Stocks for the long run?

[Sarenco]

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.

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.

 

[Duke of Marmalade]

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)

 

[Sarenco]

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.

 

[Duke of Marmalade]

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.

 

[Duke of Marmalade]

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.

 

[elacsaplau]

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

warrants....

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

gets

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!!

 

[Duke of Marmalade]

warrants....

gets

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!!

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.

 

[Fella]

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.

 

[elacsaplau]

….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!

 

[Duke of Marmalade]

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.

 

[Fella]

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

 

[Sarenco]

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.

 

[Duke of Marmalade]

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

 

[Fella]

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.

 

[Duke of Marmalade]

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 :mad:

 

[Fella]

Absolutely! Why have I been so stupid :mad:

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 .

 

[Sarenco]

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.

 

[Duke of Marmalade]

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.

 

[Gordon Gekko]

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.

 

[Duke of Marmalade]

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.