A little bit more than a year ago, Andrea invited me to participate in his InCassaforte podcast after we had a brief exchange on Twitter on why it was reasonable or not to invest in bonds when rates are at zero or negative.
This morning (which might not be your morning, since it takes me ages to write a post), Andrea published a new podcast episode after a three months hiatus and, by coincidence, I also read this post that more or less recalls our discussion.
Andrea’s line was that there is no rational reason to invest in bonds in a world of negative rates. I agree that employing your savings to lock in a negative return is not a very compelling logic. That’s when the “return free risk” claim was born, to define an asset that, like those bonds, can offer only risk in a form of a big drawdown (or god forbid a default) and no return.
In a recent interview on the OddLots podcast, also N. N. Taleb expressed the same concept: only fools would accept that type of proposition. Obviously things would have gone wrong, as they did in 2022.
I had, and still have, a different opinion.
Being Italian and running a podcast for Italians, Andrea’s point was focused on the EUR side of things, namely negative rates. But rates were not negative everywhere, you could actually find positive returns in the biggest market of the world, USD-denominated bonds. I understand very few retail investors are prone to accept FX risk in their bond bucket, but as a fervent believer in carry (the currency with the higher interest rate tends to appreciate) I see it as an added opportunity, not just a risk.
My issue was (and is) more with the reason why EUR investors should limit themselves and include only EUR-denominated bonds in their portfolio and not a global index. I do not think that an ETF like BND, the Vanguard Total Bond Portfolio, ever had a negative yield but…I do not have Bloomberg anymore and cannot check.
Negative or not, yields were historically low.
My second point is that nothing would have prevented yields to go even lower. I am old enough to remember when market participants thought yields could not go negative because no one would have bought those bonds…and yet, they did.
Once -0.5% is legit, why shouldn’t we see -1%? Or -2%? If I buy a bond when rates are at -0.5% and they go to -1%, the price of the bond I own goes up. That bond is even more convex now than it was when rates were ‘normal’, meaning bonds would have been even more effective in hedging stock losses if the market would have entered a standard recession. In the quadrant “negative growth – low inflation”, they would have worked as intended.
And they did.
My third point is that rates remained low…and then lower…and then lower for 13 fu*&(ng years. Sure, take your victory lap…now. The idea that investing in bonds was a sucker bet has to be considered as a market timing strategy, unless you always considered bonds as a sucker bet. So fine, in 2022 bonds sucked but when you actually stopped investing and when you would start again? We need to define those dates otherwise it is just a football pundit’s argument, “sure I would have scored that, if I was on the pitch” (but you were not and there is no universe where to test your claim).
I have my strategic asset allocation and I kept it in the last decade (and over). My hunch was that bonds generated a (paper) loss in 2022 but for 13 years had a higher yield than the alternative, which I would assume is cash (for sure it was for Andrea). I just never went to test it.
Roger’s post (the one linked above) just pushed me to do so. For a reason that I do not fully understand, he compares the 60/40 portfolio with a portfolio that is 80% long stocks (he does not say which index/basket) and 20% short the S&P500…which by his own admission represents a net 60% exposure to stocks. He also considers the last 10 years in his analysis…but 10 years feels a bit like a random range, why start in 2013 if rates touched 0 in 2009 (in the US)?
So I went and checked how the standard 60/40 performed against a portfolio of 60% stocks/40% cash from 2009 to today (VBAIX is basically the Vanguard version of the 60/40).
As you can see, the standard 60/40 generated c0.60% a year of extra return. Including 2022. Sure, the portfolio with cash was less volatile but to avoid that volatility, you had to give up a non-negligible return. Even risk-adjusted. Was it really worth it?
I think I choose fair parameters for this comparison, but if you have a different idea, please share it with me.
The main conclusion (for me) is that people who cheer on how smart they were, suggesting that bonds would have been a wreck, never had to measure themselves against a benchmark. Sure, eventually there would have been a reckoning, but you have to compare the lost opportunity against it. This is definitely not a Michael Burry Big Short type of shit, where he was losing a few % points for a few years to make a 4x.
Unfortunately, I see a similar type of dissonance when Ben Carlson of A Wealth of Common Sense suggests that Bills yielding 5% are a sure bet compared to the 10yr yielding 3.5%. Sure, that 5% for a year is a lock. But what you will get for the next 9 years is still up in the air.
I prefer to stick with the idea that markets ARE efficient, otherwise why not go long Bills and short Bonds? I prefer to define a strategic asset allocation and maintain it than try to ‘outsmart’ it with this type of logic that might work for a podcast but not for a spreadsheet. And unfortunately, this is a spreadsheet type of shit.
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