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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.

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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

Unfooled by Randomness?

Can people reliably distinguish between actual financial markets time series and randomized data? In the February 2010 draft of their paper entitled “Is It Real, or Is It Randomized?: A Financial Turing Test”, Jasmina Hasanhodzic, Andrew Lo and Emanuele Viola report the results of a web-based experiment designed to test the ability of people to distinguish between time series of returns for eight commonly traded financial assets (including stock indexes, a bond index, currencies and commodities, all given names of animals) and randomized data. Using a sample of 8015 guesses from 78 participants over eight contests conducted during 2009, they conclude that: Keep Reading

Ideal Hedge for High-yield Corporate Bonds?

A reader asked: “My investments of choice have always been ‘junk bonds’ – high yield corporate debt. I have hedged my ‘junk’ at times with short positions in the Russell 2000 Index and a long-term Government Treasuries Fund. Is there something better? What is the ideal hedge for low-quality, high-income corporate debt?” Keep Reading

Do TIPS Work?

Are Treasury Inflation Protected Securities (TIPS), for which the Treasury adjusts the principal based on the Consumer Price Index for all urban consumers (CPI-U), effective as an inflation hedge? In their September 2009 paper entitled “A TIPS Scorecard: Are TIPS Accomplishing What They Were Supposed to Accomplish? Can They Be Improved?”, Michelle Barnes, Zvi Bodie, Robert Triest and Christina Wang evaluate the progress of the TIPS market toward providing: (1) consumers with a hedge against real interest rate risk; (2) holders of nominal bonds with a hedge against inflation risk; and, (3) everyone with a reliable indicator of expected inflation. Using inflation rate and bond yield data available since the introduction of TIPS in September 1997, they conclude that: Keep Reading

Hedging Against Inflation

How can long-term investors best hedge against inflation’s erosion of purchasing power? In their April 2009 paper entitled “Inflation Hedging for Long-Term Investors”, Alexander Attie and Shaun Roache assess the inflation hedging properties of traditional asset classes over different investment horizons. Using total return indexes for several asset classes from initial data availability (January 1927 at the earliest) through November 2008, they conclude that: Keep Reading

Bill Gross: Top Bond Gun

A reader suggested that we evaluate the forecasting prowess of Bill Gross, manager for PIMCO of the world’s largest bond fund. PIMCO describes itself as “one of the largest specialty fixed income managers in the world…” The predictions/recommendations evaluated here extend as far back as February 2000 and come from columns in MarketWatch, CNN/Money and TheStreet.com. The table below presents highlights from his commentary and shows the change in the 10-year Treasury note (T-note) yield (as a proxy for bond/interest rate behavior) over the 21, 63, 126 and 254 trading days after the publication date for each item. Note that a decline in T-note yield means a gain in T-note price. Red plus (minus) signs to the right of specific items indicate those that the market has subsequently proven right (wrong). We conclude that: Keep Reading

Stock and Bond Returns Correlation Variability

Stocks and bonds are two of the most frequently considered asset classes in asset allocation strategies. How stable is the correlation between stock returns and bond returns? In their December 2008 paper entitled “The Dynamic Correlation between Stock and Bond Returns”, Thomas Chiang and Jiandong Li apply rolling regressions to analyze variations in the correlation between stock market returns and bond market returns. Using daily returns for the Vanguard Total Bond Market Index Fund (VBMFX) and the Vanguard Total Stock Market Index Fund (VTSMX) as proxies for their respective markets over the period 6/20/96 through 6/30/08, along with contemporaneous U.S. economic data, they conclude that: Keep Reading

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