TLT Study - Inverting History

Discussion of the Bond portion of the Permanent Portfolio

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Kbg
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TLT Study - Inverting History

Post by Kbg » Fri Apr 26, 2019 6:13 pm

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europeanwizard
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Re: TLT Study - Inverting History

Post by europeanwizard » Sat Apr 27, 2019 1:42 am

Interesting... so even if interest rates would rise, we won't get the same performance from bonds -- due to the drag inherent in bonds.

Anyway, to counteract this, they say they do the following:
We take a different approach. Our portfolios are designed by “currentizing” historical bond returns. Things get a bit technical from here, but in a nutshell, we deconstruct each bond asset’s history into all of the constituent factors that drive returns. We assume that the largest driver of bond returns, the current yield, was never higher than it stands today. We leave all other return drivers untouched.

Below we show historical returns for long-term US Treasuries (TLT) in blue, versus returns that have been currentized based on where interest rates stand today (03/2019) in orange. The difference is stark, with annual returns cut in half, and a deep drawdown in the early 1980’s.

This currentizing process means that our asset allocations will slowly change over time based on where yields stand today. That’s okay. Sound buy and hold investing requires periodically rebalancing our portfolio. Those rebalances provide the opportunity to keep up with the optimal allocation. We can also adjust to the optimal allocation when we add funds (by buying assets that we’re under-allocated to) or withdraw funds (by selling assets that we’re over-allocated to).
So if I understand this correctly, whenever bonds with a higher coupon are available, they sell their lowest yielding bonds (at a loss I presume)? Or is this too simple?

Great link, thanks for posting!
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Re: TLT Study - Inverting History

Post by pmward » Sat Apr 27, 2019 9:10 am

Another article that I came across today looking at the issue of bond returns going forward: https://movement.capital/analyzing-bond ... ded4b883a5
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Re: TLT Study - Inverting History

Post by Kbg » Sat Apr 27, 2019 9:26 am

Bonds are the easiest of all assets to understand the returns on. You will get the nominal return stated if held to maturity, period. Duration will tell you what is going to happen to face value for interest rate change if you sell early. In the context of a PP, does one say I’m not being compensated adequately for the duration risk I’m taking or do I keep them for the original purpose laid out by HB (deflation protection)?

Given the above, I think a reasonable modification to the PP is to never roll to a lower interest rate bond and always roll to a higher rate bond if one is implementing via individual LTTs. There’s goodness to this tactic on a couple of levels that I’ll leave to the reader to discover.
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Re: TLT Study - Inverting History

Post by drumminj » Sat Apr 27, 2019 10:21 am

Kbg wrote:
Sat Apr 27, 2019 9:26 am
Given the above, I think a reasonable modification to the PP is to never roll to a lower interest rate bond and always roll to a higher rate bond if one is implementing via individual LTTs. There’s goodness to this tactic on a couple of levels that I’ll leave to the reader to discover.
And if one isn't available you hold? Shortening your avg time to maturity?
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Re: TLT Study - Inverting History

Post by sophie » Sat Apr 27, 2019 10:37 am

There's just one problem with the title of that piece. It's the phrase "in the era of rising rates".

If you know for a fact that rates are going to rise, and can predict exactly when it will happen, then the solution is obvious: get out of your long bond holdings just before the rise starts, and stay with short term instruments like T bills until the increase levels off. Then buy back in.

Do the authors know something I don't? The only reason I haven't done this myself is that I don't know that we're in an "era of rising rates", and there is no assurance that T bond rates won't go down. One day maybe they'll go up, but that could be 10 years from now for all I know.
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Re: TLT Study - Inverting History

Post by pugchief » Sat Apr 27, 2019 11:27 am

This ^
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Re: TLT Study - Inverting History

Post by pmward » Sat Apr 27, 2019 12:23 pm

Also keep in mind, in regards to the PP, the idea is to rebalance over time. So if bonds are down in value and yields are going up, you will be purchasing more of them. That rebalance effect does tend to naturally claim more and more yield over time. So I think the PP will still work as intended. Just look at the 70's to mid 80s, in a rising rate environment the PP still performed in its natural historic range as a whole. The PP has also performed within its historic range as a whole when stocks and gold have been in severe bear markets, so I see no reason why it would not perform any different with bonds in a bear market. You can bet that gold would be performing well if/when this scenario takes place, as money will be looking for a new safe haven.

I think the main question I have with future bonds in the PP as a whole is the short term bonds. What does one do with these in a negative interest rate environment? Hold physical cash? Extend duration? Increase risk and go to all CD's and/or corporate short term debt? I probably would be inclined to do a bit of all the above. I'm not sure if Harry ever considered a negative interest rate environment in the PP.
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Re: TLT Study - Inverting History

Post by Kbg » Sat Apr 27, 2019 5:08 pm

Sophie,

The basic PP assumption is we do not know as we all are aware of. Hence my suggestion for those buying/rolling their own treasuries. For those using an ETF, rebalance.

Note...rolling up to higher interest rate LTT bonds is not likely to be able to make up a loss (in isolation).

STTs (or some other ST instrument) are always better than cash unless the nominal rate is actually negative. But again, what to do is not difficult at all. Go with the highest interest rate for a given length and risk level.
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Re: TLT Study - Inverting History

Post by mathjak107 » Sun Apr 28, 2019 4:48 am

once rates rise you will always be behind the curve .....

in it's simplest form take a treasury bond fund that is paying 5% and is 10 bucks a share and has a duration value of 5 , and you buy it...

if rates rise to 6% ,, the nav falls to 9.50 but you get an extra 1% interest , 6% instead of 5% for 5 years ... that extra 1% over 5 years makes you whole again , offsetting the 5% drop in nav but with a 5% return like the day you bought , that is 5% in a 6% world
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Re: TLT Study - Inverting History

Post by pugchief » Sun Apr 28, 2019 8:12 am

mathjak107 wrote:
Sun Apr 28, 2019 4:48 am
once rates rise you will always be behind the curve .....

in it's simplest form take a treasury bond fund that is paying 5% and is 10 bucks a share and has a duration value of 5 , and you buy it...

if rates rise to 6% ,, the nav falls to 9.50 but you get an extra 1% interest , 6% instead of 5% for 5 years ... that extra 1% over 5 years makes you whole again , offsetting the 5% drop in nav but with a 5% return like the day you bought , that is 5% in a 6% world
Except a 6% world didn't exist on the day you bought. So your point is moot if you want to invest in bonds. Or stocks for that matter; you can use the same erroneous logic. If you buy a stock fund today for $10 and the market drops 5% tomorrow, did you overpay for those shares? Because you now own $10 shares you could have bought for $9.50 if you had waited. Obviously, if you had known the market would drop 5% instead of going up, or that rates would rise 1% instead of going down, you would have just waited. But then your crystal ball must be better than mine.
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Re: TLT Study - Inverting History

Post by mathjak107 » Sun Apr 28, 2019 3:52 pm

pugchief wrote:
Sun Apr 28, 2019 8:12 am
mathjak107 wrote:
Sun Apr 28, 2019 4:48 am
once rates rise you will always be behind the curve .....

in it's simplest form take a treasury bond fund that is paying 5% and is 10 bucks a share and has a duration value of 5 , and you buy it...

if rates rise to 6% ,, the nav falls to 9.50 but you get an extra 1% interest , 6% instead of 5% for 5 years ... that extra 1% over 5 years makes you whole again , offsetting the 5% drop in nav but with a 5% return like the day you bought , that is 5% in a 6% world
Except a 6% world didn't exist on the day you bought. So your point is moot if you want to invest in bonds. Or stocks for that matter; you can use the same erroneous logic. If you buy a stock fund today for $10 and the market drops 5% tomorrow, did you overpay for those shares? Because you now own $10 shares you could have bought for $9.50 if you had waited. Obviously, if you had known the market would drop 5% instead of going up, or that rates would rise 1% instead of going down, you would have just waited. But then your crystal ball must be better than mine.
all irrelevant ....it has nothing to do with crystal balls .. it is simple fact and math ...if you buy a bond or bond fund and rates rise even though your interest in a bond fund will rise over time in a rising rate you will always be behind the curve plain and simple ...my comment has nothing to do with predicting a thing ... this is exactly what the duration value of a fund tells us.

kbg understands exactly what i am saying . you can work towards getting the original interest rate you had the day you bought by staying in the fund for the duration but you as long as rates rise you will always be behind current.
Kbg wrote:
Sat Apr 27, 2019 5:08 pm
Sophie,

The basic PP assumption is we do not know as we all are aware of. Hence my suggestion for those buying/rolling their own treasuries. For those using an ETF, rebalance.

Note...rolling up to higher interest rate LTT bonds is not likely to be able to make up a loss (in isolation).

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