Long-Term Bonds as Insurance?

Old_Joe

I suppose that this qualifies as a "Fund Discussion" as there are surely many funds which might provide such bonds.

There's a recent article in The Economist which has an interesting perspective on the subject. It suggests that "there is a large class of investors for whom long-dated Treasuries have an almost unique virtue. It may even include people who believe that 3% is far too low for a sensible long-term interest rate. It consists of holders of other riskier assets, such as stocks, houses (real estate generally??) or high-yield corporate bonds, who wish to hedge against falling prices in the event of a recession."

The article then mentions a few other more exotic possibilities, but goes on to say that"...buying Treasuries is less fiddly for no-nonsense investors. And this insurance policy pays 3% a year."

"Long-dated bonds offer the prospect of a bigger capital gain should recession strike." In the event of a recession and intervention by the Fed, "ten-year yields could plausibly fall to 1%, or so. Those who had bought at yields of 3% would secure a 17% capital gain. Not only would that cushion a fall in the price of stocks, it would provide the means to buy them while they are cheap."

I have to admit that I had never looked at this situation from that perspective, and I'd love to hear what anyone else on MFO has to say regarding this.

Bud

I'm not sure that investing in case of recessions would be profitable over any length of time, particularly with rates as low as they are at present. I have looked at using WHOSX as a hedge against market draw downs. And it does ying when the stock market yangs but over time it falls behind the S&P 500.

The M* comparison between whosx and Fusex:

http://performance.morningstar.com/fund/performance-return.action?t=WHOSX&region=usa&culture=en-US



Just my thoughts....

AndyJ

Hi OJ, more than just recession protection, long Ts are (normally) the most negatively correlated asset cf. equity, so some exposure (to TLT, for example) (again, normally) partially hedges an equity-heavy portfolio if that's of interest for, say, a correction, short of a bear market/recession situation.

If you want to compare correlations of different fixed income vs. equity (or any asset vs. any other asset or assets), Portfolio Visualizer is the place to go.

LewisBraham

All true except what happens in a real rising rate environment, or worse, a stagflation one? We haven't really been in a significant rising rate environment in a long time, but such an environment could be bad for both Treasuries and stocks, especially if rates rise quickly.

AndyJ

Lewis: exactly, thus the word 'normally' twice in my post. There was some 'abnormal,' more or less positive correlation earlier this year, for example, when T rates were on a fairly fast track up. That's recently faded -- for now anyway.

hank

Omitting one (unnecessary) sentence in the quoted passage brings out what I believe the passage is really saying. It than reads as follows:

"there is a large class of investors for whom long-dated Treasuries have an almost unique virtue. ... It consists of holders of other riskier assets, such as stocks, houses (real estate generally??) or high-yield corporate bonds, who wish to hedge against falling prices in the event of a recession."

Yes, longer dated bonds are often used by money managers to hedge risk from other types of assets because they tend to move inversely to those other assets. A high yield bond fund, for example, will sometimes hold long term Treasuries to help offset the risk from the junk they hold.

Other than that observation, I’d say your guess is as good as mine where the economy is heading and whether one will be happy 5-10 years out that they bought some long dated bonds today. (Wouldn’t be my choice.)

Old_Joe

Thanks to all for your responses. Sounds like this is a game for the big boys, not someone like me.

hank

Old_Joe said:

Thanks to all for your responses. Sounds like this is a game for the big boys, not someone like me.

@ Old_Joe - As bad as most hedge-like funds have proven over the years, my own efforts to hedge (usually with longer bonds or commodities) have done even worse. I’d rather pay a “hedgie” their onerous 2% (give or take) fees than to try to execute hedging strategies on my own. (I do own a couple hedge-like funds for defense - but neither is worth recommending.)

In addition to hedge (or hedged) funds, both pension funds and insurance companies use the long bond for various purposes related to their unique needs. Good topic. Surprised more haven’t offered their take ...

(Oh - I know - the stock market will keep climbing straight up forever!)

Old_Joe

@hank- Thanks for your help on this.