Simulate LTT with 401k Offering ?

[stuper1]

I have to use at least one non-optimum 401k bond fund to simulate LTT.  I read in a previous posting that a reasonable simulation can be made by using a 401k total bond fund and the EDV fund (which I will have in my Roth IRA) in a 50:50 ratio.  I think my two choices of 401k bond funds for this purpose are:

PIMCO Total Return Fund Institutional Class, weighted avg duration of 5.93 years, expense ratio of 0.46%. This fund has a great track record over 16 years.

BlackRock US Debt Index Fund, weighted avg duration of 6.34 years, expense ratio of 0.13%.  This fund has only existed for two years.

To me, the second fund sounds more like what I'm looking for, but I'm having trouble getting past the great track record of the first fund.  Does anyone have any helpful advice?  Thanks!

[melveyr]

If you are trying to use the PP framework, you really want your bonds to be a pure play on falling growth and or falling inflation. As a US investor the only bonds that are going to reliably do that are US Treasuries.

The Pimco total return fund dabbles in many different things... many of its securities offer risks that resemble equities. It is less of a pure play on deflation, and more up to the managers discretion. They will change the fund based on their predictions of the future. It might be a great fund, but it doesn't fit into the PP framework in my mind. When you use the PP framework, bonds are an instrument. If you buy a fund like Pimco's the instrument changes every quarter! You cannot consistently work their changing sentiments into your framework.

The fund that is purely Treasuries is a lot closer in my mind. However, it's duration is too short to be used as the long term bond portion. Keep in mind that the PP's bond exposure is split between extremely short bonds (T-Bills) and really long bonds (30 year Treasuries). If I were in your shoes I would use the Treasury fund to represent both T-Bills and long term bonds because it's duration is in between. I would do something like

50% BlackRock US Debt Index Fund
25% Gold
25% Stocks

The overall duration of your bond portion is still a little bit lighter than the T-Bill / 30 year combo which is something to keep in mind. You are really going to want to play around with the concept and I suggest googling "bullet vs. barbell bond portfolios". It will help you decide how you could work the BlackRock fund into your PP framework.

Another thought since your duration would still be light is too compensate by adding more weight... so something like

60% BlackRock US Debt
20% Gold
20% Stocks

The real key is to just find the weightings that keep the asset classes balanced with eachother, so that no single asset class is dominating your return profile. Please take all of this as simple suggestions for how to think about things, not advice to just run off and follow! 

[stuper1]

Thanks for your input.  I hear what you're saying.  Unfortunately, I'm stuck with these paltry options.  I'm afraid the BlackRock US Debt Index name is confusing.  I don't think it's a total Treasury index.  I think it's a total bond index, meaning both government and private bonds.  The fund description says that the Fund shall be invested and reinvested primarily in a portfolio of debt securities with the objective of approximating as closely as practicable the total rate of return of the market for debt securities as defined by the Barclays Capital U.S. Aggregate Bond Index.  It is an index fund, though.

Does that change your advice at all?

[melveyr]

Thanks for your input.  I hear what you're saying.  Unfortunately, I'm stuck with these paltry options.  I'm afraid the BlackRock US Debt Index name is confusing.  I don't think it's a total Treasury index.  I think it's a total bond index, meaning both government and private bonds.  The fund description says that the Fund shall be invested and reinvested primarily in a portfolio of debt securities with the objective of approximating as closely as practicable the total rate of return of the market for debt securities as defined by the Barclays Capital U.S. Aggregate Bond Index.

Does that change your advice at all?

I think if you really want to take advantage of this tax advantage space you will probably have to make some compromises and just understand that you won't have the PP as prescribed by HB, but instead something that is very close but not quite as resilient in depression-like conditions. If I were in your situation (and I hopefully will be in a couple of months!), I would think about

50% Aggregate bond (you could get away with Pimco as well but I just have a discipline about staying away from active managers)
25% Stocks
25% Gold

or

60% Aggregate bond
20% Stocks
20% Gold.

I would spend some time on etfreplay to examine how a portfolio of 100% BND (an aggregate bond index) versus 50% TLT (a LTT index) and 50% BIL (A T-bill index) behaves. There are some differences there. The two main ones are that the aggregate bond index has less "oomph" meaning it won't be going up as much when equities or gold are dropping, and that due to mortgages/corporate debt there are instruments in there that don't like deflation.

[Pointedstick]

Detailed posts like these are really worth their weight in gold, melveyr.