Maximum Bond Upside

[Kbg]

Dumb question : how do you get an ITT performance with discrete treasury bonds and not a treasury fund ? i.e. Do you buy 10, 7 or 5 year treasuries and hold them to they mature or sell them earlier at a defined time ? Thanks.

I have never done this, but for LTTs Harry Browne suggested buying 30-year bonds and selling them when they had 25 years left to maturity. I suppose you could do something similar with shorter bonds.

You could mimic say ishares treasury funds. Buy at 7 sell at 3, 10/7, 20/10 or make up your own 15/10, 10/5 etc.

[I Shrugged]

tarentola,

You asked for opinions, here are mine. I've been in my PP since 2009. I have not rebalanced because of the taxable gains I have, and I am still within 15-35 percent bands.

1. I am glad you realized you are not good at speculating. I realized the same thing probably about 10 years ago.
2. I like your current allocation. I personally would not change it.
3. I think as long as you are within your bands, there is nothing wrong with going with a hunch as to whether it is a good time to buy or sell.
4. I believe there is less value in backtesting than people want to believe. It can be addicting. Anything that can be addicting needs to be handled with a lot of self control and self awareness.

[tarentola]

tarentola,

You asked for opinions, here are mine. I've been in my PP since 2009. I have not rebalanced because of the taxable gains I have, and I am still within 15-35 percent bands.

1. I am glad you realized you are not good at speculating. I realized the same thing probably about 10 years ago.
2. I like your current allocation. I personally would not change it.
3. I think as long as you are within your bands, there is nothing wrong with going with a hunch as to whether it is a good time to buy or sell.
4. I believe there is less value in backtesting than people want to believe. It can be addicting. Anything that can be addicting needs to be handled with a lot of self control and self awareness.

I Shrugged
Thanks for the comments. Well done for sticking with the PP for years. I hope to do the same.

I am encouraged by your comment 2 on the allocation. Maybe having some EM and Japan is not a bad idea. And I think I will not buy or sell any bonds until the 15% level is reached (quite soon if the present trend continues!).

I agree with your comment 4 about backtesting. I would regarded backtest results as necessary but not sufficient indications of an investment's performance. Here are backtest results (thanks, Tyler) comparing a PP with LTTs and to a PP with ITTs since 1972. I don't think it is overfitting or whatever to conclude that (a) that they are not very different over the whole backtested period and (b) the PP with ITTs was ahead for nine of the first 10 years.

[yankees60]

I tried to be a bodybuilder myself, but I have to call it weight training as I seem to be too ectomorphic to gain much (like some of my VP investments).

Know it all too well! I am what is called a "hard gainer". Thin arms (which, I guess, are on thin bones?) which makes it difficult to put on muscle anywhere? I plateau out fairly quickly on free weight barbells. Today was a major victory in that I added 5 lbs to two of the three major exercises I did this morning. Adding 5 lbs is something I might not do over a whole year. Therefore, week after week, month after month, year after year, I am just maintaining. That is good in itself for an aging body It seems it is difficult for many reasons (age, body type) to get beyond those plateaus.

Vinny

[yankees60]

I did a backtest comparison of the PP, comparing it to a portfolio where ITTs replace LTTs. Results from Portfolio Visualizer.

In a backtest period 1981-2016, a (standard) PP with 25% long-term treasuries beats a PP with 25% intermediate-term treasuries. CAGRs:
with 25% LTTs: 7.41%
with 25% ITTs: 6.88%
with 25% STTs: 6.49%

The difference between CAGRs is only about half a percent. Using 25% short-term treasuries loses another half a percent. MaxDDs varied little between bond durations. I conclude that in the last 35 years, bonds of almost any duration would have given the PP a respectable CAGR. 1981-2016 is a 35-year period of falling interest rates.

The period 1972-1980 is the only multi-year period in PV's available data (1972-present) when interest rates rose, from 5% in November 1971 to 20% in December 1980. For the bond durations, the order of success is reversed. ITTs beat LTTs. (Data for STTs were not available as early as 1972.) CAGRs:
with 25% LTTs: 13.17%
with 25% ITTs: 14.50%

Using 25% ITTs beats 25% LTTs by 1.33%. Conclusion: the PP with shorter-duration bonds did better when interest rates are rising, and worse when interest rates were falling. I also compared the two in portfoliocharts.com, and the ITT version beat the LTT PP in 8 out of 9 years in the 1970s. (I can't work out how to post the image.)

The argument for longer-term treasuries in the PP is that their higher volatility compensates for the volatility in stocks or gold. So let's have a look at volatilities. Here are CAGR, MaxDD and Sharpe ratio for LTTs and STTs (alone, not in a PP) 1972-1980:
100% ITTs : 4.87%, -10.70%, -0.26
100% LTTs : -0.55%, -21.77%, -0.89

LTTs are more volatile than ITTs, no surprise there. And LTTs suffered more than ITTs as rates rose, no surprise either. But within the PP, the higher volatility of the LTTs did not compensate for their lower CAGR in 1972-80, when interest rates were rising.

This indicates to me that the dominant factor in the alleged superiority of LTTs over ITTs in the PP is not volatility, but the direction of interest rates. The dictum that LTTs are a bet on falling interest rates seems to hold, even within a PP.

Interest rates are probably going to rise soon, or at least stop falling. Like Budd, I am still holding my LTTs, but I think any future bond purchases will be ITTs. Given that the PP is intended as an all-weather portfolio, I see no evidence that LTTs are the better choice.

Is not the above one of mathjak's constant mantra's for years? You are both saying a variation of the same thing?

Vinny

[yankees60]

Interest rates are probably going to rise soon, or at least stop falling.

How long have we been hearing that? It sounds like your crystal ball is a lot clearer than mine. Could you please give us a date fixed?

Have you seen where long-bond yields are at in other countries? Is there some reason that US yields couldn't go that low?

Stuper

I could be branded a heretic for questioning the value of long-term bonds in a PP, but I don't want to be a market- or interest-rate timing heretic.

To answer your questions: 1. Years. 2. 14 December 2016 ie tomorrow at the Fed meeting (probably - we will soon find out). 3. Yes, I live in one of them. 4. No.

But my answers don't matter. Anything is possible. My conclusion was that any outperformance of LTTs over ITTs in the PP is attributable to bond interest rates falling, not to LTT volatility. Personally I am not willing to chase that slight outperformance by assuming that for the life of my PP, interest rates will continue to fall.

For fun I did a backtest comparison 1981-2016 of a standard 4x25% PP with a portfolio of 100% ITTs and one of 100% LTTs. CAGR, MaxDD, Sharpe Ratio
PP 4x25% : 7.41%, -13.40%, 0.48
100% ITTs : 7.93%, -6.47%, 0.65
100% LTTs : 9.89%, -16.68%, 0.54

Believe it or not, the clear risk-adjusted winner is 100% ITTs. Or the winner is LTTs if you don't mind the DD. For thirty-five years. What?, I hear you cry. Why are we bothering with the PP and with this forum, when we could just invest in ITTs?

You know the answer - 1981-2016 was a period of falling interest rates. Could be called cherry-picking, although 35 years is a big cherry - an investment lifetime for many. To avoid more heresy charges, let's pick the other cherry, 1972-1980.
PP 4x25% : 13.17%, -11.49%, 0.62
100% ITTs : 4.87%, -10.70%, -0.26
100% LTTs : -0.55%, -21.77%, -0.89

And the PP wins. ITTs were positive, but would not have beaten inflation which was well above 5% for most of the seventies. This is why we are bothering with the PP. It works whether interest rates are rising or falling.

And so, one could argue, do ITTs. For more fun, 1972-2016 figures are
PP 4x25% : 8.55%, -13.40%, 0.51
100% ITTs : 7.31%, -10.70%, 0.43
100% LTTs : 7.71%, -23.12%, 0.31

Looking at the whole backtestable period, including the inflationary seventies, 100% ITTs provided a decent return and low MaxDD over the last 45 years. But that's enough heresy for one day.

A full three years later, after both this and your prior analysis, what have you been deciding to do during these past three years?

Vinny

Vinny

[yankees60]

Thank you for analysis tarentola

While I still have some LTTs , I am a heretic by only buying EE bonds in their place until we get back to 4%.

I don't believe we've got back to 4% in the last three years? If so, have you held to only buying EE bonds?

Vinny

[tarentola]

Vinny

Thanks for reviving this thread. This topic is more relevant than ever I guess.

1.

A full three years later, after both this and your prior analysis, what have you been deciding to do during these past three years?

For my PP, I ended up in a compromise, buying some medium and some long.

• 3 Jan 2017 bought Amundi C73 (Euro 7-10 year treasury bond ETF), gain 12.0% to date
  12 June 2017 bought more C73, gain 8.9%
  Jan 2019 bought Lyxor MTF (Euro 15+ Treasury bond ETF), gain 25.8%
  30 Aug 2019 bought more MTF, loss 3.1%

So in fact long bonds came out on top, at least in 2019.

2. On my contention that

... the dominant factor in the alleged superiority of LTTs over ITTs in the PP is not volatility, but the direction of interest rates. The dictum that LTTs are a bet on falling interest rates seems to hold, even within a PP.

I realise that I am challenging a central tenet of the PP (which I take no pleasure in doing), but i don't remember anyone seriously refuting it.

3. Off topic, on the subject of weight training: my sympathies on being a "hard gainer". However we ectomorphs must persist even without visible gains, as after a certain age the alternative is unthinkable.

Great that you are revisiting the older threads.

[Kbg]

I’m not sure what you are challenging, the fact that LTTs will respond best in a period of falling rates?

[tarentola]

I’m not sure what you are challenging, the fact that LTTs will respond best in a period of falling rates?

The central tenet of the PP that I am challenging is that LTTs are the best bonds to use, due to their volatility. The backtesting I did indicates that LTTs are the best PP bonds only when interest rates are falling. When interest rates are rising, ITTs seem to be a better choice for the bond compartment of the PP.

[Kbg]

This goes without saying and is encapsulated by the concept of bond duration.

If the actual question is STTs and LTTs vs ITTs in a rising interest rate environment then for the little history we have ITTs did perform better. Over a longer period of time the mix gets a slight nod.

Either one is fine, which will do best going forward is purely a speculative guess.

[yankees60]

Switzerland's 50 year bond (to be precise, it's actually 48 years, due 2064) yield today fell to an all time low of 0.32%.

Yes, if you want to lend Switzerland money for the next 50 years, you're only going to get 0.32% interest per year.

Clearly at some point investors should just not be buying bonds.

In the case of the Permanent Portfolio, you'd have a hard time getting me to buy long term bonds under 1%. I say this knowing that it breaks the model. But I'd also say that 30 year bonds paying under 1% the risk is just far too high. 50 year bonds under 1% is an absurdly bad deal as well. Investors would be better in cash.

We do now have fairly recent evidence from Craig that he did drop this 1% threshold down to 0%!

Vinny

[yankees60]

Well yes I suppose there is a number for everyone. The bond number for me is 1% for sure. At that point I don't want them anymore. Under 2% I'm probably not buying them as a new investor, but if I already have them I'm not selling until 1% or so.

This is all highly subjective. But with bonds you kind of know what you're getting in terms of valuation. Stock P/E can change rapidly for a variety of reasons, but a long bond paying 0.50% is pretty much a known bad deal by most any measure I can come up with.

In terms of the Permanent Portfolio I know this would break the model, but sometimes dogma needs to step aside for reality. That reality for me is risk vs. reward for the bonds and the fact that at 1% it's just too rich for my blood and I'll go very short on the yield curve until they recover. But this of course puts investors in the unfortunate situation of asking: "When do I get back in?" And that I don't have an answer for yet. I'll cross that bridge if I'm forced to part ways with my bonds.

Are we now basically at the point that Craig is describing above?

Vinny

[yankees60]

Any thoughts? Only that I'm in no position to criticize. Many's the time I considered the same, like every time TLT breaches 130. (I'm holding bonds directly, but TLT is a convenient and simple gauge). After Craig said he'd sell at 1%, I really got the bug.

FWIW. The reason I don't comment much on what I do is because I don't want people to blindly copy it.

Mostly though with unprecedented things going on with bonds, I just wanted to say that at some point you just have to take your chips and go home. Bonds are perhaps the only asset in the portfolio that the value risk vs. reward is pretty stark. Yields are what yields are and it's known what happens up or down as interest rates move. Gold doesn't have this indicator. Stocks don't either. Cash is cash and relatively stable and short interest rates moves can be waited out.

But again, with long bonds at 1% or less, the risk of holding them for me, is just not worth it. I bring up the issue now because I feel being quiet about it isn't doing any favors. You'll notice that I rarely ever comment on portfolio assets otherwise because mostly it's just noise. But long bonds below 1% is juggling nitroglycerin kind of risk in my mind and a horrible buy.

Again as others (and I) have pointed out. It's one thing to get out, but another to know when to get back in. I think it is safe to say though that bonds that are under 1% are probably not a hot buying opportunity and I'd avoid them regardless of portfolio theory. As when to get back in? I don't know. Again I haven't had to face this question yet. But I'll point out that people have been saying since 2008 that long bonds are a horrible idea and they've been wrong, wrong, wrong. So I could be joining that crowd if I sell out at 1%, but I'll just have to deal with that.

Hopefully Harry Browne will forgive me, but I think he'd be understanding when long bonds are paying 0.50% for 50 years that they aren't worth the risk.

These are interesting times, guys. We could be witnessing the endgame for Keynesianism. The ultimate race to the bottom where mere mortals are all losers.

Here we get.....Craig on the one hand.....


Vinny

[yankees60]

I have a different take on this issue.

Currently (and at all times), the market price represents a perfect balance between buyers and sellers, which means that there is no more upward pressure on prices than there is downward pressure.

It's true that there is not anywhere near the potential upside in LT bonds at this point that there was when rates were at 4%-4.5%, which is about as high as LT rates have been since 2008, but there is still plenty of upside that can be captured from here, even though that seems crazy.  When there are more buyers than sellers, rates will fall, regardless of where they are right now.

Any PP investor should be perfectly comfortable holding all four PP assets, even if he is certain that one of the assets is going to fall in value.  If one asset falls, another asset is likely to rise and protect you from overall portfolio losses.

If you sell now, you have the daunting task of deciding when to get back in.  You are just as likely to be right as you are to be wrong, which means that selling now and buying back in later might mitigate some future losses in this part of the portfolio, but it might also put you in a position of being paralyzed and failing to buy back in at, say, 2.5%, only to see rates drop back to 1%, which would cause you to miss out on a lot of gains when rates fell again.

I'm just holding tight.  I'm okay if LT treasuries take some losses.  At any given time, some part of the portfolio is always taking losses.

That's my two cents.

Don't put too much stock in anything Craig or I have to say on this topic, though.  We don't know anything that the rest of you don't know.  LT treasuries have provided outstanding service in recent years, and people have been hating them almost the whole way.  It's very hard to think clearly about something like this when fear and uncertainty begin to creep into your mind.  It seems unlikely that simply sticking with the basic PP recipe will lead to excessive future regret, but selling one of the assets hoping you can catch it at a good future re-entry point could easily lead to a series of bad decisions than could pollute your whole portfolio.

………...and, MediumTex on the other hand!!!

VInny

[ochotona]

Dr. Lacy Hunt on debt and economic growth. Not pretty. Macrovoices.com

[garya505]

My first post here!

Just had a thought after reading a bunch of posts on low interest rates. Rather than deciding whether to hold cash OR LTT because of the risk, has anyone considered adjusting the duration of the LTT part of their PP based on current interest rates? For example, use a duration of about 10X the long term rate or maybe the 10-year rate?

This is just an example of what might work.
Rate Duration
2.5% 25 years+ (any rate higher that 2.5% would call for LTT)
2% 20 years
1% 10 years
0 0 (cash)

Just a thought I had, since the contribution of the LTT part of the PP depends on some movement of interest rates, and holding LTT at 0 rates is very risky, with not much to be gained. Sure rates could go negative, but at some point they would reach a limit, and from there they could only go up.

I figure either 1) someone has thought of this before, or 2) it's just a dumb idea.

[Cortopassi]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

[yankees60]

My first post here!

Just had a thought after reading a bunch of posts on low interest rates. Rather than deciding whether to hold cash OR LTT because of the risk, has anyone considered adjusting the duration of the LTT part of their PP based on current interest rates? For example, use a duration of about 10X the long term rate or maybe the 10-year rate?

This is just an example of what might work.
Rate Duration
2.5% 25 years+ (any rate higher that 2.5% would call for LTT)
2% 20 years
1% 10 years
0 0 (cash)

Just a thought I had, since the contribution of the LTT part of the PP depends on some movement of interest rates, and holding LTT at 0 rates is very risky, with not much to be gained. Sure rates could go negative, but at some point they would reach a limit, and from there they could only go up.

I figure either 1) someone has thought of this before, or 2) it's just a dumb idea.

Welcome to the forum!

Looking forward to more posts like this from you!

Vinny

[garya505]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

[Cortopassi]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

https://www.weforum.org/agenda/2016/11/ ... d-to-know/

[Hal]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

Hi Gary,
Welcome to the forum. You may find this link useful regarding interest rates.
https://tradingeconomics.com/country-list/interest-rate

[garya505]

Gary, read this

https://portfoliocharts.com/2019/05/27/ ... convexity/

Well, after I read that for the 3rd time I think I got it. I still think at some point (-2%, -3% maybe) there is no more upside to be had, even with convexity, unless you think rates can go even lower, like -4% or -5%.

That brings up an interesting question. What is the lowest interest rate that has been observed, anywhere in the world? Let's say in the last 100 years or so?

Edit: FWIW, I notice that Tyler's chart only goes to -3%.

https://www.weforum.org/agenda/2016/11/ ... d-to-know/

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

[Mark Leavy]

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.

[garya505]

Are you suggesting that, because of the convexity in long bonds, my idea to reduce duration of the LTT portion of a PP as rates approach 0 is good, bad, or just doesn't matter?

Hi Gary, welcome to the forum. And great questions!

Tyler and a few of the other folks have the subtlety of bonds down much better than I do, but here's my take:

Due to convexity, the volatility of bonds will remain high or even possibly increase as interest rates go down or negative. Regardless of the interest rate, you will need about the same percentage of long term bonds in your portfolio to cover swings in the other assets. I know it is counterintuitive, but bond protection is tied to the rate of change - and it is not linear. At low rates, small interest rate changes produce proportionally large swings in value. At higher interest rates, you need larger rate changes to produce the same swing in value.

Just to clarify, I was suggesting a 4x25 PP (CASH, LTT, Gold, and Stock), with the only "unconventional" thing being a reduction of duration in the LTT part as interest rates approach (or dip below) 0. And this would not be an all-or-nothing reduction in duration, but rather a stepped reduction as rates get lower and lower. The intention here would be to reduce the risk of very long bonds if interest rates were to increase from 0, without giving up ALL of the desired volatility. Would it do that?

I believe some have suggested that near-0 interest rates might "break" the PP, or at least make it not work as well as it has in the past. Did Harry Browne even consider that rates might go to 0 when he devised the PP?