Money Magic: Making Bonds Act Like Stocks

[MachineGhost]

A core tenet of risk parity is that when stocks are falling, bond prices typically rise. By using leverage, bond returns can help make up for losses on stocks. Without leverage, bond returns in a typical pension portfolio of 60% stocks and 40% bonds wouldn't be large enough to compensate for low stock returns.

http://www.nasdaq.com/article/money-mag ... 0121-00421

[melveyr]

Thanks for the link.

IMO the PP basically does the same thing except it uses high duration bonds to increase exposure. If I were a big hedge fund borrowing closer to the risk free rate I would probably lever up intermediate bonds like these Risk Parity guys do, but for retail investors I think the high duration bonds are nearly as good. 

[Tyler]

Interesting that the 60/40 split is so sacrosanct that they'd recommend leverage on the bonds rather than just changing the percentage to get the balance they want.

[melveyr]

Interesting that the 60/40 split is so sacrosanct that they'd recommend leverage on the bonds rather than just changing the percentage to get the balance they want.

But if they did 20/80 the expected return would be lower than they wanted.

In some sense though, that is what they are doing though except with leverage. A risk parity portfolio might look like 40% stocks and 160% bonds.

[craigr]

Personally, I've never met an individual investor yet that can use leverage successfully long term. When their leveraged bet turns against them they will flee in panic and lock in large losses in almost every case I can recall.

In fact, I don't even think most professional investors can handle it well.

[clacy]

Interesting that the 60/40 split is so sacrosanct that they'd recommend leverage on the bonds rather than just changing the percentage to get the balance they want.

For some reason many people don't seem to understand that not all bond portfolios are created equal. 

Most 60/40 bond portfolios use corporate bonds or a total bond fund set up (which have a lot of corporate bonds).  Corporate bonds are highly correlated to stocks.  I've seen papers that say they are 95% correlated with the market.

Vanguard's VBINX (60/40) is HIGHLY correlated to the S&P.

What is the point of investing in corporates, if they are correlated to stocks?? 

[smurff]

Interesting that the 60/40 split is so sacrosanct that they'd recommend leverage on the bonds rather than just changing the percentage to get the balance they want.

The 60/40 portfolio comes out of the same lifecycle personal finance world that teaches the percentage you should invest in bonds is equal to your age.  Rather than examine the behavior of different portfolios for different ages, it's easier to make assumptions.  The assumed  investor is 40 years old (typically the first age when an ordinary citizen of a debt- based economy has finally accumulated enough assets to make substantial investments), has a risk profile that's more moderate than conservative or aggressive, works as a white collar employee, owns a single- family house in the suburbs, and is married and has at least two children.

[frugal]

Hi,

I really prefer 50/50

[iwealth]

Interesting that the 60/40 split is so sacrosanct that they'd recommend leverage on the bonds rather than just changing the percentage to get the balance they want.

For some reason many people don't seem to understand that not all bond portfolios are created equal. 

Most 60/40 bond portfolios use corporate bonds or a total bond fund set up (which have a lot of corporate bonds).  Corporate bonds are highly correlated to stocks.  I've seen papers that say they are 95% correlated with the market.

Vanguard's VBINX (60/40) is HIGHLY correlated to the S&P.

What is the point of investing in corporates, if they are correlated to stocks??

I don't think the mindset there is to invest in an instrument that zigs while the other zags. Highest potential total return over time seems to be the goal. But if the recommendation is to hold that same allocation right up until retirement, well that's a bit nutty.

[clacy]

Well if the goal is the highest return and volatility is ignored then maybe they should be 100% SCV.

However I think the purpose of a 60/40 is to lessen volatility in most instances so I would argue that there is a better way of doing such.

[iwealth]

That's a good point regarding 100% SCV. I've read through the Bogleheads forum at length and I think they believe there have been too many periods where bonds outperform stocks to guarantee a 100% stock portfolio will always provide a higher returns. Or maybe it's just that over time a 60/40 portfolio supposedly returns nearly the same as a 100% stock portfolio with less volatility. But either way I agree, if the goal is to reduce volatility, it'd seem there are better ways to accomplish it (at least according to backtesting).

[frugal]

Well if the goal is the highest return and volatility is ignored then maybe they should be 100% SCV.

However I think the purpose of a 60/40 is to lessen volatility in most instances so I would argue that there is a better way of doing such.

That's a good point regarding 100% SCV. I've read through the Bogleheads forum at length and I think they believe there have been too many periods where bonds outperform stocks to guarantee a 100% stock portfolio will always provide a higher returns. Or maybe it's just that over time a 60/40 portfolio supposedly returns nearly the same as a 100% stock portfolio with less volatility. But either way I agree, if the goal is to reduce volatility, it'd seem there are better ways to accomplish it (at least according to backtesting).

100% SCV shall return over the years:

CAGR
10.72

with DD 40%


I doesn't seem so good.