Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for October 2024 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for October 2024 (Final)
1st ETF 2nd ETF 3rd ETF

Best Government Bonds?

| | Posted in: 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:

  • Long-term gross performance increases systematically with nominal yield, with gross annual Sharpe ratios ranging from 0.13 for the bottom fourth of yields to 0.57 for the top fourth.
  • On a gross basis over the entire sample period, the Top 33% portfolio (see the table below):
    • Beats bond portfolio benchmarks by at least 2% per year.
    • Does not have an extraordinarily high maximum drawdown.
    • Is potentially diversifying, with low monthly return correlations with U.S. Treasury notes and bonds (-.06 to 0.16), and with the S&P 500 Index (0.28) and gold (0.31).
  • The Top 33% portfolio beats the other bond portfolios in most decades.
  • Current yield for the Top 33% portfolio is about 7%, compared to 3.6% for an equally weighted portfolio of bonds for all 30 countries.

The following table, excerpted from the paper, compares gross performance statistics for the Top 33% portfolio to those for various benchmarks. Results indicate that Top 33% gross performance is generally attractive and effectively diversifies U.S. Treasuries.

government-bond-performance-statistics

In summary, evidence indicates that apparently risky high-yield government bonds are potentially attractive yield-boosters and diversifiers of U.S. Treasury notes and bonds.

Cautions regarding findings include:

  • Results do not account for trading frictions for monthly portfolio reformation/rebalancing. These frictions would reduce performance and may differ across the portfolios presented. In mitigation, the author reports that results are similar for annual reformation/rebalancing.
  • Investors may not have efficient access to Top 33% bonds, and would bear management and administrative fees for access through a fund or funds that maintain a rolling portfolio of these bonds.
  • Per the paper, short-term currency exchange rate variations “can have major impact on returns.” In other words, investors should view high-yield government bonds as a long-term allocation.
  • As noted in the paper, the Top 33% portfolio involves some ostensibly unstable countries, but historical data indicate that volatility/drawdowns are not extreme.
Login
Daily Email Updates
Filter Research
  • Research Categories (select one or more)