Bonds, Bonds, Bonds
Without fail, the beaten horse that is the U.S bond bull market is again making headlines—for all the wrong reasons:
“For Bonds It’s Probably ‘Game Over’”
SeekingAlpha, March 16, 2020 “The Bond Bubble May Be Next to Burst”
Forbes, March 12, 2020“What’s Next for 10-Year Treasuries? Wall Street Has No More Idea Than You Do”
MarketWatch, February 20, 2020At least the last headline is honest…. Market prognosticators may be good television fodder and clickbait, but not for managing client portfolios. Sadly, we’ve seen this all before:
“Bond Returns Are Sinking Fast”
Forbes, April 30, 2018 “The End of the 36-Year Bond Bull Market”
Forbes, February 11, 2018“2016 Marked the End of The Biggest Bull Market of Our Lifetimes”
Yahoo Finance, December 8, 2016“Get Out Now!”
The Wall Street Journal, January 5, 2009There are countless others. At the end of 2016, when the noise appeared as loud as it does today, the venerable David Rosenberg consolidated quite a few of those headlines published since 2010. You can peruse them here.
Why does this concern us? As proponents of risk parity investing and stewards of our own “All-Weather” strategy, U.S Treasuries are a significant allocation of our portfolio. On an asset-weighted basis, they currently comprise over 50%. On a risk contribution basis, Treasury positions generate roughly 42% of the portfolio’s volatility, on a rolling 10-year basis. This is a tactical overweight to our target 33%, which we have discussed before, and is shown below:
Can bond yields go lower from here? Maybe. Is there much room to go lower? Certainly not. However, our “overweight” exposure to U.S Treasuries has helped us immensely thus far in 2020. As equities plummet, exposure to long-term Treasuries has helped soften the blow, resulting in a portfolio that is well outperforming the stock market, and significantly outperforming a traditional 60/40 stock/bond portfolio.
Many that are critical of risk parity investing are hesitant to give equal risk exposure to bonds (let alone just U.S. Treasuries) in a period of historically low interest rates. As of late, this includes Jefferies’ Chief Market Strategist, David Zervos who, once a proponent of risk parity, now believes record low yields will put the strategy “in a coma.” Sadly, many people, like Mr. Zervos, may mistakenly view risk parity as just a levered bond portfolio, one that could be highly vulnerable to rising rates.
What we at SineCera Capital understand, and what our clients appreciate, is that our All-Weather strategy is a truly diversified portfolio designed to perform consistently—in both declining and rising interest rate environments. In periods where stocks and/or commodities decline, our bond exposure typically produces positive returns. Conversely, when bond prices decline (i.e. yields go up), we expect our stocks and/or inflation-hedging assets to produce positive returns.
One of the founders of risk parity, Edward Qian, coauthored an article that highlights how risk parity has been able to deliver positive returns even as yields were rising. As he notes, “we attribute this, perhaps surprising, outcome to the powers of both diversification and bond math…”
“If interest rates were to unexpectedly jump higher causing U.S Treasuries to decline in value, the expected magnitude of the loss contribution from fixed income is likely to be no larger than the magnitude of the potential gain contribution from either equities or inflation protected assets. The asset selection of equities, high grade fixed income, and inflation protected assets provides directional offsets to one another while the weighting by volatility ensures the magnitude of the return contribution from each asset class is similar.”
Edward Qian, Ph.D., CFA & Bryan Belton, CFA, PanAgora Asset Management, July 2015
Mr. Qian published this insight when investors were understandably nervous about bonds… in July 2015. History doesn’t repeat itself. But it sure does rhyme.
As always, if you have any questions, please do not hesitate to contact us.
Best Regards,
Adam J. Packer, CFA®
Chief Analyst | SineCera Capital
Disclaimer: The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of SineCera Capital. Neither SineCera Capital nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall SineCera Capital be liable to you or anyone else for damage stemming from the use or misuse of this information.