Maximum Bond Upside

[buddtholomew]

I'm at 9% BF after the holidays

[buddtholomew]

General consensus is to add additional cash to dampen volatility and reduce fixed income duration.
I may advocate this approach since I like holding cash.

I also hold ITT's in retirement accounts so see the benefits of bullet vs. barbell daily.

I'm probably the idiot that will be the last one holding LTT's but I've found the PP and will stick to it, which includes rebalancing.

[dualstow]

I like the new Budd!

[tarentola]

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.

[ochotona]

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

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.

Thanks for the insights.

[stuper1]

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?

[buddtholomew]

I like the new Budd!

Ha! Thanks DS.

Tarentola, thanks for the back-testing.
Switching from LTT's to ITT's would have sounded more appealing about 20% ago if I had seen these outcomes.
I would have expected a higher premium for increasing term than the meager .5%

[tarentola]

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.

[grapesofwrath]

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.

[stuper1]

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.

I'm confused about your answers. You give a date when interest rates are going to stop falling, and then you say that there is no reason that they can't go lower. So, which is it?

Here's the thing. One of the fundamental principles of the PP is that it is agnostic about the future. We really don't know what's going to happen in the future. The way I see it, yields could go up, or they could go down. They still have room to go down. Therefore, I continue to hold LTTs. Of course, you can do whatever you want with your money, but if you are going to replace LTTs with ITTs, then don't be surprised if you don't have much protection should a deflationary period arise. Another thing about the PP is that it is meant to be a set-it-and-forget-it portfolio, where you can set it up and go do other things for years at a time and not worry that it will be a mess when you get back to it. People who want to monitor and tinker more have more options.

[whatchamacallit]

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%.

[tarentola]

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.

[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.

[vnatale]

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

[vnatale]

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

[vnatale]

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

[vnatale]

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.

[vnatale]

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

[vnatale]

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