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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.

Safe Haven Asset Dynamics

How does the effectiveness of safe havens vary over time? In the February 2012 draft of their paper entitled “Safe Haven Assets and Investor Behaviour under Uncertainty”, Dirk Baur and Thomas McDermott examine the roles of gold and U.S. Treasury instruments as safe haven assets during times of financial markets uncertainty. They define a safe haven asset as an asset that is either uncorrelated or negatively correlated with other assets when those other assets are in distress. They focus on the effects of changes in uncertainty (shocks) on asset values and on the pairwise relationships between stocks, bonds and gold. Using daily returns in U.S. dollars for a global stock market index, U.S. Treasuries (2-year, 10-year and 30-year) and gold bullion (spot and futures) from 1980 through 2010 (more than 8,000 daily returns over 31 years), they find that: Keep Reading

Bond Market-Aggregate Earnings Interactions

Do aggregate corporate earnings predict bond market returns? In his January 2012 paper entitled “Aggregate Earnings and Corporate Bond Markets”, Xanthi Gkougkousi investigates the relationship between aggregate earnings and corporate bond market returns. Using quarterly aggregate earnings for a broad sample of U.S. stocks with fiscal years ending in March, June, September and December and total quarterly returns for ten U.S. corporate bond indexes during January 1973 through December 2010 (360,614 firm-quarter observations), he finds that: Keep Reading

Stocks versus Bonds as Investment Horizon Lengthens

Should investors believe in the superiority of stocks for the long run and bonds for the short run? In his December 2011 paper entitled “Stocks, Bonds, Risk, and the Holding Period: An International Perspective”, Javier Estrada examines how the absolute and relative risks of stocks and bonds evolve as investment horizon grows (time diversification). Considering both annual and cumulative returns and various measures of variability/risk, he focuses on the question of whether stocks become less risky than bonds for long holding periods. Using annual total returns for stocks and bonds in 19 countries during 1900 through 2009, he finds that: Keep Reading

Real Value of TIPS for Investors

Can Treasury Inflation-Protected Securities (TIPS), with principal indexed to the U.S. non-seasonally adjusted Consumer Price Index for all urban consumers (CPI), play a valuable role in asset class diversification? In the January 2011 draft of their paper entitled “Optimal Portfolio Choice in Real Terms: Measuring the Benefits of TIPS”, Alvaro Cartea, Jonatan Saul and Juan Toro apply mean-variance optimization to measure the empirical diversification benefits of TIPS for long-term and short-term investors with portfolios including various combinations of equities, nominal Treasuries, commodities and real estate. Using nominal monthly returns for all TIPS issued before August 2009, grouped by maturity, for the period March 1997 through March 2010 (157 monthly observations) and contemporaneous returns for nominal U.S. Treasury instruments, U.S. stocks, commodities and U.S. home prices, they find that: Keep Reading

Futures Market Open Interest as Return Predictor

Do changes in the level of futures markets activity predict returns for corresponding asset classes? In their January 2011 paper entitled “What Does Futures Market Interest Tell Us about the Macroeconomy and Asset Prices?”, Harrison Hong and Motohiro Yogo relate futures markets open interest (the number of contracts outstanding) to future asset class returns. They focus on the 12-month change in open interest and 12-month future return. As noted by the authors, simple logic suggests that open interest should be a non-directional because each futures contract involves countering long and short positions. However, changes in the number of futures contracts could indicate changes in anticipated economic risks. Using monthly open interest data for 30 commodity futures, eight currency futures, ten bond futures, 14 stock index futures and corresponding asset class returns for periods from earliest availability of data through 2008, they find that: Keep Reading

Hedges and Safe Havens Across Asset Classes

How effectively and consistently do equities, bonds, oil, gold and the dollar serve as hedges and safe havens for each other? In their September 2010 paper entitled “Hedges and Safe Havens – An Examination of Stocks, Bonds, Oil, Gold and the Dollar”, Cetin Ciner, Constantin Gurdgiev and Brian Lucey investigate pairwise hedging and safe haven relationships among these five major assets/asset classes. The define an asset as a hedge (safe haven) for another if respective returns are uncorrelated or negatively correlated on average over the long term (during relatively short intervals of stress). They define the long term (relatively short intervals) as their entire sample period (rolling four-month subperiods). They define intervals of stress as returns in the lowest fourth of observations. Using daily levels of the S&P 500 Index, an index of 10-year Treasuries, nearest-month gold and oil futures and the Federal Reserve Nominal Trade Weighted Effective Index for the dollar from January 1985 through October 2009 (nearly 25 years), they find that: Keep Reading

Testing Bond Allocation Strategies

Can investors anticipate long-term changes in the interest rate environment accurately enough to support active management of bond portfolios? In their September 2010 paper entitled “Gains from Active Bond Portfolio Management Strategies”, Naomi Boyd and Jeffrey Mercer investigate the effectiveness of using Federal Reserve policy signals for two types of bond allocation timing strategies: (1) increasing (decreasing) portfolio duration in anticipation of rate decreases (increases); and, (2) anticipating narrowing or widening of the yield spreads between categories of bonds with different credit ratings. They assume that a falling (rising) interest rate interval begins the month after an Federal Open Market Committee (FOMC) bank discount rate decrease (increase) that follows an increase (a decrease) and ends the month after the next discount rate increase (decrease). Using FOMC announcements and monthly total returns for U.S. 30-day Treasury Bill (T-bill), U.S. Intermediate-term Government Bond, U.S. Long-term Government Bond, U.S. Long-term Corporate Bond and Domestic High-yield Corporate Bond indexes spanning 1973-2006, they find that: Keep Reading

Momentum Timing of Junk Bond Fund?

A reader commented and suggested: “Because bond trading costs would probably dwarf the excess profits described in ‘Momentum in U.S. Corporate Bond Returns’ for individual investors, perhaps the relevant question is whether switching from one junk bond fund to another based on 6-month momentum (with one skip-month) is effective.” Since the momentum in this case belongs to an asset class (junk bonds) rather than to specific bonds within it, a more useful investigation might be whether one should get in and out of junk bond funds based on momentum. Using monthly dividend-adjusted closes for the T. Rowe Price High-Yield mutual fund (PRHYX) and the 13-week Treasury bill (T-bill) yield (a proxy for return on cash) during September 1990 through July 2010 (239 months), we find that: Keep Reading

Momentum in U.S. Corporate Bond Returns

Do corporate bond returns, like stock returns, exhibit intermediate-term momentum? In their July 2010 paper entitled “Momentum in Corporate Bond Returns”, Gergana Jostova, Stanislava Nikolova, Alexander Philipov and Christof Stahel measure return momentum for U.S. corporate bonds. They form equally-weighted momentum portfolios monthly based on past six-month return, with a skip-month between ranking interval and portfolio formation to avoid short-term reversal, holding each portfolio for six months. Using total returns associated with 3.2 million quotes and transactions for 77,150 bonds over the period 1973-2008, they find that: Keep Reading

Closed-End Versus Open-End Bond Funds

A reader requested comments on the paper “Why Do Closed-End Bond Funds Exist?” by Edwin Elton, Martin Gruber, Christopher Blake and Or Shachar. This study investigates the unique aspects of closed-end bond funds using characteristics and performance data mostly from 1996-2006 for two samples: (1) 54 pairs of closed-end and open-end bond funds matched for manager, fund family and type of bond fund; and, (2) 332 closed-end bond funds. The essence of their findings (from the “Conclusions” section of the paper) is: Keep Reading

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