Wise move to sell LTTs and buy new 30-years?

Discussion of the Bond portion of the Permanent Portfolio

Moderator: Global Moderator

Post Reply
Pet Hog
Executive Member
Executive Member
Posts: 218
Joined: Tue May 28, 2013 4:08 pm

Wise move to sell LTTs and buy new 30-years?

Post by Pet Hog » Sat Mar 07, 2020 5:19 pm

I have a question that you all might have some idea about.

I own two lots of LTTs, with 27 and 28 years left to maturity. I bought them with yields of about 3%. Each price today is over $140. Both gained around 7% on Friday. Crazy!

Let's say I bought $10,000 of bonds. Now they're worth $14,000. If I hold to maturity, I'll get back my $10,000, so there is the perception that I will lose $4000 over the next 27/28 years, but of course I will be getting about $300 per year in coupon payments (about $8000). Total over next 27/28 years: about $18,000.

Here's what I'm thinking. What if I sell what I have and buy $14,000 in new 30-years at the next auction? It gives the appearance of locking in the gains. In 30 years' time I'll get my $14,000 back -- that's better than $10,000, right? But the problem is that I'll get only 1.25% yield (as of today). Holding to maturity will get me (30 years x 0.0125 x $14,000) $5250 in coupon payments. Total over next 30 years: about $19,000. So, really, it's a wash. Of course there's no free lunch.

But, with the PP, we don't hold LTTs to maturity. So my question is, does locking in the gains early make sense if I'll only be getting the higher coupon for a few more years anyway (seven or eight years, according to orthodoxy) before substituting for lower-yielding 30-year treasuries. Relatively high future coupon payments is the reason my bonds are priced at $140 today -- it's factored in already. Or, put another way, I have already received some of those coupons in the form of higher principal. So maybe it's in my financial interest to lock in the gains today? Or is it all just six of one and half a dozen of the other? It's not intuitively obvious to me.

Thoughts?
pmward
Executive Member
Executive Member
Posts: 1120
Joined: Thu Jan 24, 2019 4:39 pm

Re: Wise move to sell LTTs and buy new 30-years?

Post by pmward » Sat Mar 07, 2020 5:37 pm

Are these held taxable or tax deferred? If taxable there is benefit to selling and realizing the gain as a long term cap gain and trading down to the lower yield (you may even be able to harvest some stock losses right now to help pay the tax bill). Now, you do alter your average maturity when you do this, so volatility will pick up a little bit on fresh 30's, so do also be aware of that. But other than tax and the volatility from a larger average maturity, like you said, it's basically a wash.
Pet Hog
Executive Member
Executive Member
Posts: 218
Joined: Tue May 28, 2013 4:08 pm

Re: Wise move to sell LTTs and buy new 30-years?

Post by Pet Hog » Sat Mar 07, 2020 6:36 pm

pmward wrote:
Sat Mar 07, 2020 5:37 pm
Are these held taxable or tax deferred? If taxable there is benefit to selling and realizing the gain as a long term cap gain and trading down to the lower yield (you may even be able to harvest some stock losses right now to help pay the tax bill). Now, you do alter your average maturity when you do this, so volatility will pick up a little bit on fresh 30's, so do also be aware of that. But other than tax and the volatility from a larger average maturity, like you said, it's basically a wash.
Tax-deferred in my case, but good point. I'm happy with more volatility and, in fact, my plan was to hold only these two sets of bonds in a "two-rung stepladder" of LTTs, with about 2-3 years between the rungs. So I was considering substituting the 27-year bond later this year or early next. But with that now-juicy 3% coupon, I'm reconsidering -- maybe sell now ("lock in the gains"), maybe hold for several more years (keep the larger coupons for reinvesting in the broader PP).
Pet Hog
Executive Member
Executive Member
Posts: 218
Joined: Tue May 28, 2013 4:08 pm

Re: Wise move to sell LTTs and buy new 30-years?

Post by Pet Hog » Sat Mar 07, 2020 8:02 pm

Just thinking out loud. Writing this stuff down to see if I can convince myself that there is any potential advantage.

Perhaps I should consider of a more extreme example. There is a 21-year treasury (maturing 5/15/2041) with a 4.375% coupon, currently valued at $159.63. As a PP investor, I would hold this bond for one more year before substituting it for a new 30-year. Let's say I bought it at auction nine years ago for $10,000. Now it's worth $15,963. This year I will get $437.50 in coupon payments. That means I've already received about $5500 in future coupon payments (for the years from 2021 to 2041) in the form of increased principal. It's like a loan that I don't have to pay back.

As luck would have it (for me, so I don't have to use any formulas), there is a 20-year treasury with the same coupon, 4.375%, that is currently valued at $158.24. If yields don't change for the next year, that's what my now-21-year bond would be worth a year from now. So a year from now I'd have $15,824 in principal and $437.50 in cash, a total of $16,261.50. That cash would have earned a little bit of interest, too, perhaps $3 (the coupons come six months apart, May and November, and reinvesting is possible at 1.25% at best). Let's say around $16,265 all together.

Alternatively, I sell my 21-year bond now and buy a new 30-year for $16,000-ish with a 1.25% coupon. That's a coupon payment of $200 per year, maybe earning $2 in interest itself. A year from now I have $16,202 plus whatever capital appreciation on the principal there would be for a 29-year with the current yield curve. And without using formulas or looking anything else up, I'm going to guess that's around $60 -- and conclude that there's no free lunch! The returns are probably the same, but the volatility will increase with the longer maturity -- and that's most important for the PP investor, right? So there seems to be only that advantage to the strategy.

Investing in bonds seems relativistic to me. The speed of light is always constant, no matter how fast you travel. The returns from bonds are always the same, no matter what your clever strategy is!
pmward
Executive Member
Executive Member
Posts: 1120
Joined: Thu Jan 24, 2019 4:39 pm

Re: Wise move to sell LTTs and buy new 30-years?

Post by pmward » Sat Mar 07, 2020 8:45 pm

Pet Hog wrote:
Sat Mar 07, 2020 8:02 pm
Investing in bonds seems relativistic to me. The speed of light is always constant, no matter how fast you travel. The returns from bonds are always the same, no matter what your clever strategy is!
The sheer size of the treasury market means it's pretty difficult to perform any real worthwhile arbitrage. If a spread shows itself, some algo will arb it out much faster than you can, haha.
User avatar
sophie
Executive Member
Executive Member
Posts: 3528
Joined: Mon Apr 23, 2012 7:15 pm

Re: Wise move to sell LTTs and buy new 30-years?

Post by sophie » Sun Mar 08, 2020 10:39 am

I wouldn't do this in taxable, since I'd have to swallow the short-term capital gains (subject to ORDINARY income tax!). Don't see the point in tax-deferred, but if your bond fund has an ER that is more than 10x the bid/ask spread of the government bonds, you could make a case to do it.
User avatar
jhogue
Executive Member
Executive Member
Posts: 494
Joined: Wed Jun 28, 2017 10:47 am

Re: Wise move to sell LTTs and buy new 30-years?

Post by jhogue » Sun Mar 08, 2020 11:18 am

Pet Hog,
I think that there is a real world factor missing in your proposed thought problem: if one asset (LTTs) goes up, another in the HBPP (stocks or gold) eventually goes down.

In my real world portfolio, bonds have gone up since the beginning of the year, but the value of my stocks have declined. If my bonds hit a 35% rebalance band, I will sell some (but not all) of my bonds to get back down to a 25% position and then use those proceeds to buy stocks.

Real gains always come from selling something high, and buying something else low.
“Groucho Marx wrote:
A stock trader asked him, "Groucho, where do you put all your money?" Groucho was said to have replied, "In Treasury bonds", and the trader said, "You can't make much money on those." Groucho said, "You can if you have enough of them!"
Post Reply