1954 to 1982?

 

[OrcasIslandBound]

While the market was down about 2.5% today, my investments were down about 1%. I have mostly index ETFs including VYM, BND, BLV and a few mutual funds including jabax, FLPSX, mwtrx, fsevx, fsivx, a couple of reits including o and hcn, and finally $11k of VDE that I bought about a month ago that is now worth $10k. This last was an energy index, mostly oil including xom as it's top holding. 45% stocks 55% bonds. It is a very dividend focus group of investments as my goal is to not sell the pieces during retirement. Over 3% yield overall. I can provide the % in each if desired.

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[mathjak107]

What about that long rise in rates from 1954 to 1982?

they were accompanied with lower stock valuations . very different from low rates high stock valuations . equity's rose 11% cagr over that time frame .

think we are looking at 11% average returns at this stage ? not likely for many many many years .

 

[OrcasIslandBound]

Unfortunately, the trend is continuing.

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[Ed_The_Gypsy]

What about that long rise in rates from 1954 to 1982?

Great question! I am not confident I can answer that, but let me share what I have. First, I am indebted to big-papa for directing me to Simba's spreadsheet (updated) from Bogleheads. The spreadsheet must have been an enormous amount of work by Simba, updated by several others. A thousand thanks to all!

https://drive.google.com/file/d/0B6rEnGbxebTBOWRfMUpDOC1jbWc/view?pli=1

The first image is from FRED (thank you for the reference!) showing long-term (>20 years?) since 1954. Note the gap when LTB were not issued. Interest rates peaked in 1982.

The second image is from Simba's spreadsheet for 100% LTB from 1972 to 2014. I believe this would be for a LTB fund, but I cannot confirm that. I believe this is for no withdrawals, just compounding. The blue dots are for the Coffeehouse Portfolio, for reference. (LTB<<CHP.)

The third image is also from Simba's spreadsheet showing 100% SCV. Again, the blue dots are for the Coffeehouse Portfolio. (SCV>>CHP.)

The fourth image is for a 50/50 SCV/LTB (fund?) portfolio vs CHP. The red dots are for the portfolio rebalanced; the yellow ones are for not-rebalanced (why would that be interesting? Dunno. Can't shut it off, though.) Note that the rebalanced 50/50 SCV/LTB outperforms the CHP and takes a shallower dip in 2008.

Finally, the fifth image shows 50/50 (P1, navy-blue diamond), 100% LTB (P2, purple square) and 100% SCV (P3, yellow triangle) returns vs risk, measured as annual standard deviation. (Ignore the light blue diamond and the grey circle.)

Over the 43 year period,
50/50 had a 12%+ annualized total return with 11.8% SD and outperformed the CHP,
100% LTB had a 8.9%+ annualized total return with 12.1% SD and did NOT outperform the CHP (no surprise),
and 100% SCV had a 15.3% annualized total return with 20.4% SD and outperformed the CHP.

Back to your question, it looks like the equivalent of a LTB fund weathered 1972-1984 just fine. (Not sure how they got this performance as there does not seem to have been a LTB fund that goes that far back, although I checked performance against one fund as far back as I could and they match. I have not seen any comparable data from 1954-1972.)

What are your thoughts? Anyone? Someone please poke holes in this study. It looks too good to be true: only two funds, rebalanced, outperform the CHP with less volatility.

 

[Lsbcal]

You could look up "Larry Portfolio" which is something like 30/70 (small cap US + small cap international + 5 year Treasuries). It is a somewhat similar type of idea but probably a little more diversified.

For me such portfolios are too much tracking error. Should it under perform for 10 years that is a real issue for me. Even if it had under performance for a few years it would be not to my taste. One should ask themselves how long they might hold a portfolio that under performs or goes down when the market is going up.

Someone who does not need a lot of performance from the equity side of the portfolio such as a high net worth person or one with a good pension might consider the Larry Portfolio.

 

[big-papa]

Great question! I am not confident I can answer that, but let me share what I have. First, I am indebted to big-papa for directing me to Simba's spreadsheet (updated) from Bogleheads. The spreadsheet must have been an enormous amount of work by Simba, updated by several others. A thousand thanks to all!

https://drive.google.com/file/d/0B6rEnGbxebTBOWRfMUpDOC1jbWc/view?pli=1

The first image is from FRED (thank you for the reference!) showing long-term (>20 years?) since 1954. Note the gap when LTB were not issued. Interest rates peaked in 1982.

The second image is from Simba's spreadsheet for 100% LTB from 1972 to 2014. I believe this would be for a LTB fund, but I cannot confirm that. I believe this is for no withdrawals, just compounding. The blue dots are for the Coffeehouse Portfolio, for reference. (LTB<<CHP.)

The third image is also from Simba's spreadsheet showing 100% SCV. Again, the blue dots are for the Coffeehouse Portfolio. (SCV>>CHP.)

The fourth image is for a 50/50 SCV/LTB (fund?) portfolio vs CHP. The red dots are for the portfolio rebalanced; the yellow ones are for not-rebalanced (why would that be interesting? Dunno. Can't shut it off, though.) Note that the rebalanced 50/50 SCV/LTB outperforms the CHP and takes a shallower dip in 2008.

Finally, the fifth image shows 50/50 (P1, navy-blue diamond), 100% LTB (P2, purple square) and 100% SCV (P3, yellow triangle) returns vs risk, measured as annual standard deviation. (Ignore the light blue diamond and the grey circle.)

Over the 43 year period,
50/50 had a 12%+ annualized total return with 11.8% SD and outperformed the CHP,
100% LTB had a 8.9%+ annualized total return with 12.1% SD and did NOT outperform the CHP (no surprise),
and 100% SCV had a 15.3% annualized total return with 20.4% SD and outperformed the CHP.

Back to your question, it looks like the equivalent of a LTB fund weathered 1972-1984 just fine. (Not sure how they got this performance as there does not seem to have been a LTB fund that goes that far back, although I checked performance against one fund as far back as I could and they match. I have not seen any comparable data from 1954-1972.)

What are your thoughts? Anyone? Someone please poke holes in this study. It looks too good to be true: only two funds, rebalanced, outperform the CHP with less volatility.

The Simba spreadsheet has a tab that shows the source of the returns it uses. It actually has two tabs for two different timeframes. It uses Vanguard funds when they existed, before then they are derived from indices or research.

OK, I once went this same route for a while (SCV + LTB) for exactly the same reason you did. You have two asset classes with large returns. And everybody knows that stocks/bonds are a good mix.

However, over the entire timeframe of stocks and bonds, you'll see that both Intermediate govt bonds and Long Term government bonds are actually uncorrelated to stocks, not anti-correlated. The simba spreadsheet also has a nice correlation table for 1972-2014 by the way. If you go back to 1926 you'll see that the uncorrelated nature of stocks to govt bonds (both long term and intermediate) still holds over that timeframe (that data is available in Ibbotson's annual yearbook available at most university libraries) Now that doesn't mean that there won't be periods of time within the 1926-2014 timeframe where they're correlated or anti-correlated. You'll notice that LTBs did phenomenally well in 2008 against stocks. In the 2000-2002 bear market they did well for 2 of those 3 years but not for all 3 years. But if you go back to the bear market of the early 1970's you'll see they didn't do as well as the more recent bear markets. Why is that? Was it inflation? Was it where the interest rates were back then vs more recently? I'm not sure and that's something on my to-do list to look at.

But make a note that the bigger anti-correlation during big downturns (and the subsequent big recovery year) is a more recent phenomenon - not guaranteed to always be the case.

Big-Papa

 

[OrcasIslandBound]

Bonds and stocks go down simultaneously when the Fed is bumping up the interest rates to fight inflation. If a different cause is driving stocks down, like Lehman Brothers going bankrupt, then stocks and long term treasuries are anticorrelated. In a steep downturn, bond quality is paramount. Only the highest quality bonds have this anticorrelation characteristic. Lower quality bonds will go down along with stocks.

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[Mulligan]

Bonds and stocks go down simultaneously when the Fed is bumping up the interest rates to fight inflation. If a different cause is driving stocks down, like Lehman Brothers going bankrupt, then stocks and long term treasuries are anticorrelated. In a steep downturn, bond quality is paramount. Only the highest quality bonds have this anticorrelation characteristic. Lower quality bonds will go down along with stocks.

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That is what makes this interest rate increase "cycle" so unique and hard to handicap. They are fighting "anticipated" but not yet occurring inflation. And no rate tightening has ever started this late in a "recovery cycle". But in the early going it is mimicking your last two sentences for sure.


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[OrcasIslandBound]

Agreed. In fact, the thought has occurred to me that I might replace BLV in the portfolio with half really long term treasuries (like long term on steroids) and the other half shorter term corporate bonds. I think the long term corporate bonds part of BLV may hurt it's performance a bit during those downturns.

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[Mulligan]

Agreed. In fact, the thought has occurred to me that I might replace BLV in the portfolio with half really long term treasuries (like long term on steroids) and the other half shorter term corporate bonds. I think the long term corporate bonds part of BLV may hurt it's performance a bit during those downturns.

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I have even went longer. I have most of my money in perpetual "yield trapped" preferred stocks, that in essence mirror the bond market. Most were issued when 10 year treasury was between 4-5%. Being now 400 plus basis points above treasury as opposed to historical 200 basis points should provide a ballast that long and liquid bonds will not. They are "trapped" at a higher rate because issue price cant rise to lower the yield to true market price because fear of possible par call. Nobody in their sane mind would risk paying $3-$4 over par for a past call issue so the price stays low and yield return high.



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[OrcasIslandBound]

Sorry, what are "yield trapped" preferred stocks? Actually, never mind the yield trapped part, what are preferred stocks?

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[Mulligan]

Sorry, what are "yield trapped" preferred stocks? Actually, never mind the yield trapped part, what are preferred stocks?

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Orcas in this Stock Picking and Market strategy section there is a continuous thread titled "Preferred Stocks, the Good, the Bad....". It is a continuous thread explaining them. In very short loose summary, they are stocks that trade like high yielding bonds that get rated by bond agencies like a bond because they trade like a bond...I generally stay in investment grade perpetual issues (meaning company can "call" or never "call" the issue. I tend to stick with electrical utility ones that yield around 6-6.5% but I do buy higher yielding ones from other safe companies also.


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[Ed_The_Gypsy]

However, over the entire timeframe of stocks and bonds, you'll see that both Intermediate govt bonds and Long Term government bonds are actually uncorrelated to stocks, not anti-correlated.

That is not bad. There is no point in having two correlated assets. Anti-correlated is best; uncorrelated is OK.

 

[Lsbcal]

That is not bad. There is no point in having two correlated assets. Anti-correlated is best; uncorrelated is OK.

Why not just focus on total return? The addition of an asset should increase total return, no? Or at least lower standard deviation without decreasing return much.

 

[big-papa]

Why not just focus on total return? The addition of an asset should increase total return, no? Or at least lower standard deviation without decreasing return much.

Anti-correlated being best really depends on how much anti-correlation - obviously no sense in having two completely anticorrelated items in your portfolio, unless you want growth to come to a grinding halt. As for me, I prefer uncorrelated assets, though as everybody who experienced 2008 knows, sometimes seemingly uncorrelated assets can become correlated for brief enough periods to do some damage.

On the total return question, I think that's exactly what he's trying to do - he's using SCV for the stock portion and trying to push down the overall volitility using long term bonds.

As for me, as I mentioned in an earlier response, I started off with SIMBA's spreadsheet and headed down this path as well. But somewhere along the way, I realized that the long bond returns in that spreadsheet came about as a result of high interest rates of the late 70's/early 80's and the slow-but-steady long term drop in interest rates since then, culminating in the near zero rates that happened after 2008. Ultimately, I steered to the middle, moving more towards mid-cap value and to intermediate govt bonds. In Simba's spreadsheet, you can only backtest this combination in the 1985-2014 tabs.