Stocks for the long run?

[Duke of Marmalade]

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.

 

[Silvius]

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?

 

[Sarenco]

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.

 

[Sarenco]

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.

 

[Silvius]

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....?

 

[Duke of Marmalade]

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.

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.

 

[Sarenco]

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.

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.

 

[Sarenco]

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.

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).

 

[Duke of Marmalade]

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.

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).

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

 

[lledlledlled]

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

 

[Silvius]

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.

 

[lledlledlled]

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?

 

[Silvius]

Do you have a mortgage or are you paying rent?

Thankfully, no.

 

[lledlledlled]

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.

 

[Sarenco]

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?

 

[Silvius]

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.

 

[Steven Barrett]

 

[Sarenco]

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) -

1. 100% equities - annualised return 10.92%; worst year -37.45%; maximum drawdown -50.97%
2. 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.

 

[Steven Barrett]

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

 

[lledlledlled]

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?