Formulating my 2014 allocation: age 58 with plan to retire someday! In these times of recent equity run up and irrational rates
S&P large cap 25%
S&P Mid Cap 5%
S&P Small Cap
Total WOrld Stock (exUS developed/developing) 20%
Emerging Markets 5%
High Dividend Yield 10% 70%
Interest Rate Hedged
-High Yield 10%
-Investment Grade 10%
Floating Rate Bonds 10% 30%
Short Term Duration Bonds
Might seem to be heavy in equities but given current investment climate dont know that I can stomach more fixed income.
Purposely out of small caps I think their pricing is pretty rich but larger cap may have some more room to run; general uncertainty has me taking a rather large stake in perhaps the most diverse of foreign indexes (both developed and developing) and a little bit of emerging markets for growth
Recognize some overlap between large cap and dividend index and between (2) foreign stock indexes
Taking stake in high dividend index to add some “bond-like exposure”
Within fixed income, approaches to minimizing rate risk are
-short duration bonds
-longer term hedged rate bonds leaning towards high yield as opposed to investment grade
Small stake in gold as it has been on downward slide of late and might be expected to offer further hedge against increasing rated
Nothing in real estate as I feel my residence provides more than sufficient exposure here of sorts
If you feel like chiming in on anything you like or dislike about this I am always interested in hearing from smart people…what say you…I think the text book only takes you so far in addressing this fairly unique environment!
Don’t venture outside of short duration bonds. It can be as risky as equities in the next decade.
As the long-gone VCH said: “See you in church??”
It is only 10%, other than the high yield stuff, which is more equity-like without being as correlated as equities. So I don’t see it all that bad.
At the same time, unless you need to neutralize specific liabilities, it is hard to argue the case for long-term bonds. TO some extent, there is a diversification argument for bonds, but even so, a rising interest rate environment is likely to hurt bonds AND equities at the same time, so the correlation will probably rise.
You could say that you’re holding long-term bonds because worried about deflation, but then holding cash will accomplish much the same thing, plus retain the option to invest when things look better.
All of this suggests that when long-term rates start to rise, they may rise quickly, since no one (except maybe the Fed and some insurance companies) is really going to want to buy long-term bonds. A long-term interest rate shock may not be such a bad thing (except for housing prices), since once interest rates rise, there will be more people interested in buying them. The main concern about letting long term rates rise is what the effect on employment is likely to be, plus the short term pain it will cause in equities.
Actually both the high yield and investment grade ETF’s (HYHG and IGHG, respectively) represent a long position in subject bonds - coupled with a short treasury position - bringing the net effective duration to around zero. It a relatively new offering but it seems to make sense to me…with the potential to earn the better return while also hedging the interest rate risk. That coupled with the floaters suggests a bond portfolio relatively free rate triggered capital erosion.
I don’t see where you are short treasuries in that mix, or maybe it’s just the way the numbers post on my screen.
The curve is likely to steepen before it rises in parallel, so the key rate durations need to be fairly matched. to get that net zero effect that you are talking about. In effect, that makes you long credit spreads, (as well as with the floaters). I’m not sure that’s a great place to be either. The effect of higher interest rates is likly to be to sqeeze aggregate demand, profit margins. I see that as an event that would more likely widen credit spreads. If you’re wrong, you lose money; if you’re right, you need to have much more allocated to make a difference.
High yield makes more sense. It might not be good to have now, but over the full business cycle, high yield bonds do seem to be nicely uncorrelated to both equities and fixed income, mostly because their rise and fall is out of phase with both equities and fixed income.
I believe simply the way the particular noted ETF’s are structured…those two noted ETFs combine the subject bonds with a short treasury position within them bringing their duration to about zero. I am not doing it, the hedge is structured in the productx themselves. These products appear to be designed with this investment climate in mind.
True that…my position is an implicit bet on narrowing credit spreads by intent. The treasury moves will be made only when data suggest traction toward a strengthening economy which typically would be associated with narrowing credit spreads. Agree with all you have said relative to the steepening of the curve and the effect of increasing long term rates on margins but its quite challenging to calibrate the net effect. Just trying to find a spot to weather the storm that you speak of (while trying not to avoid bonds altogether) for purposes of diversification.
And High Yields have been on a pretty good run of late…and can also be adversely effected by rate impacted shrinking margins so not certain that is a safe harbor either. No slam dunks to be found LOL.