Hi Guys,
In a recent “Wealth of Common Sense” column, the author discusses a chart prepared by Vanguard that summarizes relative median returns for various asset classes during equity market downdrafts.
Much recent MFO Board discussion has centered on near-term protection against some lean equity years, so you folks might want to access the piece. Here is a Link to the article:
http://awealthofcommonsense.com/From a quick scan of the chart, it still appears that bonds are a reasonable choice to dampen downside equity disappointments.
The author recognizes those benefits, but cautions that: “If you’re looking for safety and a lower probability for losses during stock market corrections, high quality bonds should still prove to help more often than not. But, ….. there is a legitimate possibility that we could see both stocks and bonds down during the same year at some point in the near future.” Not an attractive happening.
Several other personal observations based on the chart are worth mentioning. Note that High Yield Bonds behave more like equities than the other bond categories. Note that the grand old standby, US Treasury Bonds, do their duty. Note further that the Hedge fund group didn’t absorb all the losses of the Equity category, but still did not eliminate losses during these stressful periods.
Will these category tendencies exist in the future? Nobody can answer that question with high certainty.
Today, the correlations between these asset classes can be calculated using the Asset Correlation tool option available on Portfolio Visualizer. Here is the Link:
https://www.portfoliovisualizer.com/asset-correlationsI’ll do a few sample calculations to illustrate its utility.
The correlation coefficient between the Vanguard S&P 500 Index fund (VFINX) and the Vanguard Intermediate-Term Government Bond Index (VSIGX) is -0.16. That’s terrific as a diversifier.
The calculation was made for data starting on the first day of 2013 using monthly inputs. These correlations are dynamic and change over time. How stable is that correlation coefficient over a longer time horizon, say since January, 2010? The value is even better at the -0.45 level.
What about over the short haul, say since the beginning of this year? The correlation coefficient, based on daily returns, is -0.15. Not too shabby in terms of downside protection if the future resembles the past. That’s always the big “if” when investing.
I hope you guys found this diversion useful.
Best Regards.
