Bonds

Bonds have two price components, yield and response of price to prevailing interest rates. How much of a return premium should investors in bonds expect? How can investors enhance this premium? These blog entries examine investing in bonds.

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Preliminary Value Strategy Update

The home page and “Value Strategy” now show preliminary asset class ETF value strategy positions for May 2016. There may be small shifts in allocations based on final data.

Simple Term Structure ETF/Mutual Fund Momentum Strategy

Does a simple relative momentum strategy applied to tradable U.S. Treasury term structure proxies produce attractive results by indicating the best duration for exploiting current interest rate trend? To investigate, we run short-term and long-term tests. The short-term test employs four exchange-traded funds (ETF) to represent the term structure:

SPDR Barclays 1-3 Month T-Bill (BIL)
iShares 1-3 Year Treasury Bond (SHY)
iShares Barclays 7-10 Year Treasury Bond (IEF)
iShares Barclays 20+ Year Treasury Bond (TLT)

The second test employs three Vanguard mutual funds to represent the term structure:

Vanguard Short-Term Treasury Fund (VFISX)
Vanguard Intermediate-Term Treasury Fund (VFITX)
Vanguard Long-Term Treasury Fund (VUSTX)

For each test, we allocate all funds at the end of each month to the fund with the highest total return over a specified ranking interval, ranging from one month to 12 months. To accommodate the longest ranking interval, portfolio formation commences 12 months after the start of the sample. We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Using monthly dividend-adjusted closing prices for BIL, SHY, IEF and TLT since May 2007 and for VFISX, VFITX and VUSTX since October 1991, all through March 2016, we find that: Keep Reading

Best Government Bonds?

Are high-yield government bonds good bets? In his January 2016 paper entitled “Finding Yield in A 2% World”, Mebane Faber applies a simple value metric to global government bonds. He specifies a value portfolio as the equally weighted third (Top 33%) of 30 government bonds with the highest nominal yields, reformed/rebalanced monthly. He considers two benchmarks: (1) an equally weighted portfolio of all 30 bonds (Equal Weight); and, (2) a GDP-weighted index of 10-year government bonds of 17 non-U.S. developed countries (Foreign 10-year). He also considers performance of U.S. government Treasury bills (T-bills), 10-year notes and 30-year bonds. Using monthly total returns for the specified bonds in U.S. dollars during 1950 through 2012, he finds that: Keep Reading

Best Safe Haven ETF?

A subscriber asked which exchange-traded fund (ETF) asset class proxies make the best safe havens for the U.S. stock market as proxied by the S&P 500 Index. To investigate, we consider the the following 12 ETFs as potential safe havens:

Utilities Select Sector SPDR ETF (XLU)
SPDR Dow Jones REIT ETF (RWR)
iShares 20+ Year Treasury Bond (TLT)
iShares 7-10 Year Treasury Bond (IEF)
iShares 1-3 Year Treasury Bond (SHY)
iShares Core US Aggregate Bond (AGG)
iShares TIPS Bond (TIP)
SPDR Gold Shares (GLD)
PowerShares DB Commodity Tracking ETF (DBC)
United States Oil (USO)
iShares Silver Trust (SLV)
PowerShares DB G10 Currency Harvest ETF (DBV)

We consider three ways of testing these ETFs as safe havens for the U.S. stock market based on daily, weekly and monthly return measurement frequencies:

  1. Contemporaneous return correlation with the S&P 500 Index during all market conditions.
  2. Return/performance during S&P 500 Index bear markets as specified by the index being below its 200-day/40-week/10-month simple moving average (SMA) for the prior measurement interval.
  3. Return/performance during S&P 500 Index bear markets as specified by the index being in drawdown from a prior high-water mark by more than some percentage (baseline -10%) for the prior measurement interval.

Using daily, weekly and monthly dividend-adjusted closing prices for the 12 ETFs from their respective inceptions through January 2016, and contemporaneous daily, weekly and monthly levels of the S&P 500 Index from 10 months before the earliest ETF inception through January 2016, we find that: Keep Reading

SACEMS-SACEVS Mutual Diversification

Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, we relate monthly returns for the SACEVS and the SACEMS exchange-traded fund (ETF) selections and look at the performance of an equally weighted portfolio of the two strategies, rebalanced monthly (50-50). Specifically, we consider: SACEVS Best Value paired with SACEMS Top 1; and, SACEVS Weighted paired with SACEMS Equally Weighted (EW) Top 3. Using monthly gross returns for SACEVS Best Value and SACEMS Top 1 since January 2003 and for SACEVS Weighted and SACEMS EW Top 3 since August 2006, all through November 2015, we find that: Keep Reading

Analyst Disagreement on Risk-free Rate and Equity Risk Premium

What do company valuation experts think about the level of the risk-free rate and the equity risk premium? In their October 2015 paper entitled “Huge Dispersion of the Risk-Free Rate and Market Risk Premium Used by Analysts in 2015”, Pablo Fernandez, Alberto Pizarro and Isabel Acín summarize assumptions about the risk-free rate (RF) and the market/equity risk premium (MRP or ERP) used by expert analysts to value companies in six countries (France, Germany, Italy, Spain, UK and U.S.). Using 156 company valuation reports from 2015, they find that: Keep Reading

Frontier Government Bonds as Diversifiers

Are frontier government bonds useful as incremental diversifiers of diversified portfolios? In their September 2015 paper entitled “Frontier and Emerging Government Bond Markets”, Vanja Piljak and Laurens Swinkels examine the diversification value of U.S. dollar-denominated frontier government bonds at aggregate, regional and country levels. They first look at return correlations and then consider mean-variance portfolio optimization with global equities, U.S. Treasury bonds, U.S. high-yield corporate bonds, emerging government bonds and frontier government bonds. Using weekly total returns in U.S. dollars for 29 frontier government bond markets in the J.P. Morgan Next Generation Markets Index and for other J.P. Morgan bond indexes and the MSCI All Country World Index during December 2001 through December 2013, they find that: Keep Reading

Best Bear Market Asset Class?

A subscriber asked which asset (short stocks, cash, bonds by subclass) is best to hold during equity bear markets, defined simply as intervals when SPDR S&P 500 (SPY) is below its 10-month simple moving average (SMA10). To investigate, we test the following nine alternatives, five of which are bond-like mutual funds and two of which are gold-related:

Short SPY
Cash, with return estimated as the yield on 13-week U.S. Treasury bills (T-bill)
Vanguard GNMA Securities (VFIIX)
T. Rowe Price International Bonds (RPIBX)
Vanguard Long-Term Treasury Bonds (VUSTX)
Fidelity Convertible Securities (FCVSX)
T. Rowe Price High-Yield Bonds (PRHYX)
Fidelity Select Gold Portfolio (FSAGX)
Spot Gold

Specifically, we compare monthly return statistics, cumulative performances and maximum drawdowns of these nine alternatives for months during which SPY is below its SMA10. Using monthly T-bill yield and monthly dividend-adjusted closing prices for the above assets during January 1993 (as limited by SPY) through August 2015, we find that: Keep Reading

Evaluating Country Investment Risk

How should global investors assess country risk? In his July 2015 paper entitled “Country Risk: Determinants, Measures and Implications – The 2015 Edition”, Aswath Damodaran examines country risk from multiple perspectives. He provides an overview of sources and measures of country risk, addressing both sovereign default risk and equity risk premiums. Based on a variety of sources and methods, he concludes that: Keep Reading

SACEVS Input Risk Premiums and FFR

The “Simple Asset Class ETF Value Strategy” seeks diversification across a small set of asset class exchanged-traded funds (ETF), plus a monthly tactical edge from potential undervaluation of three risk premiums:

  1. Term – monthly difference between the 10-year Constant Maturity U.S. Treasury note (T-note) yield and the 3-month Constant Maturity U.S. Treasury bill (T-bill) yield.
  2. Credit – monthly difference between the Moody’s Seasoned Baa Corporate Bonds yield and the T-note yield.
  3. Equity – monthly difference between S&P 500 operating earnings yield and the T-note yield.

Premium valuations are relative to historical averages. How might this strategy react to increases in the Federal Funds Rate (FFR)? Using end-of-month values of the three risk premiums, FFR, total 12-month U.S. inflation and core 12-month U.S. inflation during January 1990 (limited by availability of specific FFR targets) through June 2015 (306 months), we find that: Keep Reading

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Current Momentum Winners

ETF Momentum Signal
for May 2016 (Final)

Winner ETF

Second Place ETF

Third Place ETF

Gross Compound Annual Growth Rates
(Since August 2006)
Top 1 ETF Top 2 ETFs
11.3% 11.5%
Top 3 ETFs SPY
12.4% 7.2%
Strategy Overview
Current Value Allocations

ETF Value Signal
for May 2016 (Final)

Cash

IEF

LQD

SPY

The asset with the highest allocation is the holding of the Best Value strategy.
Gross Compound Annual Growth Rates
(Since September 2002)
Best Value Weighted 60-40
12.7% 9.8% 7.8%
Strategy Overview
Recent Research
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