ARF projections

[Colm Fagan]

No, I'm not saying that I'm an exceptionally good investor. What I AM saying is that equities are expected (in the mathematical sense) to deliver a far superior return to bonds and cash. That's true in theory and in practice. There are bumps in the road, of course, but give the probabilities enough time to do their thing and the superior returns will come through. My ARF is invested on the assumption that we could be around for 30 years from my "retirement" nine years ago. That's plenty time for the probabilities to work in my favour.

 

[elacsaplau]

My ARF is invested on the assumption that we could be around for 30 years...…...That's plenty time for the probabilities to work in my favour.

There's a good chance that there were lads in Japan who had similar beliefs 30 years ago - no more fancy cameras for dem fellas.

The thing is that one anticipates the equity risk premium because, well, one is taking risk.

Certain ARFers will be able to withstand a prolonged slump in equity returns by, as suggested, drinking lower grade Pinot. Others simply will have insufficient scope to withstand a bad sequence of investment returns. There is a material difference in one's capacity to take risk if one has an ARF of €400,000 versus investable assets of, say, €4 million. I don't know what the average ARF size is for retirees but I'd suspect it's a lot closer to €400k than €4 million and hence more representative of the considerations of the broader population.

 

[NoRegretsCoyote]

What I AM saying is that equities are expected (in the mathematical sense) to deliver a far superior return to bonds and cash. .......My ARF is invested on the assumption that we could be around for 30 years from my "retirement" nine years ago. That's plenty time for the probabilities to work in my favour.

That's a more general, and defensible point.

Your strategy is a long-term one and as such it's probably still too soon to be citing events as supportive of it.

Let's talk again when you're in your mid-90s

 

[Colm Fagan]

There's a good chance that there were lads in Japan who had similar beliefs 30 years ago - no more fancy cameras for dem fellas.

I can't understand why people keep grasping at straws to defend investment strategies that are patently wrong. Some of them should know better.

The Japanese market in the decade or more from 1990 was unique. Have you studied the background to it, and the fallout? I have. I refer you to my presentation of 7 February 2018 to the Society of Actuaries in Ireland
http://www.colmfagan.ie/documents/33_Document.pdf?d=September 07 2019 10:21:29.

Slide 42 studies the circumstances in Japan at that time. Just to take a couple of examples from that slide: Before the crash, the Imperial Palace in Tokyo was supposedly worth more than the entire state of California. Nippon Telephone & Telegraph was floated at a P/E of 250 in 1987, and the price kept going up until the crash started on the first day of trading in 1990. It's a utility. They normally trade on P/E multiples of less than 10, less than 20 in the raciest of markets. We're nowhere near that sort of territory.
As an aside, a Japanese saver who invested in the Japanese stock market at the height of the boom, even at those crazy prices, would probably be better off now than if they left their savings in cash.

 

[elacsaplau]

I can't understand why people keep grasping at straws to defend investment strategies that are patently wrong.

I am very patient man but yet again am frustrated by your comments. And please lets try to take the emotive language away. I am as convinced that you are "wrong" as you are that I am so please lets park de handbags!

What specific investment strategy are you accusing me of defending?

Additionally, please answer another specific question.....do you accept my belief that people have different levels of scope to take investment risk?

 

[Sarenco]

A Japanese retiree that withdrew 4% of the opening balance of an all-Japanese equity portfolio every year from 1990 would have been flat broke in less than 15 years.

A sobering example of the dangers of running an all-equity portfolio within an ARF.

 

[cremeegg]

Before the crash, the Imperial Palace in Tokyo was supposedly worth more than the entire state of California. Nippon Telephone & Telegraph was floated at a P/E of 250 in 1987, and the price kept going up until the crash started on the first day of trading in 1990. It's a utility. They normally trade on P/E multiples of less than 10, less than 20 in the raciest of markets.

Did no one call a bubble.

Probably lots of people called a bubble, but funds kept investing because there mandate was to invest as broadly as possible.

Have we a bubble in bonds today.

Will people in 30 years time look back and say "bonds had negative yields and still people invested in them"

Or what I really want to know, and I will start a thread if i can phrase the question, is how exposed am I as an investor in a pension medium risk fund, to a collapse in bonds. Thanks by the way to Colm for addressing that in post above.

 

[NoRegretsCoyote]

As an aside, a Japanese saver who invested in the Japanese stock market at the height of the boom, even at those crazy prices, would probably be better off now than if they left their savings in cash.

Not true.

The Nikkei 225 is worth a little over 50% of its peak in yen terms.

Purchasing power of the yen has only fallen in 11% since 1990, due to very low inflation.

Keeping yen under your mattress would have appreciably outperformed Japanese equities over the last 30 years.

 

[Sarenco]

Short of an outright default, you can't really have a collapse in bonds.

If there's a sharp uptick in yields then there will be a sharp downturn in bond prices. However, the increased yields will quickly overwhelm and supersede the capital losses within a bond fund.

What impact will a sharp uptick in the cost of debt have on equities (bearing in mind that corporates now carry a lot more debt than was the case 10 years ago)? And what impact will a sharp increase in the cost of debt have on property prices?

 

[Colm Fagan]

What specific investment strategy are you accusing me of defending?

I don't want to sound harsh, but one anonymous poster is much the same as another. As an aside, why do people feel the need to write under the cloak of anonymity?
As it happens, though, you have defended the strategy I'm unhappy with, of excessive belief in so-called "defensive" assets and "sequence of return" risk:

people can be and have been mushed by the sequence of returns. Excessively high or low allocation to return seeking (as opposed to defensive) assets should be a minority sport. I don't mind those in this minority enjoying their fetish so long as they acknowledge that their extreme position is not appropriate for the majority

You also asked:

Additionally, please answer another specific question.....do you accept my belief that people have different levels of scope to take investment risk?

Of course. My initial post under this thread was to praise Steven Barrett's (thank you Steven for using your real name) comment:

Don't use growth projections to fit the income you want. Adjust your income to the volatility you can handle and afford.

 

[cremeegg]

Short of an outright default, you can't really have a collapse in bonds.

But people see bonds as safe investments, even a small loss would be unexpected.

Colm has outlined how a fairly significant loss could be made under circumstances which are hardly unforeseeable.

Interest rates are currently at zero (more or less). That makes the maths simple. My guess at a reasonable "worst case" scenario is for interest rates to increase to (say) 3%, with an average bond duration of 7 years. Suppose you hold a 3% coupon bond. Its value at 0% interest is 7*3+100 = 121. Its value at 3% interest is 100, so the fall in market value of the bond element of the portfolio in that "worst case" scenario is 17.3%. (1-100/121).

I have no idea what the average maturity of the bonds in my pension is.

Am I the only investor who does not understand the risks I am exposed to in bonds.

However, the increased yields will quickly overwhelm and supersede the capital losses within a bond fund.

Can you explain this. I would have thought that in the case outlined above the income I receive on the bond is unaffected.

What impact will a sharp uptick in the cost of debt have on equities (bearing in mind that corporates now carry a lot more debt than was the case 10 years ago)?

This is a good point, although companies have the potential to adapt their strategies to changing circumstances, something that does not happen with.

And what impact will a sharp increase in the cost of debt have on property prices?

Less than you might think. The interest element of the repayments on a new mortgage are small. If the increase in the cost of debt occurs along with an increase in inflation then property prices may even increase.

 

[Colm Fagan]

Not true.

The Nikkei 225 is worth a little over 50% of its peak in yen terms.

I don't have the figures to hand, but your 50% ignores dividends. With dividends, the conclusion is different. Also, I was using "cash" as a short-hand for money on deposit in Japan, earning negative interest.
In any event, I have already argued that Japan was a one-off, and shouldn't be used as an example of what might happen in the long-term with a pure equity-based strategy. Even I, who favour a concentrated portfolio, would not put all my eggs in one basket in one country, and at values that I could never justify in projected cash flow terms. For all of my bigger investments, I do the DCF calculations to check that they will deliver real value in the long-term on plausible assumptions for how the future might unfold. Referring back to @cremeegg 's question above, many of us DID recognise a massive bubble in Japan back in the late 1980's, in exactly the same was as we recognise a massive bubble in bond prices today.

 

[elacsaplau]

Colm,

Why say things that are not true?

Firstly,

I don't have the figures to hand, but your 50% ignores dividends. With dividends, the conclusion is different. Also, I was using "cash" as a short-hand for money on deposit in Japan, earning negative interest.

Since January 1990 to date, the Nikkei has returned -19.06%...….that is with dividends reinvested. Thus, the central conclusion remains valid.

Note: Even before getting the figures, I knew that this would be the case. You can't have it both ways by claiming earlier that Japanese prices were in the stratosphere relative to earnings and that a portion of these same miserable earnings would subsequently be distributed as dividends and would somehow save the day.

Secondly,

As it happens, though, you have defended the strategy I'm unhappy with, of excessive belief in so-called "defensive" assets:

I don't have an excessive belief in defensive assets. I actually said the opposite in relation to holding excessive levels of defensive assets - as in: "excessively high or low allocation to return seeking assets should be a minority sport."

It follows that you made an accusation that was completely without foundation and that rather than acknowledge this, regrettably, you have tried Boris-like to deflect the issue by stating that I had said something that I hadn't said and by questioning my anonymous status! That bates Banagher so it does....

Finally, I am pleased that you have acknowledged that that people have different capacities to take risk. It follows that they need to determine an appropriate asset allocation based on their capacity to take investment risk. In designing this strategy, especially in respect of the income drawdown phase, sequence of risk is a real consideration...……...

 

[Sarenco]

@cremeegg

A few points:-

1. (Intermediate-term) bond funds don't have a stable value - but they're nowhere near as volatile as equity funds. Bond funds can certainly suffer drawdowns over any short-term period.

2. Bond fund portfolios are not static, their composition changes constantly. So, if there's a spike in yields, the portfolio manager would reinvest bond income in the now higher-yielding bonds or would use the principal value of a maturing bond within the portfolio to buy such higher-yielding bonds, etc.

3. The effective duration of the aggregate Eurozone bond market is a little over 7 years so it's fair to assume your bond fund has a broadly similar term exposure.

4. The last time we saw a spike in borrowing costs equities and real estate got crushed.

5. Finally, the correlation between different asset classes is important. When stocks suffer a drawdown, there is often a "flight to safety" causing bond prices to rise.

 

[NoRegretsCoyote]

I don't have the figures to hand, but your 50% ignores dividends. With dividends, the conclusion is different.

Agreed. But even with reinvesting earnings, you still have a -12% negative return August 1989 to date on the Nikkei 225.

Also, I was using "cash" as a short-hand for money on deposit in Japan, earning negative interest.

But short-term interest rates have been positive almost the whole period since 1989 in Japan! See chart.

However way you cut it, cash on deposit over the last 30 years has performed better than equities in Japan. Sorry for the pedantry but you are making throwaway claims that are demonstrably false. You say you dislike pseudonymous posting. Fair enough. I find it bizarre that someone whose website trumpets their actuarial qualifications would be so loose with basic facts about financial history.

In any event, I have already argued that Japan was a one-off, and shouldn't be used as an example of what might happen in the long-term with a pure equity-based strategy.

Japan is and was a large, industrialised, diversified economy. It wasn't a small island which had struck oil prone to boom and bust. It's a useful cautionary example to what can happen to equities.

in exactly the same was as we recognise a massive bubble in bond prices today.

If it's a bubble, how much is it overvalued by, and when will it adjust? It's easy to toss around the word 'bubble', but without specifics it's not a meaningful term.

 

[NoRegretsCoyote]

5. Finally, the correlation between different asset classes is important. When stocks suffer a drawdown, there is often a "flight to safety" causing bond prices to rise.

True, there is greater demand for bonds when equities are on the slide. But that was when interest rates were higher and in positive territory. There is a natural floor to interest rates. No one knows where it is, but we are close to it. A world of a -2% risk-free rate is not impossible to envisage.

So my question is who will buy all these bonds with a guaranteed negative return? My guess (and it's just a guess) is that any correction in equity prices could see property prices go up, as people chase yield.

 

[Duke of Marmalade]

@cremeegg

3. The effective duration of the aggregate Eurozone bond market is a little over 7 years so it's fair to assume your bond fund has a broadly similar term exposure.

cremeegg with 7 year duration a "crash" in bond prices is not going to happen but it is not terribly important if it does. In 7 years time the 30% of you current holdings which are in 7 year bonds will be worth what they are today, as they have a "guaranteed" yield of c. 0%. So it is dead money rather than money waiting to fall off a cliff. So what purpose does dead money serve? None as far as I can see. Cash might be viewed as dead money but it is ready to pounce into life on an uptick in interest rates. 7 year bonds are zombies for the next 7 years.