# Stocks for the long run?



## Sarenco (24 Mar 2020)

It's commonly stated that stocks provide superior long-term returns to bonds.

But what does "long-term" mean in this context?

Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than 2%.

However, over the same time period long-term (20 year) US Treasuries provided an annualised 7.4% return.

Is this unprecedented?

Nope.

For the 30-year period to 30 September 2011, the S&P500 returned an annualised 10.8%, compared to an annualised return of 11.5% on long-term Treasury bonds.

In fact, for the 40-year period to 31 December 2008, the annualised return on the S&P500 was essentially the same as the return on 20-year US Treasuries (8.98% v 8.92%).


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## settlement (25 Mar 2020)

Sarenco I could highlight other arbitrary 20 or 30 year periods where stocks vastly outperformed treasuries


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## Sarenco (25 Mar 2020)

settlement said:


> Sarenco I could highlight other arbitrary 20 or 30 year periods where stocks vastly outperformed treasuries


Of course.  But that's not the point.

We each only have one investment lifetime and luck plays a huge role in the returns we receive.

If you look at the _really_ long-term, the outperformance of stocks over bonds may be somewhat exaggerated -





__





						Only Two Centuries of Data
					





					www.efficientfrontier.com


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## Gordon Gekko (25 Mar 2020)

Yes, but if that investment lifetime is starting now or in its infancy, one would fancy equities to trounce bonds given the relative starting points.


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## Sarenco (3 Apr 2020)

US bonds generally (not just long-term treasuries) have outperformed US equities since the turn of the century.

From the close of trading on 31 December 1999, the Bloomberg Barclays US Aggregate Bond Index (known as the "Agg") has produced a cumulative total return of 176% to 1 April 2020.

The S&P500, in contrast, has risen 149% in the century to date on a total-return basis.

Obviously that tells us nothing about the future but it does demonstrate that bonds can outperform equities over extended periods of time.


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## DeeKie (3 Apr 2020)

If you were starting to build a portfolio now where would you start?


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## Duke of Marmalade (3 Apr 2020)

Sarenco said:


> Over the last 20 years, the S&P500 has produced an annualised 4% return, with all dividends reinvested. That's an annualised real (after-inflation) return of less than 2%.
> 
> However, over the same time period long-term (20 year) US Treasuries provided an annualised 7.4% return.


Actually one can be reasonably certain of bond returns.   If 20 year US Treasuries provided 7.4% return over the last 20 years that is because their yield in 2000 was 7.4% p.a.
The yield on 20 year US Treasuries today is 1.04% p.a.  That is what you will nominally earn for certain over the next 20 years if you invest in them.
After tax, costs, inflation and exchange rate movements you would have a fair certainty that you will get a negative return over the next 20 years.  In fact if you wanted to avoid the exchange rate risk it is German 20 year bonds you would plump for, yielding -0.25% p.a. before costs.
I don't know how any investment manager can justify having bonds in a retail investment fund at these yields.  If the punters are risk averse then sit on cash until some normality returns.


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## confused12 (3 Apr 2020)

Sarenco said:


> US bonds generally (not just long-term treasuries) have outperformed US equities since the turn of the century.
> 
> From the close of trading on 31 December 1999, the Bloomberg Barclays US Aggregate Bond Index (known as the "Agg") has produced a cumulative total return of 176% to 1 April 2020.
> 
> ...



Can you explain the difference between bonds and long-term treasuries?


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## EmmDee (3 Apr 2020)

confused12 said:


> Can you explain the difference between bonds and long-term treasuries?



Treasury bonds are just long term bonds issued by the US Government.


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## galway_blow_in (4 Apr 2020)

I opened a thread several years ago asking why U.S treasuries were so cheap relative to European sovereign debt

It was a very sound buy at the time, still is in my view when you see how little unity there is in Brussels as to how to deal with this


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## joe sod (4 Apr 2020)

Duke of Marmalade said:


> In fact if you wanted to avoid the exchange rate risk it is German 20 year bonds you would plump for, yielding -0.25% p.a. before costs.
> I don't know how any investment manager can justify having bonds in a retail investment fund at these yields.



Warren Buffet made this point in back february , nobody buying negatively yielding bonds now expects to hold them to maturity, they will all be looking to offload them to someone else, what happens if they all look to do this at once? 
It wasn't very prescient advice as the stock market started crashing a week later and bond prices rose to new heights a trend they have been in since 1982. 
The irish government are going to borrow much more money from the bond markets at very low interest rates and they are not one bit worried about getting this money. I think this is very good for the irish government and it is good that they can do this, but who would want to buy those bonds ?


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## Sarenco (4 Apr 2020)

I think it's important to consider the diversifying potential of bonds within a portfolio, even at historically low yields.

The equity funds within my pension are down around 18%, year-to-date (boo!).

However, my bond fund is up around 2%, year-to-date (yay!).

So at a portfolio level, the bond fund has helped to cushion the falls. 

I don't hold bonds for income or return - I hold them to dial down the volatility within my equity heavy portfolio.


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## zephyro (4 Apr 2020)

Sarenco said:


> The equity funds within my pension are down around 18%, year-to-date (boo!).
> 
> However, my bond fund is up around 2%, year-to-date (yay!).



How far are you from retirement?


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> I think it's important to consider the diversifying potential of bonds within a portfolio, even at historically low yields.
> 
> The equity funds within my pension are down around 18%, year-to-date (boo!).
> 
> ...


That is the Capital Asset Pricing model.  People hold a mix of the overall equity market and risk free cash.  That gives the Capital Market Line which varies from entirely risk free to whatever risk you want (if necessary by gearing).  The expected reward will be an increasing function of the risk taken.

But bonds are not risk free, in fact at these yields the risk seems to me all downside, unless of course you hold to maturity it which case you will get a negative return albeit without any "risk" to that return.

Following all that PRISM stuff punters have to indicate their risk rating on a scale of 1 to 7.  The only credible way to meet that range of requirements is to adjust the mix of equities and cash as per the Capital Asset Pricing model.  At these negative yields bonds have no role to play  in a retail investment fund.


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## Sarenco (4 Apr 2020)

DeeKie said:


> If you were starting to build a portfolio now where would you start?


I would start with a global equity fund and then add a Euro Government Bond fund to taste.


zephyro said:


> How far are you from retirement?


I don't know TBH - it's a bit of a moving target.  

My rough plan at the moment (which may change over time) is to hold roughly 10 years' worth of annual expenses in fixed-income investments (bonds and cash deposits) at retirement, with the balance in a global equity fund.


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## Sarenco (4 Apr 2020)

Duke of Marmalade said:


> At these negative yields bonds have no business in being in a retail invstment fund.


You have been making that point for some time now Duke.

I'm surprised that you can't see that recent events have demonstrated the potential value of holding bonds within an equity heavy portfolio.

Duration has very definitely been my friend in recent weeks.

Cash de-risks a portfolio but it doesn't diversify a portfolio.


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> You have been making that point for some time now Duke.
> 
> I'm surprised that you can't see that recent events have demonstrated the potential value of holding bonds within an equity heavy portfolio.
> 
> ...


Any asset class which is uncorrelated is a diversification but I won't get into the semantics.
In "normal" times, say when interest rates are at 3% or higher I would absolutely agree that bonds are a suitable asset class for the retail investor.
You are recommending Euro govies and indeed you claim a +2% kicker YTD on the bond portion of your investments.  German 10 year yields have fallen from -.22% to -.44% YTD i.e. a .2% fall and that roughly translates as a 2% price appreciation.
What do you think is the further upside?  Can bond yields fall a further .2% to give what is after all a relatively modest kicker?
The pricing here is meaningless to the retail investor.  She is definitely better with it under the mattress than earning negative yields. But for a bank or insurance company the mattress costs money and hence the Central Banks are able to force the institutions to pay for custodianship of their liquid assets.  But this has limits.  Switzerland has been able to charge people for holding their deposits for some time but I doubt that charge ever exceed 1% p.a.  So you really must see very little upside potential in bonds at these yields.
On the other hand there is a school of thought that borrowing rates for governments could soar as they seek to fund the massive fiscal deficits incurred in defence of the virus.  If bond yields reverted to say 2% p.a. (itself historically very low) 10 year govies would fall c. 25%. 
I can't understand why you don't see the risk reward dynamics of current bond yields as hugely skewed against the retail investor.


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## Sarenco (4 Apr 2020)

Duke of Marmalade said:


> Any asset class which is uncorrelated is a diversification but I won't get into the semantics.


I disagree.

Diversification strives to smooth out portfolio returns, so the positive performance of some investments neutralises the negative performance of others. The benefits of diversification only hold if the securities in the portfolio are not perfect correlated - that is, they respond differently, often in opposing ways, to market influences.

Cash dilutes equity risk but it doesn't diversify equity risk. Cash doesn't "respond" to a falling stock market.

High quality bond prices, on the other hand, often move in the opposite direction to equities during a sharp correction. That's what happened in 2008 and that's what happened last month.

Plenty of talking heads argued until recently that bonds could no longer diversify an equity portfolio at historically low (or even negative) yields.  It turns out they were wrong.

As an aside, the interest rate on deposits held by the life company where I have my retirement savings is currently negative.  Hiding out in cash doesn't necessarily avoid negative interest rates.


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> I disagree.
> 
> Diversification strives to smooth out portfolio returns, so the positive performance of some investments neutralises the negative performance of others. The benefits of diversification only hold if the securities in the portfolio are not perfect correlated - that is, they respond differently, often in opposing ways, to market influences.
> 
> ...


Oh dear!  I didn't want to go down the rabbit hole of diversification.  The correlation of cash returns and equity returns is zero ergo it provides diversification.  The correlation of bond returns and equity returns has flipped from positive during the high inflation period to negative during this low inflation/deflation and so may be a *better *diversifier than cash, I'll concede you that and I'm climbing out of this rabbit hole now.
I am trying to get you to agree that bonds have much more downside risk than upside potential at these (negative) yields.  The fact that I would have stated this at the beginning of the year and yet there has still been a 2% upside YTD does not negate the statement.  If you think the risk is symmetric then we will have to agree to disagree.
I know cash is earning a small negative yield but I am addressing in this discussion the asset price risk which does not exist for cash.


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## Sarenco (4 Apr 2020)

I don't agree that it's a rabbit hole - it's really my core point and the reason why I hold bonds in my portfolio.  

I'm not suggesting that the correlation between equities and bonds is consistent.  However, when stock prices are tumbling the correlation _tends_ to turn negative and hence the potential diversification benefit.  But look, fair enough, I'll leave it there.


Duke of Marmalade said:


> If bond yields reverted to say 2% p.a. (itself historically very low) 10 year govies would fall c. 25%


That's not really as scary a prospect as it may seem.  If there is a spike in bond yields then bond prices would obviously suffer a corresponding fall. But bond funds would start buying bonds at these lower prices, with correspondingly higher yields, and would quickly recover.

Besides, can you imagine what a spike in borrowing costs of that order would do to equities?

Stocks are always riskier (more volatile) than bonds; and bonds are always riskier than cash.  That's as true today as it's always been.


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> Besides, can you imagine what a spike in borrowing costs of that order would do to equities?


After a bit of Googling, I see that the negative correlation of bonds with equities is accepted wisdom and has itself led to a demand for bonds.  But I do think you are massively overrating the syndrome.  YTD it has yielded you a 2% kicker compared to say 0% on cash.  
But consider the above line extracted from your recent post.  I presume you mean that if bond yields and therefore interest rates spiked to 2% equities would take dive - the total reverse of negative correlation.  
There is no telling the macroeconomic fall out of this unprecedented crisis but it is not too far fetched to imagine a big spike in bond yields as governments everywhere scramble to fund their deficits.  
I stand by my assertion that at these yields bonds present a very asymmetric risk reward proposition for the retail investor, indeed aggravated by the fact that a big spike in borrowing costs would hit equity markets hard as well.
To me this is wait and see territory, far too much uncertainty, cash is king.


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## Silvius (4 Apr 2020)

Sarenco said:


> I would start with a global equity fund and then add a Euro Government Bond fund to taste.


Which global equity fund would you choose and why?


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## Sarenco (4 Apr 2020)

Duke,

Compare the performance of the following two portfolios over the last 40 years -

*Portfolio 1* comprised 50% US equities (total market) and 50% cash (3-month T-Bills), rebalanced annually.  Annualised return of 7.87%, worst year -17.75%; maximum drawdown -26.83%.

*Portfolio 2* comprised 50% US equities (total market) and 50% long-term (30-year) Treasuries, rebalanced annually.  Annualised return of 10.68%; worst year -7.26%; maximum drawdown - 20.39%.

So, the portfolio with long-term treasuries had a materially higher return, with lower drawdowns.

Why?  Diversification.

Portfolio 1 was 100% correlated with the US stock market.  As you said yourself, the correlation between equities and cash is exactly zero.  Cash diluted equity risk but provided zero diversification benefit.

Portfolio 2 was only 80% correlated with the US stock market.  Replacing cash with long-term treasuries actually created a more efficient portfolio from a risk/reward perspective.

Now, cash may well outperform long-term treasuries over the coming decades (although I personally think that is highly unlikely).

But cash cannot, by definition, diversify an equity portfolio.


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## Sarenco (4 Apr 2020)

Silvius said:


> Which global equity fund would you choose and why?


The cheapest global index tracker that my pension provider offers.  I don't invest in equities outside my pension.

Alternatively, you could invest in a number of separate index funds to approximate the same thing.


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## Silvius (4 Apr 2020)

Sarenco said:


> you could invest in a number of separate index funds to approximate the same thing.


Even with the tax implications? I've actually done that already, put some into the Vanguard S+P and the MSCI World but am thinking of putting a separate tranche into a few Investment Trusts because of the tax situation. How much does one let tax influence investment decisions....?


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> Duke,
> 
> Compare the performance of the following two portfolios over the last 40 years -
> 
> ...


This helps pass the time  
Back down the rabbit hole.  I accept that cash does not bring (significant) diversification benefit but that is not because it has zero correlation, it is because it has zero risk.  Diversification in a portfolio is when the standard deviation of the portfolio return is less than the weighted sum of the standard deviations of the components.  As a mathematical tautology since the standard deviation of cash is effectively zero there is no diversification effect.  But this is not a function of zero correlation.  See the following graphic




The yellow line is the rolling 5 yr correlation of US bond returns and equity returns over the last 40 years.  It can be seen that for the first (inflationary) period the correlation is positive (a bad thing) but in the low inflation of recent times the correlation has indeed been negative (a good thing).  Overall it looks around zero correlation over the 40 year period.  But zero correlation can still give significant diversification benefit.
Jumping out of the rabbit hole
I have already said that I fully bought into the role of bonds in a balanced portfolio in *normal *times.  But nothing can convince me of any role for bonds with negative yields.


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## Sarenco (4 Apr 2020)

Silvius said:


> Even with the tax implications?


There are no tax implications with splitting out your portfolio into separate funds within a pension fund (although I would recommend opting for a single global equity fund, if available, for the sake of simplicity).  Bear in mind that I said I don't invest in equities outside my pension funds.


Silvius said:


> How much does one let tax influence investment decisions....?


Big time in an Irish context.  Our high income tax and CGT rates really skew the risk/reward analysis.


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## Sarenco (4 Apr 2020)

Duke of Marmalade said:


> I accept that cash does not bring (significant) diversification benefit but that is not because it has zero correlation, it is because it has zero risk


With respect Duke, that really is indulging in semantics. 

Adding cash to a portfolio of stocks in Portfolio 1 didn't add any diversification benefit because the overall portfolio was at all times 100% correlated to the US stock market.  Cash cannot "respond" (positively or negatively) to stock market movements.


Duke of Marmalade said:


> The yellow line is the rolling 5 yr correlation of US bond returns and equity returns over the last 40 years. It can be seen that for the first (inflationary) period the correlation is positive (a bad thing) but in the low inflation of recent times the correlation has indeed been negative (a good thing). Overall it looks around zero correlation over the 40 year period. But zero correlation can still give significant diversification benefit.


Absolutely.  In fact, I think there may have been a modestly positive correlation between stocks and bonds over the full time period.

However, the correlation turned sharply negative at the most opportune times (2000, 2008, last month).


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## Duke of Marmalade (4 Apr 2020)

Sarenco said:


> With respect Duke, that really is indulging in semantics.
> 
> Adding cash to a portfolio of stocks in Portfolio 1 didn't add any diversification benefit because the overall portfolio was at all times 100% correlated to the US stock market.  Cash cannot "respond" (positively or negatively) to stock market movements.
> 
> ...


I concede you have won the diversification argument.  But still I can see no justification for investing in bonds at negative yields.


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## lledlledlled (5 Apr 2020)

Silvius said:


> Even with the tax implications? I've actually done that already, put some into the Vanguard S+P and the MSCI World but am thinking of putting a separate tranche into a few Investment Trusts because of the tax situation. How much does one let tax influence investment decisions....?



I would say tax has a major influence on investment decisions. Personally speaking, it is the reason I no longer invest in equities outside of my pension arrangement. 
Investment Trusts are slightly better than ETFs in this regard, but still heavily taxed IMO


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## Silvius (6 Apr 2020)

Thanks for the replies. Investing outside a pension is my only option right now so it's good to get the different perspectives on it.


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## lledlledlled (6 Apr 2020)

Silvius said:


> Thanks for the replies. Investing outside a pension is my only option right now so it's good to get the different perspectives on it.



Do you have a mortgage or are you paying rent?


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## Silvius (6 Apr 2020)

lledlledlled said:


> Do you have a mortgage or are you paying rent?


Thankfully, no.


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## lledlledlled (6 Apr 2020)

Silvius said:


> Thankfully, no.



Unless you have free accommodation for life, i would probably focus on gathering a deposit for a house rather than investing in the stock market.


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## Sarenco (6 Apr 2020)

Silvius said:


> Thanks for the replies. Investing outside a pension is my only option right now so it's good to get the different perspectives on it.


Could I suggest starting a new thread to deal with your own circumstances rather than dragging this thread any further off topic?


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## Silvius (6 Apr 2020)

Sure thing, didn't meant to drag it off topic and would rather not get into my own circumstances anyway. Was more interested in the general discussion about building a portfolio for the long run, how would one start from scratch now and unfortunately that seems to be inseparable from tax considerations in Ireland.


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## Steven Barrett (7 Apr 2020)




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## Sarenco (7 Apr 2020)

Yup, Steven's chart shows that the Agg outperformed the S&P500 over the last 20 years.

I think it's interesting to compare the performance over the last 40 years of an all-equity portfolio (S&P500) with a traditional portfolio made up of 60% equities (S&P500) and 40% bonds (10-Year Treasuries)  -

100% equities - annualised return 10.92%;  worst year -37.45%;  maximum drawdown -50.97%
60/40 portfolio - annualised return 10.25%;  worst year -14.00%;  maximum drawdown -26.46%.
So the all-equity portfolio modestly outperformed the 60/40 portfolio over the full 40-year period but that outperformance came with some stomach churning drawdowns.


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## Steven Barrett (7 Apr 2020)

Ran figures for Global Bonds and MSCI All Country which European investors may use a bit more. Equities still lag behind bonds over the last 20 years. Investment period is a lot shorter than the S&P500 stats put up previously


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## lledlledlled (7 Apr 2020)

SBarrett said:


> Ran figures for Global Bonds and MSCI All Country which European investors may use a bit more. Equities still lag behind bonds over the last 20 years. Investment period is a lot shorter than the S&P500 stats put up previously
> 
> View attachment 4416



Am i missing something here? I thought equities have out-performed all other asset classes over almost any reasonably long-term time frame?


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## cremeegg (7 Apr 2020)

lledlledlled said:


> Am i missing something here? I thought equities have out-performed all other asset classes over almost any reasonably long-term time frame?



Seems that is not true.

While Property returns are difficult to substantiate, I suggest that make all the above look, rather poor.


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## Sarenco (7 Apr 2020)

lledlledlled said:


> I thought equities have out-performed all other asset classes over almost any reasonably long-term time frame?


You thought wrong.  That's the key takeaway from this thread.


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## Sarenco (7 Apr 2020)

cremeegg said:


> While Property returns are difficult to substantiate, I suggest that make all the above look, rather poor.


Could you point us to anything that might help to substantiate that claim?


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## cremeegg (7 Apr 2020)

Sarenco said:


> Could you point us to anything that might help to substantiate that claim?


Well as I said property returns are difficult to substantiate.

In post 39 above the period 1999 to 2020 was referenced.

in Dec 1999 the average house rice in Ireland was €127,000 (I can't really substantiate that but i am open to being corrected) Today its in the region of €250,000. Thats a return of just over 3% if my maths is correct. Add to that a yield of say 5% gives for a return of 8%. A different league from anything quoted above. A competent manager could easily manage a higher yield.

Of course if the yield was to be calculated on the original purchase price, which i think is more appropriate the return is higher again.


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## Duke of Marmalade (7 Apr 2020)

Steven those are interesting stats.  But they are history.
Equities earned 3.03% p.a. over the last 20 years.  They may well do that again over the next 20 years.  They might do 6% p.a. or they might go sideways.
Bonds earned 4.25% p.a. over the last 20 years.  With yields on long term bonds currently at 0%, near as makes no difference, it would be in defiance of the law of gravity for them to earn 4.25% over the next 20 years.  I say to anybody uninitiated in these matters that those historic returns might give a flavour of the range of possible future equity returns they can't possibly describe the range of future bond returns.
I will repeat again what has not yet been refuted or accepted by others:  historically bonds have provided a useful and rewarding diversification in a balanced retail portfolio.  However, at current (artificial yields) they can't possibly fulfil that role from this point.  *They should not be in a retail investment portfolio.*


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## Protocol (7 Apr 2020)

https://www.frbsf.org/economic-research/files/wp2017-25.pdf
		


The Rate of Return on Everything.

*Abstract*
This paper answers fundamental questions that have preoccupied modern economic thought since the 18th century. What is the aggregate real rate of return in the economy? Is it higher than the growth rate of the economy and, if so, by how much? Is there a tendency for returns to fall in the long-run? Which particular assets have the highest long-run returns? We answer these questions on the basis of a new and comprehensive dataset for all major asset classes, including—for the first time—total returns to the largest, but oft ignored, component of household wealth, housing. The annual data on total returns for equity, housing, bonds, and bills cover 16 advanced economies from 1870 to 2015, and our new evidence reveals many new insights and puzzles.

Keywords: return on capital, interest rates, yields, dividends, rents, capital gains, risk premiums, household wealth, housing markets. JEL classification codes: D31, E44, E10, G10, G12, N10


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## Gordon Gekko (8 Apr 2020)

Sarenco said:


> You thought wrong.  That's the key takeaway from this thread.



I don’t think that’s accurate.

Equities “have out-performed all other asset classes over almost any reasonably long-term time frame”...we’ve seen a period where that hasn’t been the case...but note the use of the term “almost any”.


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## Sarenco (8 Apr 2020)

Gordon Gekko said:


> Equities “have out-performed all other asset classes over almost any reasonably long-term time frame”...we’ve seen a period where that hasn’t been the case...but note the use of the term “almost any”.


I would have thought that 20 years was a "reasonably long-time frame".


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## Sarenco (8 Apr 2020)

Duke of Marmalade said:


> They might do 6% p.a. or they might go sideways.


Or they might fall.

Japan had the largest stock market in the world by market cap back in 1989.  Japanese stocks have still to reach previous highs reached over 30 years ago.

The US stock market took 25 years to fully recover from the 1929 crash.

We simply don't know whether or not stocks will outperform bonds over the next 20 years.  


Duke of Marmalade said:


> I will repeat again what has not yet been refuted or accepted by others: historically bonds have provided a useful and rewarding diversification in a balanced retail portfolio. However, at current (artificial yields) they can't possibly fulfil that role from this point.


Bond yields fell (from historically low levels) during the most recent stock market correction.  I can't see any basis for your assertion that bonds cannot diversify an equity portfolio going forward.


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## Fella (8 Apr 2020)

I don't worry so much what my actual return is , that is totally out of my control . Of course I would like it to be positive .

But I try to make the correct decisions.

When I choose investing in the stock market I make this choice because I believe it has he highest expected return .

Of course we only have data going back since the beginning of the stock market from what I can find is that bonds averaged 2.5% over 145 years V's stocks 6.9% .

I would expect stocks to out perform bonds over my lifetime investing but it may not but over multiple lifetimes people should expect a higher % returns from stocks . Of course each person only gets a limited time frame to invest in so it's down to chance , but your expected return is higher with stocks.


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## Gordon Gekko (8 Apr 2020)

Sarenco said:


> I would have thought that 20 years was a "reasonably long-time frame".



No; that’s not what’s being said. Finding one 20 year period where that has not been the case does not disprove the fact that equities have outperformed over almost any reasonably long time frame. It’s essentially citing the proverbial needle in the haystack as something other than merely that.


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## elacsaplau (8 Apr 2020)

If we compare the 20 year return of the S&P against the US Aggregate Bond Index for the last 300 month ends (i.e. the last 25 years), there has only been 7 months where the Bond Index outperformed.


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## Sarenco (8 Apr 2020)

@Gordon Gekko

If you re-read the OP you will see that the outperformance of long-term US treasuries over a 20 year period is not without precedent.  

And 20 years is not the longest period where long-term US treasuries outperformed US stocks (S&P500).

And that's just the US.  

Long-term government bonds have outperformed domestic stocks for periods of 20 years or more in every major industrial nation.

In any event, I read the phrase "almost any reasonable long-term period" as referring to the length of the period - not the frequency of such periods.

For the avoidance of doubt, I am not suggesting that bonds have frequently outperformed stocks over long time periods - they clearly haven't.  Over the vast majority of long-terms holding periods, stocks have outperformed bonds.

Nor am I making any prediction - implicit or otherwise - about the future performance of any asset class.


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## Sarenco (9 Apr 2020)

cremeegg said:


> Well as I said property returns are difficult to substantiate.


Yes and it's notoriously difficult to accurately compare the return on a rental property with the return on an index tracker.

A few points missing from your comparison:-

The acquisition and disposal costs for rental properties are significantly higher;
Rental properties need to be maintained, insured and taxed (LPT);
Running a rental property is a part-time job so you should really account for your time; and
The greater proportion of the return on a rental property comes from rental profits which are generally more highly taxed than capital gains.


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## DK123 (9 Apr 2020)

Re 6.9 % equity return on stocks over 145 years.Am i right to presume that this is adjusted for inflation i. e.buying power or real terms.If not then we are only kidding ourselves i think.


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## Gordon Gekko (9 Apr 2020)

Sarenco said:


> @Gordon Gekko
> 
> If you re-read the OP you will see that the outperformance of long-term US treasuries over a 20 year period is not without precedence.  Nor is 20 years the longest period where long-term US treasuries outperformed US stocks (S&P500).
> 
> ...



My point is that such periods are extraordinarily rare. They’re almost black swan events.


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## Sarenco (10 Apr 2020)

Gordon Gekko said:


> My point is that such periods are extraordinarily rare. They’re almost black swan events.


According to Vanguard, stocks underperformed bonds about 18% of the time over 10-year rolling periods between 1926 and 2016. 

Over 20-year rolling periods, stocks underperformed bonds over 4% of the time.

https://www.marketwatch.com/story/long-term-stock-investors-may-not-be-thinking-long-term-enough-2017-08-21

Of course, there is no guarantee that the next 90 years will follow a similar pattern.


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## Gordon Gekko (10 Apr 2020)

1/25...I like those odds...it would be interesting to see what has happened in the period immediately following those rare periods when bonds have won out. I would not like to own bonds from here. If I was a 60/40 man, I think the 40 would be cash.


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## Sarenco (10 Apr 2020)

Gordon Gekko said:


> If I was a 60/40 man, I think the 40 would be cash


While I can't predict the future, I can state as a certainty that while cash can dilute equity risk, it cannot diversify an equity portfolio.

Over the last 40 years -


Sarenco said:


> *Portfolio 1* comprised 50% US equities (total market) and 50% cash (3-month T-Bills), rebalanced annually. Annualised return of 7.87%, worst year -17.75%; maximum drawdown -26.83%.
> 
> *Portfolio 2* comprised 50% US equities (total market) and 50% long-term (30-year) Treasuries, rebalanced annually. Annualised return of 10.68%; worst year -7.26%; maximum drawdown - 20.39%.


Over the same timeframe, a US equity (total market) portfolio had an annualised return of 10.66%,; worst year -37.04%; maximum drawdown; -50.89%.

So, over the last 40 years, the all-equity portfolio actually marginally underperformed the portfolio with 50% in long-term bonds.  And the all-equity portfolio suffered some stomach churning drawdowns.


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## Gordon Gekko (10 Apr 2020)

I didn’t say that cash added diversification. My point is that if I wanted to reduce the volatility from here using a traditional 60/40 split, I’d have equities and cash. I don’t see how bonds can continue to surprise in a good way.


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## Sarenco (10 Apr 2020)

Gordon Gekko said:


> My point is that if I wanted to reduce the volatility from here using a traditional 60/40 split, I’d have equities and cash.


That's what diversification achieves - it reduces the volatility of a portfolio.

Diversification strives to smooth portfolio returns, so the positive performance of some investments neutralises the negative performance of others. The benefits of diversification only hold if the securities in the portfolio are not perfectly correlated - that is, they respond differently, often in opposing ways, to market influences.

Long-term bonds are volatile assets - far more volatile than cash.  However, adding long-term bonds to an equity portfolio reduced volatility at a portfolio level to a far greater degree than adding cash to an equity portfolio over the last 40 years.

That's because bond prices often rise when equities crash (the flight to safety effect).  Cash cannot "respond" to stock market crashes in this way.

Again, cash can dilute equity risk but it cannot diversify equity risk.


----------



## Sarenco (10 Apr 2020)

Incidentally most life companies and other pension providers are currently paying banks around 60bps for their deposits (which is obviously borne by policyholders).

In contrast, the yield to maturity on Eurozone Government bonds (EGBI) at 31 March 2020 was (positive) 0.25%.


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## Gordon Gekko (10 Apr 2020)

And cash clearly reduced volatility which is all I am saying. i.e. that, going forward, if I was someone who couldn’t deal with volatility, I would have (say) 40% in cash rather than bonds.


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## Sarenco (10 Apr 2020)

Do you mean volatility at an overall portfolio level or volatility within the fixed-income portion of a portfolio?


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## Gordon Gekko (10 Apr 2020)

Sarenco said:


> Do you mean volatility at an overall portfolio level or volatility within the fixed-income portion of a portfolio?



Volatility at portfolio level. As in, let’s say I’m of a nervous disposition and can’t really take drawdowns of more than, say, 20-25%. So full equity risk isn’t a runner. But if I have 60% equities and 40% cash and global equities fall by 35%, as they have recently, my portfolio falls by 21%.


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## Duke of Marmalade (11 Apr 2020)

Sarenco said:


> Incidentally most life companies and other pension providers are currently paying banks around 60bps for their deposits (which is obviously borne by policyholders).
> 
> In contrast, the yield to maturity on Eurozone Government bonds (EGBI) at 31 March 2020 was (positive) 0.25%.


Let us get this diversification thing in perspective.  The first and foremost consideration for an asset class is its long term growth prospects.  Next we consider its short to medium term price volatility in its own right.  If it cuts mustard on this risk reward assessment then we consider as a bonus its diversification possibilities.
In "normal" times (before the financial crisis) we might be looking at equities with long term growth prospects (net of annual management charges) of, say, 6% p.a. and short term volatility of 20%.  We might be looking at bonds with yields (net of AMC) of 3% p.a. and volatility of 5% p.a.  Throw in a lack of correlation and we have a good case for a diversified equity/bond portfolio.  Indeed this was the mainstay of the collective investment industry in its heyday (90s and early noughties).  This is the world that is depicted by looking at 20 year historic performance. But we are in a completely different place today.
Today we actually would probably have the same assessment of equities (6% growth/20% volatility).  But the bond universe has changed utterly.  Now we have yields of around -1% p.a. net of AMC.  Bonds do not even get past first base - they are actually  *guaranteed *to destroy nominal wealth over the long term.  It doesn't matter if they have total negative correlation with equities i.e. perfect diversification, they simply do not belong in a retail portfolio.
But neither does cash.  Cash is yielding about -2% p.a. after AMC.
So the retail investor should decide her appetite for equities and yes satisfy that with a low charge, tax efficient collective vehicle - passive investment trusts spring to mind.
Ignoring property, the rest of her investments should be in state savings and/or retail bank deposits.


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## Gordon Gekko (11 Apr 2020)

Duke, for the avoidance of doubt I’m not suggesting that someone keep cash in their portfolio incurring costs.

Say my wife and I had €500k to invest and were candidates for a traditional 60/40 portfolio because, from a behavioural perspective, we just couldn’t handle a 30-40% drawdown.

I believe that a more sensible approach would be for us to keep €200k separately in cash or State Savings, have a €300k equity portfolio, and treat it as a single €500k portfolio with rebalancing undertaken as required.

So by 23 March, our ‘portfolio’ would have declined by around €105k / 21% and not €105k / 35%.


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## Sarenco (11 Apr 2020)

Duke of Marmalade said:


> Today we actually would probably have the same assessment of equities (6% growth/20% volatility).


Are we?  I personally think it is highly unlikely that we will see an equity risk premium of 6%+ over the coming decades.


Duke of Marmalade said:


> Ignoring property, the rest of her investments should be in state savings and/or retail bank deposits


But Duke, it's not possible to hold State Savings products and/or retail bank deposits within a pension wrapper.

I certainly think that State Savings Certificates are an excellent home for after-tax savings, while maintaining a higher allocation to equities within a pension vehicle.  I've been making that argument for some time, however, I would suggest that most folks won't have that flexibility.


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## Duke of Marmalade (11 Apr 2020)

Gordon Gekko said:


> Duke, for the avoidance of doubt I’m not suggesting that someone keep cash in their portfolio incurring costs.
> 
> Say my wife and I had €500k to invest and were candidates for a traditional 60/40 portfolio because, from a behavioural perspective, we just couldn’t handle a 30-40% drawdown.
> 
> ...


_Gordon_, I think we are on the same page.  Cash is king these days for your flight to safety but not within a collective vehicle.  
My main point is that bonds today are utterly unrecognisable from the animals of the same name that I remember during the 90s/noughties.  They are not investments in the traditional sense of  meaning assets with a prospect of a positive return.  They are purely technical instruments in the ALM requirements of financial institutions.  Investing in German long bonds at negative yields can make sense to a bank if it reduces its capital requirements.  A reduction in capital requirements has no value for the retail investor so it is completely priced out of that market.  I Googled a few fund brochures and amazingly they are still waxing about the bond content of their diversified portfolios.


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## Gordon Gekko (11 Apr 2020)

I agree 100%. Bonds have no place in a private investor’s portfolio. And what’s even worse is that, because of the lack of return, lots of wealth managers have pushed their clients into higher yield corporate bonds and loan funds for the ‘40%’ and many of these things are now behaving like equities.


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## Sarenco (11 Apr 2020)

Ok, I'll try it a different way.

What is somebody in their 60s with all their retirement savings wrapped up in a pension to do?  State savings or retail deposits aren't an option within a pension.

Would you advise that individual to hold an all-equity portfolio?


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## RobFer (11 Apr 2020)

Duke of Marmalade said:


> Let us get this diversification thing in perspective.  The first and foremost consideration for an asset class is its long term growth prospects.  Next we consider its short to medium term price volatility in its own right.  If it cuts mustard on this risk reward assessment then we consider as a bonus its diversification possibilities.
> In "normal" times (before the financial crisis) we might be looking at equities with long term growth prospects (net of annual management charges) of, say, 6% p.a. and short term volatility of 20%.  We might be looking at bonds with yields (net of AMC) of 3% p.a. and volatility of 5% p.a.  Throw in a lack of correlation and we have a good case for a diversified equity/bond portfolio.  Indeed this was the mainstay of the collective investment industry in its heyday (90s and early noughties).  This is the world that is depicted by looking at 20 year historic performance. But we are in a completely different place today.
> Today we actually would probably have the same assessment of equities (6% growth/20% volatility).  But the bond universe has changed utterly.  Now we have yields of around -1% p.a. net of AMC.  Bonds do not even get past first base - they are actually *guaranteed *to destroy wealth over the long term.  It doesn't matter if they have total negative correlation with equities i.e. perfect diversification, they simply do not belong in a retail portfolio.
> But neither does cash.  Cash is yielding about -2% p.a. after AMC.
> ...


Are they such thing? I cant find any examples.


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## Sarenco (11 Apr 2020)

RobFer said:


> Are they such thing? I cant find any examples.


No, there's no such thing.

And, no, bonds are not guaranteed to destroy wealth over the long-term.


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## Duke of Marmalade (11 Apr 2020)

Sarenco said:


> No, there's no such thing.
> 
> And, no, bonds are not guaranteed to destroy wealth over the long-term.


I felt when I invented "passive investment trusts" that they would be a unicorn.  For pension investments the investment trust aspect is not required.
The *guaranteed *was bold in my original so I don't think _robfer _was questioning it.  Please describe the circumstance where a 20 year bond yielding -1% p.a. after AMC would add to wealth over the long term


Sarenco said:


> Ok, I'll try it a different way.
> 
> What is somebody in their 60s with all their retirement savings wrapped up in a pension to do?  State savings or retail deposits aren't an option within a pension.
> 
> Would you advise that individual to hold an all-equity portfolio?


No.  I suppose it has to be part cash or maybe short bonds which are quasi cash.  It's the  long bonds that I see no role for in a retail fund.  The combined drag of AMC and negative wholesale deposit rates/bond yields could produce situations where it would be better to cash out of the ARF despite the negative tax consequences but I haven't thought that through.  Certainly "gross roll up" is a negative in this scenario.


.


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## Sarenco (11 Apr 2020)

Duke of Marmalade said:


> Please describe the circumstance where a 20 year bond yielding -1% p.a. after AMC would add to wealth over the long term


I was simply contradicting your statement that bonds are guaranteed to destroy wealth over the long-term.  That is simply untrue.  We could be entering a period of long-term deflation for all I know.


Duke of Marmalade said:


> I suppose it has to be part cash or maybe short bonds which are quasi cash. It's the long bonds that I see no role for in a retail fund.


Fine.  In effect you are saying you have an edge over one of the largest, most liquid markets in the world.  I have no idea what interest rates will look like in the future so I am agnostic on duration - I let the market decide.


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## RobFer (11 Apr 2020)

Sarenco said:


> No, there's no such thing.
> 
> And, no, bonds are not guaranteed to destroy wealth over the long-term.


Well I won't stop looking. There must be some conglomerate somewhere that at least acts like that like Berkshirehathaway.


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## Gordon Gekko (11 Apr 2020)

RobFer said:


> Well I won't stop looking. There must be some conglomerate somewhere that at least acts like that like Berkshirehathaway.



What about...Berkshire Hathaway?


----------



## Duke of Marmalade (11 Apr 2020)

Sarenco said:


> I was simply contradicting your statement that bonds are guaranteed to destroy wealth over the long-term.  That is simply untrue.  We could be entering a period of long-term deflation for all I know.


I have inserted the word "nominal"  to the original post.  We are not in a court of law - you know what I meant.  We are comparing with retail deposits and state savings and these do guarantee to add to nominal wealth.


> Fine.  In effect you are saying you have an edge over one of the largest, most liquid markets in the world.  I have no idea what interest rates will look like in the future so I am agnostic on duration - I let the market decide.


Ahhh!  a little side swipe.  I am not claiming any edge over anybody.  I have already explained that there are technical reasons why institutions will hold long term bonds at negative yields - it does not mean they think they are good investments.  I don't know if you ever heard of an outfit called EIOPA.  They regulate EU life companies and pension funds.  They have the concept of a Ultimate Funding Rate which funds can use to discount their liabilities.  The argument goes that they don't trust the markets beyond the 20 year point and so they put in their own estimates of what ultimately interest rates will be.  They have come up with the figure of 3.75% despite yields on 30 year money being effectively zero.  Are you shocked to know that EU life companies and pension funds value their liabilities on the assumption that they will ultimately earn 3.75% p.a.?  So whilst not claiming any edge over the experts but rather sharing the view of the experts the future trajectory of yields has to upwards - there is a definite floor to how far lower they can go and there are very strong economic and empirical reasons to believe that we are near that floor. There is no upside left but very considerable downside risk. *There is no role for long bonds in a retail portfolio.*  (My emphasis)


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## elacsaplau (11 Apr 2020)

Duke of Marmalade said:


> Are you shocked to know that...….pension funds value their liabilities on the assumption that they will ultimately earn 3.75% p.a.



Me shocked! Me very shocked. Please explain in the Irish context.


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## Sarenco (11 Apr 2020)

Duke of Marmalade said:


> I am not claiming any edge over anybody


German bond yields range from around -0.70% (3 months) to +0.06% (30 years).

By favouring securities at the short end of the yield curve, you are implicitly claiming that the market has mispriced longer-term yields.

Market participants already know the demands of certain institutions for bonds of different durations.  There is no reason to believe that isn't already reflected in bond prices.


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## Duke of Marmalade (11 Apr 2020)

Sarenco said:


> German bond yields range from around -0.70% (3 months) to +0.06% (30 years).
> 
> By favouring securities at the short end of the yield curve, you are implicitly claiming that the market has mispriced longer-term yields.
> 
> Market participants already know the demands of certain institutions for bonds of different durations.  There is no reason to believe that isn't already reflected in bond prices.


You are not listening.  I am not claiming that cash or short bonds are good investments - they are terrible investments in an institutional wrapper.  But long term bonds are simply accepting wealth destruction over that longer term - no justification for that at all.  Not a good place to be but IMHO the retail investor has no choice but to hold her risk reducing assets in cash/short instruments and hope for some return to normality.


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## Duke of Marmalade (11 Apr 2020)

elacsaplau said:


> Me shocked! Me very shocked. Please explain in the Irish context.


Oh dear I hope the Sunday World are not looking in - I have blown the cover.  Trusting you are not taking the pis*, I will try to explain.
The UFR was a compromise to get the new solvency regime over the line in 2016.  The essence of Solvency II is to be market based.  But with the low interest rates its initial intended introduction in 2012 was postponed until the UFR compromise was agreed.  The cynics say that without the compromise the German annuity market and possibly even the UK annuity market would be technically insolvent.
Ireland not very big on annuities.  I am not expert on pension fund legislation but I think the Minimum Funding Standard is a pure market based test and so the UFR does not apply.  But we know that many defined benefit schemes do not meet the MFS.


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## Sarenco (11 Apr 2020)

Duke of Marmalade said:


> You are not listening


I am actually.  I just don't think you have made a convincing argument for favouring securities at the short end of the yield curve within a pension.


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## elacsaplau (11 Apr 2020)

Duke of Marmalade said:


> Are you shocked to know that.....pension funds value their liabilities on the assumption that they will ultimately earn 3.75% p.a.?


warrants....


elacsaplau said:


> Me shocked! Me very shocked. Please explain in the Irish context.


gets


Duke of Marmalade said:


> Explanation about the UFR...….blah, blah blah...….I am not expert on pension fund legislation but I think the Minimum Funding Standard is a pure market based test and so the *UFR does not apply*. But we know that many defined benefit schemes do not meet the MFS.


warrants......
An Oh dear of my own plus
1. The MFS is not a pure market based test;
2. If there is a weaker valuation basis, I'd love to know it; and
3. Whether schemes meet the MFS or not is irrelevant to the assertion that shocked! 

Your central point about being wary about bonds is valid, completely so!!


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## Duke of Marmalade (11 Apr 2020)

elacsaplau said:


> warrants....
> 
> gets
> 
> ...


continuing on the premise that you are discussing in good faith (possibly nigh eve based on past experience)  I thought the MFS was based on current annuity rates available in the market but correct me if I am wrong.


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## Fella (11 Apr 2020)

I have to agree with @Sarenco from what I know about bonds there seems to be good reason to have them in your portfolio. Negative yield bonds can still generate a positive return, you are only guaranteed to lose money if you hold them to maturity but what if yields fall further after you buy you can sell them and make a positive return.

If inflation falls below the yield of the bonds so we end up with deflation surely a negative yielding bond is better in this instance so it better than cash.
And bank rates are so low what if we see negative interest rates ? Where are we going to store our money , we would have to pay to store it in vaults so negative yielding bonds have a place in a porfolio.

And when stock markets go down do people not move to bonds ? It still seems bonds are worthwhile and a good diversification.


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## elacsaplau (11 Apr 2020)

Duke of Marmalade said:


> ….I thought the MFS was based on current annuity rates available in the market but correct me if I am wrong.



This is indeed true for pensioners but not true for active and deferred members.

Anyway, the MFS is a point in time discontinuance standard so future investment growth is irrelevant for calculating the pensioner liability (coz based on annuity buy-out cost) and just wrong for the other two cohorts.

And, of course, MFS is just one of a number of valuation bases - none of which use, as suggested, the fabled return (unless by coincidence!)

It was a bluff......it didn't work...….no matter!


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## Duke of Marmalade (11 Apr 2020)

Fella said:


> Where are we going to store our money , we would have to pay to store it in vaults so negative yielding bonds have a place in a porfolio.


That is precisely why negative yields exist today despite every text book and John Maynard Keynes taking it as axiomatic that zero is a floor to interest rates.  Storage is indeed an issue for institutions and possibly your good self _Fella_ but for ordinary folk like me it will be the mattress before I ever pay anybody to hold my deposits.  Even for institutions there is a definite floor where indeed they would resort to the vaults.  Maybe JMK overestimated the floor but it surely can't be far off these levels.
I am aware of the math and that technically bonds could still rise in price and a real shrewdie like yourself could then sell.  AFAIK _sarenco _is not arguing that long bonds are good investments because of these trading possibilities.  He is arguing a buy and hold strategy and that price movements will be uncorrelated with equity movements and thus good for the nerves but not of itself adding any extra value.  A 20 year bond yielding -1% after AMC will yield precisely that but its price movements along the way  will be a palliative for the equity roller coaster. A lot cheaper to buy nerve tablets.


> And when stock markets go down do people not move to bonds ? It still seems bonds are worthwhile and a good diversification.


Yes, that is the reason for the modest negative correlation observed in recent times. _sarenco _has mentioned that he got a 2% kicker to compensate for the recent X% plunge in equity prices.  I am not denying its existence merely that I think _sarenco _has greatly overstated its relevance. But believe me if interest rates spike (say 2%  !) because of the need to fund this bug, equities will likely dive in sympathy. I think it was _sarenco _himself who alluded to this perfect storm.


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## joe sod (11 Apr 2020)

elacsaplau said:


> warrants......
> An Oh dear of my own plus


Finding difficulty understanding some of your posts, what does the above mean? You are too fond of using jargon and abbreviations


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## elacsaplau (11 Apr 2020)

joe sod said:


> The *e*nglish language has...…..



grammatical rules also, Joe 

****************
Edit:

Ah, Joe - you've just done a Marc on me!

MFS = Minimum Funding Standard (basically it's a b/s standard that checks the solvency of Irish DB pension plans )


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## Freddie (11 Apr 2020)

So this thread isnt about "Stocks for the Long Run" then??? 

Ye should just exchange contact details to argue over the minutiae of ....

The saying " he knew more and more about less and less until eventually he knew everything about nothing" comes to mind.


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## Duke of Marmalade (11 Apr 2020)

Freddie said:


> So this thread isnt about "Stocks for the Long Run" then???
> 
> Ye should just exchange contact details to argue over the minutiae of ....
> 
> The saying " he knew more and more about less and less until eventually he knew everything about nothing" comes to mind.


_Freddie_ the debate has developed into is there a role for long bonds in a retail investment portfolio, quite important.  Have you anything to contribute to that debate other than smart ass cliches?


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## Fella (11 Apr 2020)

This thread is very educational to an uneducated sole like myself. It's making me think I should add long bonds to my portfolio although I'm also thinking about what Duke said the floor for yields and bond investment and wondering will Gold be the beneficiary if we reach that floor.

Please continue the debate because I for one learn alot thanks


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## Freddie (12 Apr 2020)

Duke of Marmalade said:


> _Freddie_ the debate has developed into is there a role for long bonds in a retail investment portfolio, quite important.  Have you anything to contribute to that debate other than smart ass cliches?


This post is so far off topic it should be renamed. Otherwise what's the point in having titles or categories. Thats what I have to add.

Debate....with statements from yourself like "you are not listening"  "let me try to expain" , pretty condescending to me.


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## Duke of Marmalade (12 Apr 2020)

Freddie said:


> This post is so far off topic it should be renamed. Otherwise what's the point in having titles or categories.


The first line of OP makes it clear that this thread is about how shares compare with bonds.  I don’t quite know what you were expecting from the title. Perhaps it was what to bring with you on a marathon in which case I hope the following image is of some help.


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## Freddie (12 Apr 2020)

As with all your posts you are *always right.* Just borrowing the bolding, you need to use, to show us mere morals how irrefutable your views are.

I'm sure you'll need to get the last word/post on this...you're that type of person I think.

I'm sure Brendan will step in soon after.


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## Sarenco (12 Apr 2020)

Duke of Marmalade said:


> The first and foremost consideration for an asset class is its long term growth prospects. Next we consider its short to medium term price volatility in its own right. If it cuts mustard on this risk reward assessment then we consider as a bonus its diversification possibilities.


I disagree.

I don't invest in bond funds within my pension for their long-term growth prospects and I'm fairly unconcerned about the short to medium-term price volatility of those bond funds.

I invest in bond funds for their potential to diversify my equity-heavy portfolio.  I am solely concerned with reducing volatility at an overall portfolio level.

Retail investors have some advantages over institutional investors in the after-tax space.  Retail deposits don't currently attract a negative interest charge.  5-year State Savings Certs currently earn 1% pa if held to term, whereas 5-year Irish Government bonds currently have a negative yield.

But none of that is relevant to my pension.


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## Duke of Marmalade (12 Apr 2020)

Sarenco said:


> I invest in bond funds for their potential to diversify my equity-heavy portfolio.  I am solely concerned with reducing volatility at an overall portfolio level.


I have accepted the diversification aspect.  You obviously rate that very highly.  That is a personal value judgement, I guess.
If I were a financial advisor, which I am not and never was, I would be advising that the diversification benefit is hugely swamped by the long term negative drag of bonds at current yields.  But their day may return.

Anyway, I have to be more circumspect in my comments - there be trolls about


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## Fella (12 Apr 2020)

It's hard to see how @Sarenco is wrong here, investing in negative yield bonds is the correct decision from every evidence I can find.


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## Duke of Marmalade (12 Apr 2020)

Fella said:


> It's hard to see how @Sarenco is wrong here, investing in negative yield bonds is the correct decision from every evidence I can find.


Absolutely!  Why have I been so stupid


----------



## Fella (12 Apr 2020)

Duke of Marmalade said:


> Absolutely!  Why have I been so stupid



No need to be like that, but your case that there is a bottom that yields can go is not strong enough for me and I feel you are trying to predict future behavior, I think when it comes to wealth preservation people would happily lower there risk and you'd be surprised how much they would he willing to lock in at a loss .

I feel sarenco makes a stronger argument for bonds in a portfolio .


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## Sarenco (12 Apr 2020)

Duke of Marmalade said:


> I have accepted the diversification aspect. You obviously rate that very highly.


I do indeed.  After all, diversification is the only free lunch in investing.

But leaving that aside, the Euro Government Bond fund that I hold currently has a positive yield-to-maturity of 0.25%.  On the other hand, cash deposits with the life company where I have my pension currently carry a negative interest rate of -0.6% (which is very much in line with the short end of the current yield curve).

So, if I was basing the decision on yield alone, I would still favour the bond fund over cash.


----------



## elacsaplau (12 Apr 2020)

Fella said:


> I feel sarenco makes a stronger argument for bonds in a portfolio .



Yep - Sarenco well ahead on points and hasn't had to resort to concocting illusory shocks.


----------



## Duke of Marmalade (12 Apr 2020)

Sarenco said:


> I do indeed.  After all, diversification is the only free lunch in investing.
> 
> But leaving that aside, the Euro Government Bond fund that I hold currently has a positive yield-to-maturity of 0.25%.  On the other hand, cash deposits with the life company where I have my pension currently carry a negative interest rate of -0.6% (which is very much in line with the short end of the current yield curve).
> 
> So, if I was basing the decision on yield alone, I would still favour the bond fund over cash.


_sarenco _as an aside I see that I have really got up the trolls' noses, that gives me a buzz, but I won't be engaging with them.

You obviously firmly believe in your argument and I think we are reaching "agree to disagree" territory.

For avoidance of doubt I agree that cash in an institutional wrapper is an awful investment.  If someone is trapped in such a wrapper they face a real quandary as to how to get the portfolio risk rating aligned with their needs (unless of course they are risk rating 7).  You cite a 0.85% differential between long bonds and cash, maybe if I was in that position I would after all risk the long bonds.
For those not forced into a wrapper (because of Revenue rules) the Gordon Gecko approach makes perfect sense to me  - collective diversified 100% equity portfolio for your risk appetite and state savings/retail deposits for your risk dampener.


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## Gordon Gekko (12 Apr 2020)

Exactly. You’re arguing the merits of a dog-do sandwich versus a kitty-litter stew; why not just have neither?

Take your equity risk through the pension and hold cash personally; the whole thing is an advert for looking at one’s overall asset allocation rather than each bucket individually.

I agree that government bonds have no place in a private investor’s portfolio; he or she is almost guaranteed to lose money in real terms.


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## Fella (12 Apr 2020)

Duke of Marmalade said:


> _sarenco _as an aside I see that I have really got up the trolls' noses, that gives me a buzz, but I won't be engaging with them.
> 
> You obviously firmly believe in your argument and I think we are reaching "agree to disagree" territory.
> 
> ...



I don't know who is trolling , there's no need for it.
Using myself as an example I keep cash on deposit earning nothing and state savings maxed out. I have as much as I want to risk in equities . 
Sarenco has made a decent argument for me to move some of this cash to negative yield long term bonds, the reason I think of it as an option is if stocks crash it's likely there will be a move to bonds and I am likely to see a gain if yields move further negative. This seems a decent hedge to me and I can also look at the option of currency hedging if I wanted to diversify from a largely euro holding. Holding cash doesn't offer these benefits as far as I can see.


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## Cricketer (12 Apr 2020)

This is a *test* post.


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## Duke of Marmalade (12 Apr 2020)

Gordon Gekko said:


> Take your equity risk through the pension and hold cash personally; the whole thing is an advert for looking at one’s overall asset allocation rather than each bucket individually.


_GG _I think the problem is that there can be compelling tax reasons for having all your pension funding in an institutional wrapper.  Having all of that fund in equities might not be within the risk appetite of the person - to mitigate the risks they seem trapped into awful cash deposits and/or negative yielding bonds.


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## Sarenco (12 Apr 2020)

Duke of Marmalade said:


> You cite a 0.85% differential between long bonds and cash, maybe if I was in that position I would after all risk the long bonds.


No, 0.25% is the yield-to-maturity of the FTSE EMU Government Bond Index (EGBI), which captures Euro government bonds of all durations at market weight, as at 31 March 2020.  


Duke of Marmalade said:


> collective diversified 100% equity portfolio for your risk appetite and state savings/retail deposits for your risk dampener.


I've been arguing that very split for a long time around these parts.

But here's the problem - not everybody will have sufficient after-tax savings to fully achieve their desired allocation across all accounts (pension and after-tax).  I know I don't.


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## elacsaplau (13 Apr 2020)

Sarenco said:


> But here's the problem - not everybody will have sufficient after-tax savings to fully achieve their desired allocation across all accounts (pension and after-tax).  I know I don't.



That's such an important point, Sarenco - for solutions to genuinely apply in the real world, they need to be actionable.


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## Duke of Marmalade (13 Apr 2020)

Sarenco said:


> I've been arguing that very split for a long time around these parts.
> 
> But here's the problem - not everybody will have sufficient after-tax savings to fully achieve their desired allocation across all accounts (pension and after-tax).  I know I don't.


I think I read somewhere that 40% of ARF moneys are in cash.  I am not going to question the wisdom of that as an investment strategy.  But you have highlighted the institutional drag in keeping cash in the ARF wrapper.
I see best retail deposit buys of 0.8% and of course State Savings of up to 1% tax free.  Combine this with wholesale rates of -0.6% and AMC and we might have a whopping drag of -3% p.a.
ARF withdrawals will incur tax at the marginal rate but if this is only foregoing tax deferral then we have the opposite to gross roll up, we have gross roll down - so if it is mere tax deferral you should immediately withdraw your cash holdings in the ARF.
It will usually be a lot more complicated than that as leaving it in the ARF may involve deferral to a point when there is less or no marginal taxation on withdrawal.
I know this is a tad off topic but I would ask moderators not to open a new thread on the point - that usually kills off discussion.


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## elacsaplau (13 Apr 2020)

I agree with the Duke's request to the moderators and have a certain sympathy for what the Duke is trying to say in the above post.

Problem is that it seems a little extreme and thus not really actionable – and, as I specifically mentioned earlier, solutions really do need to be actionable to be truly useful. There’s that sense of a hammer being used to crack a nut or the medicine being more brutal than the illness.

Applying a permanent drastic solution (selling-up) does seems like an over-action to what many believe are market conditions that will not endure forever.

Continuing the medical analogy from earlier – there really is little merit in having a very successful operation in which the patient dies.


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## Duke of Marmalade (13 Apr 2020)

If I were relying on a €1M ARF invested 40% in cash I would be getting a gross income of €40K p.a. It would certainly stick in the craw to think that €12k p.a. (3% of €400k) was going down the plughole of institutional drag.  But of course encashing €400k would trigger a tax charge approaching €200k.  So indeed one would seem to be stuck in the headlights.

What a turnaround.  I recall that one of the minor selling points of unit linked policies was that the life company could use its clout to earn wholesale rates on its cash which would be superior to the rip off retail rates.  What has caused this turnaround is that the populace are armed with their mattresses whilst that is not a practically available instrument to the big boys.

And zero seems to be very much a cusp point in the retail space.  Deposit Best Buys of this forum show rates ranging from .05% to .8%.  It seems that rates of .1% can survive alongside rates twice as high but no-one dare go negative - they would lose their retail deposit base overnight, and retail deposits are still desirable in their own right.


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## joe sod (13 Apr 2020)

Duke of Marmalade said:


> The essence of Solvency II is to be market based. But with the low interest rates its initial intended introduction in 2012 was postponed until the UFR compromise was agreed. The cynics say that without the compromise the German annuity market and possibly even the UK annuity market would be technically insolvent.



What does this mean,what was the UFR compromise in english please Im interested? My take away is that the annuity markets were insolvent because they never expected the extremely low interest rates following the financial crash so they could not generate the income needed to pay out the annuities. But my question is how did the "UFR compromise" change things that stopped them going insolvent?


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## Duke of Marmalade (13 Apr 2020)

joe sod said:


> But my question is how did the "UFR compromise" change things that stopped them going insolvent?


Ahhh! We are in serious danger of going down the deepest rabbit hole known to woman
"Insolvency" is a very ambiguous term in insurance circles.  In legal terms it means you haven't got the money to meet your day to day obligations. For a well capitalised annuity company, even if current v. low interest rates persisted, that day might be 50 years off.
By "insolvent" in this context I mean not having sufficient assets to cover the present *discounted* value of *future* liabilities as stipulated by regulation.  If the regulators had stuck to the original spirit of Solvency II and insisted on long term market interest rates for the discount rate it would have put companies with very long term liabilities in a very precarious situation from a *regulatory viewpoint*.
So they decided (compromised) that long term market rates were not reliable and came up with their own estimate of the appropriate ultimate interest rates at a higher level.  At a stroke the companies' regulatory liabilities were "written down" whilst their assets remained unchanged.  Ergo they looked much healthier, and that eventually got Solvency II over the line 4 years behind schedule.
Hope that helped but possibly I missed the point of your query.


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## joe sod (13 Apr 2020)

Yes that makes it much clearer, Im just interested to see how these regulatory bodies themselves are dealing with negative interest rates, and as you have explained they are not extending them far out into the future. Of course their primary concern was to get these insurance companies over the line but by saying that the market is wrong about long term interest rates and increasing substantially their own figure. Even though they did this for a technical fix it shows that negative interest rates are not normal. But the guys that set the rate in the bond markets dont care what the interest rate will be in 20 years time on these bonds anyway as they are only in it themselves for the very short term


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## Sarenco (19 May 2020)




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