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.
Although I agree with some of what Bernstein says here, I find it amusing for him to use the term "rational investor" in the same article he uses the term "riskless." Nothing in life is riskless. Investors call T-bill interest the "risk-free rate" because it is backed by the "full faith and credit" of the U.S. government. In the short-time frame that T-bills have to mature, that is a fairly safe bet, although the debt ceiling debate shenanigans currently reveal how even a T-bill is not truly riskless. But 30 years? 30 YEARS. I can barely predict what is going to happen tomorrow in the U.S. or in my own life let alone 30 years from now. To assume that a 30-year TIPS is riskless if you hold it to maturity is a mistake.
Securities markets are not rational. People are not rational. Spock, or our inner Spock as Bernstein describes it, is a fictional television character I think certain men with a scientific bent aspire to as a role model. Yet the show was interesting enough to expose the flaws in Spock's beliefs--yes, belief, not absolute fact--in reason. And Spock, and the investment models and algorithms "rational" investors use are also designed by flawed humans to measure other flawed humans financial behavior.
There's a reason physics, chemistry and biology are called the "hard sciences" while economics and psychology are called soft sciences, and even the former despite the scientists in those fields attempts at objective measurability are subject to human biases. I'm not sure finance even qualifies as a soft science as a subset of economics. It's very difficult to determine what is luck and what is skill in this field.
Yet it is very important from a marketing perspective to present certain professional investors as rational. That is the emotional subtext behind this veneer of rationality in the investment management business--greed for investor assets. The usual line of advertising goes: These extremely educated investors approach finance as a science and have developed a never-fail rational and repeatable scientific system for beating the market. See how well that worked with the Long-Term Capital hedge fund.
Alternatively, the line of advertising logic goes for indexing "scientists": Our data of the last 100 years indicates in the long-term the market rises. In every ten year period if you just bought and held, you would have had strong positive performance, and beaten the active managers. And because this was true in the last 100 years we are now going to extrapolate into eternity that owning an index of U.S. stocks is a good idea because human history and global history always repeat themselves.
The irony to me is the most predictable thing in finance may be the fees professional investors charge for us to believe in them. I would add this is where Bernstein, Bogle, and indexers are, for the most part, rationally right. Bogle aways said it wasn't the efficient market hypothesis he subscribed to. It was the costs matter hypothesis.
Well said @LB. As an individual investor, cost of asset ownership is something I have absolute control. Thus, index funds and ETFs are preferred. So are those OEFs with lower expense ratio.
With regard to TIPS, I would only consider the shortest duration individual TIPs of 5 year, and hold it till maturity. The only TIPS funds that I am interested are the new short duration TIPS fund from Vanguard, VTIP, and Blackrock’s STIP. I have no interest in longer duration TIPS such as 30 years, since many changes can take place. Same goes for TIPS funds and their year-to-year performance speaks for themselves
True @Sven, many changes can take place. But the reward (and risk) are amplified in longer duration TIPS. I can see, or hope, that at the end of this rate rising cycle the risk/reward may be on the side of the mid to long duration investor going forward. Of course, my crystal ball often misguides me. That said, I have starting positions in both VTIP and longer duration LTPZ.
I think it makes complete sense to discuss the probability of a 30-year TIPS being a good long-term investment and here's why or why not. Once anyone in finance uses absolute terms like "riskless" or "guaranteed," they've usually lost some of my trust. Fat tails and black swans in finance, unseen and unpredictable risks, are a real thing.
I would say the risk of owning a 30-Year TIPS until maturity if it adheres to all of its debt covenants are extraordinarily low. I would say the political and macro risks that TIPS could violate or alter the debt's terms or covenants--change how their payouts work, how the CPI is calculated to reduce return, or default altogether because the U.S. becomes dysfunctional, or, worse than dysfunctional in the next thirty years--are not extraordinarily low. How high those political or macro risks are is difficult, perhaps impossible, to tell.
Then there are the individual investor, personal, risks. What if you can't hold the 30-year TIPS to maturity for various reasons such as health or other unexpected events? What if your heirs need to sell it to raise cash before maturity and they have to sell it at a loss? I would say this is a medium to high risk for many individual investors with unpredictable finances and health situations.
Many writers often over-simply complex subject matter as black and white. Then the absolute terms can mislead their audience. I think the probability of further rate hike is declining since inflation appears to be slowing. This morning the Feb’s PCE increased by 0.5% y-o-y, lower than that of January 2023. The next FOMC meeting is in May. We will see what the Fed would do at that point. Powell has a way to become hawkish and reaffirm their fight against inflation while this inflation remains sticky due to many complex factors such as tight labor market.
As for investment, short- and intermediate-term bond funds/ETFs make perfect sense in this environment. When the Fed announces the end of rate hike, it would be compelling to move to long duration bond.
You are quite correct that nothing in life is riskless, least of all in investing.
"Riskless" is a financial term of art that can mean several things, most commonly that if these vehicles fail to deliver, which they well might, then you've got far bigger problems than your investment portfolio. In other words, financial economists use the term in the same way that a physicist might use the term "spherical cow." Trust me, the AdvisorPerspectives audience well understands these usages, and I doubt that any of them regard any human operation, investing or otherwise, as "riskless" as defined by the OED or Merriam Webster.
As long as you've got me going: Yes, my backgound is in the sciences, but I view investing as half math and half Shakespeare, and if you only master the former, the latter will surely get you. (See "Long-Term Capital Management.")
I'm also fond of pointing out that if we take the half-millennium survival of the Roman Empire as a starting point, that gives the average person about a one in six (Russian Roulette) chance of falling victim to such an event during their lifetime.
And that's before we consider that several times in the past half century mankind came withing a hair's breadth of nuclear annihilation.
Not to pile on here, but I don't write that much about the sciences, and David might tell you that I have been known to write about history.
So, just to reassure you, I don't view any investment activity, or even tying my own shoelaces, as "riskless" in the literal sense you're using it.
Thanks for your cogent response, William. These are all good points. I've been examining the finance industry and markets for a while too, so words like "riskless" or "guaranteed" I've seen often are, I admit, pet peeves of mine. I think though you are correct that the audience of AdvisorPerspectives should know what you mean. That, I hope, would also be true for the most part on this board.
The quote I've heard from managers humbled by the way economies and markets sometimes behave is: "Investing is more art than science." Yet I don't usually see such quotes too often on the advertising side of things. To me, investing is a game of probabilities, and sometimes even the best models get those probabilities wrong, or the improbable occurs, or the unknown unknown not even factored into the model that no one ever expected. I also think the longer the time horizon of a projected probabilistic return, the greater the likelihood that the improbable or a fat tail will happen.
The truth is no one knows the future. Civilizations, as you rightly pointed out, are fragile, as, I think, are democracies and the rule of law, including the laws governing securities markets. That said, much like death and taxes, management fees being collected are I would say a high probability future event.
Nice exchange. Thanks gentlemen. I’ve mostly avoided TIPs because I find them difficult to understand / analyze. Thats’s admittedly a stain on me rather than the product or its proponents. However, I have two possibly related thoughts: (1) Any investing approach recommended to the public should also take into account the relatively short time-span adhered to by most retail investors (“the public”) today. One may argue the merits, but such is greatly encouraged and facilitated by modern technology, 24-hour connectivity, no-cost / low-cost trading platforms, etc. If I understand the 30-year TIPS concept correctly, it’s intended as a long term “buy and hold” strategy. (2) Per my previous point, investor psychology would seem to be the unseen elephant in the room here. Would those who bought into the approach have the necessary “staying power” during tough times to see it through to fruition? Most I fear would not.
Apologies if I’m missing something and the laudable goal of the concept advanced is fundamentally to promote long-term investing. To that I say good luck. / George Bernard Shaw (RFK) - “Some men see things as they are …”
You'e not missing anything. In order to invest competently, you need 4 skills/proclivities:
1) The horsepower to do the math. 2) An interest in the subject. 3) The knowledge base (historical returns, a working grasp of the finance literature) 4) The discipline to stay the course in the worst of times, so as not to interrupt compounding.
Lack any one of them and you're screwed. What percent of the population do you think has all 4 of the above?
To add to these 4 above points the ability to withstand the constant distractions from Wall Street and the marketing champions. I put the chances are almost zero for the majority of the investors base. Accepting powerlessness is helpful in not giving up.
Retail investors may not have the fortitude to hang on to 30-yr TIPS. But IMO, holding 5-yr TIPS to maturity and rolling them over (and laddering) should work fine too to approximately capture the CPI. The real-yields (TIPS yields) have been in +/- 2% range most of the time (FRED charts go back to 2003 although TIPS started a few years back in late-1990s), so it isn't as if the investors would miss the boat on locking high real-rates. BTW, the current real yields are 5-yr 1.20%, 10-yr 1.16%, 30-yr 1.44%.
I think a lack of discipline or psychology plays a role in selling a 30-year TIPS before maturity, but that characterization puts the reason for selling completely on the investor's shoulders as some sort of moral or psychic failing. A lot can happen to one's finances in 30 years that may have nothing to do with discipline and everything to do with unavoidable liquidity needs. I've seen some market commentators point out that if you just bought and held onto stocks through the Great Depression you would've done fabulously. Meanwhile unemployment peaked at 25% in 1933. Many people in such circumstances were understandably afraid and sold after an 89% decline in the Dow from peak to trough, but just as many I imagine had no choice but to sell to stay alive back then. Discipline or a lack of it has nothing to do with selling for unemployed people who have to pay their bills. That is is the unseen personal 30-year risk in holding such a long-term bond. Today, I would think unforseen health risks, might be a more likely reason for selling before maturity, as uncovered medical bills are still a large cause of bankruptcy in the U.S. But recessions, job loss, and selling of securities do tend to go hand in hand.
I would add just from a market history perspective, that leverage plays a really terrible role in the above recession/depression scenario. A recession hits, people lose their jobs, stocks fall and suddenly investors are getting margin calls on their leveraged bets which they can't pay because they're out of work. That forces them to sell their securities even if they want to hold on for a recovery. Worse, when they sell, that puts further downward pressure on the market and more people who consequently get margin calls. Selling begets selling and you end up in a weird kind of death spiral caused by leverage. My impression is margin levels were really high and easy to get prior to the Great Depression. And we saw just what happened with leverage in the 2008 crash. And now we see what happened with SVB, and seemingly safe Treasury bonds. This is why the FDIC exists, and they label banks too big to fail, although I think there are other ways of addressing these problems that benefit the public more and banks less.
Reality check - How many of your current holdings (aside from cash) did you possess …
- 20 years ago?
- 25 years ago?
- 30 years ago?
None of mine date back 25 years (1998 or earlier). But three go back over 20 years. Two are multi-asset funds (10% of portfolio each). The third is a balanced fund (5-7% of portfolio).
I actually don't see a government bond portfolio, or for that matter anything in financial life, as something that I should decide today and never change my mind on. In fact, I promise I will change my mind if I have the wisdom to grasp the facts and market consistent risk reward appropriately.
I don't think any writer writes for just the audience. Especially in online forums, where the audience is a total unknown, trying to tailor make articles is difficult and misguided. I much rather do my research, enjoy learning, and share my learning through the writing. Every column I write is a way for me to learn more and for the reader to learn new things potentially.
Specifically to the TIPS, I very much hope that TIPS outperformance in bearish equity tapes will be a reason to rebalance out of bonds and into stocks. We all use bonds for different reasons. Some hold it for rebalancing optionality, some for the interest income, and some for the cash like properties. Everyone needs to figure out their own equation or get a financial advisor who can help.
TIPS are a risky asset short term, primarily because of their poor liquidity. (Even in normal times the spreads on the longer ones approach 50bp.) Planning on rebalancing out of them into stocks during a crunch might not be a great idea; for example, take a gander at what TIPS prices did in late 2008.
I agree with you on the illiquidity aspects as well as the complete destruction in 2008. Part of the problem then and up until last one or two years has been that Deflation has been the monster in the room. Even a month ago, as recession fears increased with the SVB fiasco and banking crisis, TIPS underperformed Nominals and breakeven were down to 2.03%. This time though, at least on the economic front, we might be dealing with Inflation, and not deflation. Yet, I fully agree, your points hold. No free lunch. It is part of a portfolio of bonds I carry - holding TIPS alone would be suicidal. The one reason I do tend to encourage a conversation on TIPS is because many folks have not generally held inflation linked bonds, find them complex to understand. These government bonds do deserve a deep look.
I think you’re right that TIPS do deserve a look. I think the hardest thing for many investors to understand is the impact of duration and rates on TIPS, and how their inflation adjustments work, with a phantom income like component. Explaining these features to them is valuable.
There is an officially published schedule, posted by the Treasury, as to just exactly which day the INFLATION-peg of the TIPs will be adjusted, isn't there? Is it quarterly? Am I dreaming? I've been looking for an explanation as to why SCHP seems not to pay a dividend between Dec and March. But I see one coming TODAY, April 03. (Tiny, though.)
@Crash, TIPS use (unadjusted) CPI with 2-mo lag. Treasury publishes detailed TIPS index tables that look confusing until one figures out this 2-mo lag. The monthly (unadjusted) CPI changes are at FRED, https://fred.stlouisfed.org/graph/?g=128qr
@Crash, TIPS use (unadjusted) CPI with 2-mo lag. Treasury publishes detailed TIPS index tables that look confusing until one figures out this 2-mo lag. The monthly (unadjusted) CPI changes are at FRED, https://fred.stlouisfed.org/graph/?g=128qr
Comments
Securities markets are not rational. People are not rational. Spock, or our inner Spock as Bernstein describes it, is a fictional television character I think certain men with a scientific bent aspire to as a role model. Yet the show was interesting enough to expose the flaws in Spock's beliefs--yes, belief, not absolute fact--in reason. And Spock, and the investment models and algorithms "rational" investors use are also designed by flawed humans to measure other flawed humans financial behavior.
There's a reason physics, chemistry and biology are called the "hard sciences" while economics and psychology are called soft sciences, and even the former despite the scientists in those fields attempts at objective measurability are subject to human biases. I'm not sure finance even qualifies as a soft science as a subset of economics. It's very difficult to determine what is luck and what is skill in this field.
Yet it is very important from a marketing perspective to present certain professional investors as rational. That is the emotional subtext behind this veneer of rationality in the investment management business--greed for investor assets. The usual line of advertising goes: These extremely educated investors approach finance as a science and have developed a never-fail rational and repeatable scientific system for beating the market. See how well that worked with the Long-Term Capital hedge fund.
Alternatively, the line of advertising logic goes for indexing "scientists": Our data of the last 100 years indicates in the long-term the market rises. In every ten year period if you just bought and held, you would have had strong positive performance, and beaten the active managers. And because this was true in the last 100 years we are now going to extrapolate into eternity that owning an index of U.S. stocks is a good idea because human history and global history always repeat themselves.
The irony to me is the most predictable thing in finance may be the fees professional investors charge for us to believe in them. I would add this is where Bernstein, Bogle, and indexers are, for the most part, rationally right. Bogle aways said it wasn't the efficient market hypothesis he subscribed to. It was the costs matter hypothesis.
With regard to TIPS, I would only consider the shortest duration individual TIPs of 5 year, and hold it till maturity. The only TIPS funds that I am interested are the new short duration TIPS fund from Vanguard, VTIP, and Blackrock’s STIP. I have no interest in longer duration TIPS such as 30 years, since many changes can take place. Same goes for TIPS funds and their year-to-year performance speaks for themselves
I would say the risk of owning a 30-Year TIPS until maturity if it adheres to all of its debt covenants are extraordinarily low. I would say the political and macro risks that TIPS could violate or alter the debt's terms or covenants--change how their payouts work, how the CPI is calculated to reduce return, or default altogether because the U.S. becomes dysfunctional, or, worse than dysfunctional in the next thirty years--are not extraordinarily low. How high those political or macro risks are is difficult, perhaps impossible, to tell.
Then there are the individual investor, personal, risks. What if you can't hold the 30-year TIPS to maturity for various reasons such as health or other unexpected events? What if your heirs need to sell it to raise cash before maturity and they have to sell it at a loss? I would say this is a medium to high risk for many individual investors with unpredictable finances and health situations.
As for investment, short- and intermediate-term bond funds/ETFs make perfect sense in this environment. When the Fed announces the end of rate hike, it would be compelling to move to long duration bond.
Thanks for your insightful comments.
You are quite correct that nothing in life is riskless, least of all in investing.
"Riskless" is a financial term of art that can mean several things, most commonly that if these vehicles fail to deliver, which they well might, then you've got far bigger problems than your investment portfolio. In other words, financial economists use the term in the same way that a physicist might use the term "spherical cow." Trust me, the AdvisorPerspectives audience well understands these usages, and I doubt that any of them regard any human operation, investing or otherwise, as "riskless" as defined by the OED or Merriam Webster.
As long as you've got me going: Yes, my backgound is in the sciences, but I view investing as half math and half Shakespeare, and if you only master the former, the latter will surely get you. (See "Long-Term Capital Management.")
I'm also fond of pointing out that if we take the half-millennium survival of the Roman Empire as a starting point, that gives the average person about a one in six (Russian Roulette) chance of falling victim to such an event during their lifetime.
And that's before we consider that several times in the past half century mankind came withing a hair's breadth of nuclear annihilation.
Not to pile on here, but I don't write that much about the sciences, and David might tell you that I have been known to write about history.
So, just to reassure you, I don't view any investment activity, or even tying my own shoelaces, as "riskless" in the literal sense you're using it.
Take care,
William Bernstein
The quote I've heard from managers humbled by the way economies and markets sometimes behave is: "Investing is more art than science." Yet I don't usually see such quotes too often on the advertising side of things. To me, investing is a game of probabilities, and sometimes even the best models get those probabilities wrong, or the improbable occurs, or the unknown unknown not even factored into the model that no one ever expected. I also think the longer the time horizon of a projected probabilistic return, the greater the likelihood that the improbable or a fat tail will happen.
The truth is no one knows the future. Civilizations, as you rightly pointed out, are fragile, as, I think, are democracies and the rule of law, including the laws governing securities markets. That said, much like death and taxes, management fees being collected are I would say a high probability future event.
It's nice hearing from you.
Best,
Lewis
Apologies if I’m missing something and the laudable goal of the concept advanced is fundamentally to promote long-term investing. To that I say good luck. / George Bernard Shaw (RFK) - “Some men see things as they are …”
1) The horsepower to do the math.
2) An interest in the subject.
3) The knowledge base (historical returns, a working grasp of the finance literature)
4) The discipline to stay the course in the worst of times, so as not to interrupt compounding.
Lack any one of them and you're screwed. What percent of the population do you think has all 4 of the above?
https://fred.stlouisfed.org/graph/?g=1264R
https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_real_yield_curve&field_tdr_date_value=2023
I would add just from a market history perspective, that leverage plays a really terrible role in the above recession/depression scenario. A recession hits, people lose their jobs, stocks fall and suddenly investors are getting margin calls on their leveraged bets which they can't pay because they're out of work. That forces them to sell their securities even if they want to hold on for a recovery. Worse, when they sell, that puts further downward pressure on the market and more people who consequently get margin calls. Selling begets selling and you end up in a weird kind of death spiral caused by leverage. My impression is margin levels were really high and easy to get prior to the Great Depression. And we saw just what happened with leverage in the 2008 crash. And now we see what happened with SVB, and seemingly safe Treasury bonds. This is why the FDIC exists, and they label banks too big to fail, although I think there are other ways of addressing these problems that benefit the public more and banks less.
- 20 years ago?
- 25 years ago?
- 30 years ago?
None of mine date back 25 years (1998 or earlier). But three go back over 20 years. Two are multi-asset funds (10% of portfolio each). The third is a balanced fund (5-7% of portfolio).
I don't think any writer writes for just the audience. Especially in online forums, where the audience is a total unknown, trying to tailor make articles is difficult and misguided. I much rather do my research, enjoy learning, and share my learning through the writing. Every column I write is a way for me to learn more and for the reader to learn new things potentially.
Specifically to the TIPS, I very much hope that TIPS outperformance in bearish equity tapes will be a reason to rebalance out of bonds and into stocks. We all use bonds for different reasons. Some hold it for rebalancing optionality, some for the interest income, and some for the cash like properties. Everyone needs to figure out their own equation or get a financial advisor who can help.