Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Support MFO
Donate through PayPal
Low Bond Yields Are Upending A Basic Tenet of Portfolio Construction
@Ted. Thanks for the link. An interesting write. Okay. I've only had one cup of coffee, out of bed at 5:30 am, outside work for awhile (as the heat index is going to be near 100 degrees this afternoon) so some outside work has to be done now, BUT................I'm having a problem with the info in this article.
From the article: "But the portfolio padding provided by bonds may be wearing thin. To fully offset a 10% drop in the S&P 500 index, a 60/40 portfolio would need to see a rally in bond prices, pushing yields to new record lows. The 10-year Treasury note’s yield would need to fall by 1.62 percentage points to negative 0.24%, according to calculations by Morgan Stanley. That’s not impossible, but it would take a huge move lower from already record low levels, and relying on such an outcome is inadvisable, the bank found." I suspect the writer intended to state "would need to fall by XXX basis points or yield or whatever". A yield move from the current (about) +1.40% to a -.24% yield is a tremendous percentage move. The "balancing act" chart in the article is also very confusing. At many different trading day periods for this year, relative to the 10 year note yield; has found very large percentage changes at a daily basis, let alone the percentage change YTD. Perhaps I'm "Dazed and Confused" (from that generation). Help me out, if I've dug an improper information hole. Okay, I have not performed the math on the yield change move noted above; as I gotta get me arse outside again. Regards, Catch
The article has a fair description of the problem, but offers no suggestions.
I see three reasons for traditionally holding bonds: income generation (more stable cash flow than selling appreciated assets), improved risk/reward profile (give up a little total return in exchange for significantly reduced volatility), and ballast (sleep at night).
To varying degrees, the investment grade bond market no longer helps the first two. Yields are not much above cash, so while bonds still generate more income, they don't seem worth the risk. As far as ballast is concerned, one may sleep better with cash (that won't go down in nominal value) than with bonds (interest rate risk).
Of course the problem with moving to other types of bonds is that either correlation with stocks increases (junk bonds) or one adds currency risk (foreign bonds) or political risk (esp. EM markets) or some combination. But such a move can increase generated income.
So IMHO one approach is to move some of one's investment grade bond allocation to a mix of more aggressive bonds (e.g. multi-sector) and cash. The former to boost yield, the latter to mitigate some of the risk without severely damaging yield (since cash isn't yielding that much less now).
I remain a fan of short-intermediate munis in taxable accounts. Not much better pre-tax yield than cash (and often less), but post-tax yield seems a little better with not that much more risk, while preserving a traditional benefit of bonds - low correlation with stocks (reduced volatility).
For example, VMLTX (2.5 year duration, 0.86% SEC yield), or BTSMX (2.3 year duration, 0.99% SEC yield). Each has a higher min share class that does about 0.2% better.
Comments
Okay. I've only had one cup of coffee, out of bed at 5:30 am, outside work for awhile (as the heat index is going to be near 100 degrees this afternoon) so some outside work has to be done now, BUT................I'm having a problem with the info in this article.
From the article: "But the portfolio padding provided by bonds may be wearing thin. To fully offset a 10% drop in the S&P 500 index, a 60/40 portfolio would need to see a rally in bond prices, pushing yields to new record lows. The 10-year Treasury note’s yield would need to fall by 1.62 percentage points to negative 0.24%, according to calculations by Morgan Stanley. That’s not impossible, but it would take a huge move lower from already record low levels, and relying on such an outcome is inadvisable, the bank found."
I suspect the writer intended to state "would need to fall by XXX basis points or yield or whatever". A yield move from the current (about) +1.40% to a -.24% yield is a tremendous percentage move. The "balancing act" chart in the article is also very confusing.
At many different trading day periods for this year, relative to the 10 year note yield; has found very large percentage changes at a daily basis, let alone the percentage change YTD.
Perhaps I'm "Dazed and Confused" (from that generation).
Help me out, if I've dug an improper information hole.
Okay, I have not performed the math on the yield change move noted above; as I gotta get me arse outside again.
Regards,
Catch
I see three reasons for traditionally holding bonds: income generation (more stable cash flow than selling appreciated assets), improved risk/reward profile (give up a little total return in exchange for significantly reduced volatility), and ballast (sleep at night).
To varying degrees, the investment grade bond market no longer helps the first two. Yields are not much above cash, so while bonds still generate more income, they don't seem worth the risk. As far as ballast is concerned, one may sleep better with cash (that won't go down in nominal value) than with bonds (interest rate risk).
Of course the problem with moving to other types of bonds is that either correlation with stocks increases (junk bonds) or one adds currency risk (foreign bonds) or political risk (esp. EM markets) or some combination. But such a move can increase generated income.
So IMHO one approach is to move some of one's investment grade bond allocation to a mix of more aggressive bonds (e.g. multi-sector) and cash. The former to boost yield, the latter to mitigate some of the risk without severely damaging yield (since cash isn't yielding that much less now).
I remain a fan of short-intermediate munis in taxable accounts. Not much better pre-tax yield than cash (and often less), but post-tax yield seems a little better with not that much more risk, while preserving a traditional benefit of bonds - low correlation with stocks (reduced volatility).
For example, VMLTX (2.5 year duration, 0.86% SEC yield), or BTSMX (2.3 year duration, 0.99% SEC yield). Each has a higher min share class that does about 0.2% better.