You still need bonds

RYAN  By Guest Blogger Ryan Lewenza

We routinely meet with clients to discuss their portfolio, review their financial plan, provide our current outlook and to see if anything material has changed with them. In a recent review with a client, I recommended reducing risk in the portfolio by rebalancing the asset mix back to our long-term 60/40 asset allocation, trim higher risk US small-cap securities, and add to a low-risk bond position. The client asked why we were trimming securities that were doing so well and were profitable for a position that hasn’t done much over the last while. In response, I went through the merits of rebalancing, the benefits of a balanced portfolio, and discussed the importance of balancing risk with returns. That call got me thinking about this topic, so today I’m going discuss the need for bonds in a portfolio and how best to position the bond allocation in a rising interest rate environment.

First and foremost, the main reason we recommend holdings bonds is that it helps to reduce portfolio volatility, smooth out the ride, and through this, help keep our emotions in check so that we stick to the long-term plan.

One common way to measure volatility is using standard deviation, which measures the variability of returns around the long-term average – the higher the number the higher the volatility. Over the last 10 years, the TSX has exhibited price volatility of 14.1%, meaning that TSX returns have been 14.1% above/below the long-term average return over the last 10 years. Volatility (standard deviation) has been 11.4% for the S&P 500 over this period. And for the average Canadian balanced portfolio, the standard deviation has been much lower at 8.3%. So, we prefer balanced portfolios to an all-equity portfolio since the ride is much smoother and with more consistent yearly returns.

Volatility of Different Investments

Source: Canadian Investment Fund Standards, Turner Investments

The other important reason we like balanced portfolios is because bonds often zig when equities zag. This dynamic is why a balanced portfolio exhibits lower volatility.

In good economic times corporate profits rise and investors feel more optimistic about the outlook that they are willing to pay higher multiples (e.g., P/Es) for stocks. This combination of rising corporate profits and valuations pushes stock prices higher.

Central banks in turn tighten monetary policy by hiking interest rates. This helps to push bond prices lower (prices move inversely with yields). So stocks go up and bond prices go down, generally, in a strong economy.

Conversely, in a weak economy stocks typically decline and central banks lower interest rates to help spur growth which leads to higher bond prices. Again, bonds zig when equities zag. This is perfectly captured in the chart below which shows the relative performance of Canadian bonds and the TSX. Note how bonds will outperform stocks over certain periods (in green) and underperform stocks in other periods (in red). This chart captures the essence of why a solidly constructed and well-managed balanced portfolio works!

Bonds/Equities Out/Underperform Over Time

Source: Morningstar, Turner Investments

Finally, how should investors structure their bond holdings in this rising interest rate environment?

First is to focus on lower duration bonds. Duration measures a bond’s price sensitivity to changing interest rates. If a bond (or in our case a bond ETF) has a duration of 8, it means the bond will decline approximately 8% for every 1% increase in interest rates, or rise 8% for every 1% decrease in rates; the higher the duration the higher the price sensitivity to rising rates.

Given our view that rates are going to continue to slowly rise, we are positioning our balanced portfolio with lower duration bond ETFs so as to minimize the impact of rising rates. Later when interest rates are higher we’ll look to reverse this call and shift into higher duration/yielding bond ETFs.

The other key strategy for bonds in a rising rate environment is to overweight corporate bonds versus government bonds.

With the Fed and BoC now hiking rates, government bond yields are moving up and prices lower. This of course weighs on all bonds but corporate bonds tend to outperform when rates rise. This happens for a few reasons. First corporate bonds offer higher coupons (yields), which help lower the duration relative to lower yielding government bonds. Second, because investors are feeling more optimistic about the economy and financial markets they are more willing to buy corporate bonds, which pushes up their prices relative to government bonds resulting in compression of the yield spread over government bonds.

Below is a chart comparing US investment grade corporate bond yields to comparable US government bond yields. Currently with US corporate bonds yielding 4.25% and US government bonds yielding 2.35%, this results in a “spread” of 190 bps. As the economy picks up this spread compresses which results in corporate bonds outperforming government bonds. We believe this spread could compress a bit further resulting in additional outperformance from corporate bonds. We’ll look to reverse this trade as we start to believe the economy is rolling over.

US Credit Spreads

Source: Bloomberg, Turner Investments

We get it. In a raging bull market like we’ve been in for some years, bonds can be disappointing and cause us to deviate away from a balanced portfolio, focusing more on equities. But as we’ve shown, the benefits of including bonds in a portfolio are to reduce volatility and provide more consistent returns. And we’re not always going to be in a bull market so you’ll need protection against this inevitability. I feel confident that our client will call me up to thank me for our recent portfolio adjustments, likely when that dreaded bear market rears its ugly head. How are you positioned for this eventuality?

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

88 comments ↓

#1 LivinLarge on 12.09.17 at 2:55 pm

It will be fun to watch the comments today.

No friends in dire straights, no mention of Morneau, T2 or even some poor schmuck paying his lawyer’s Mercedes lease to chase a sleazy RE agent who crapped on a house purchase.

The truly important investment education stuff isn’t sexy enough to get a deplorable out of bed on a Saturday.

#2 How am I positioned ? on 12.09.17 at 2:56 pm

100% equities

(20% of which is in small caps and tech)

35 yr time horizon. Bonds decease volatility and returns .no interest in them

I’ll reasses when getting closer to retirement
.And when in retirement it will morph into an income generating portfolio . The yield shield

#3 Lost...but not leased on 12.09.17 at 3:14 pm

Phyyrrzzzt..

Don’t miss my post re: BitCoin in last thread..what’s the difference between Bitcoin and Bitcon…

#4 For those about to flop... on 12.09.17 at 3:19 pm

Pink Pumpkins being carved in Coquitlam.

This is an old case that has been on and off the market as they are fighting to break even.

Shelled out 1.28 in March 2017.

Had it back on the market in May trying to make a quick buck.

Probably didn’t take them long to realize that things have changed slightly in Vancouver.

I wonder what some of these guys are going to get their realtor for Christmas…

M43BC

819 RONDEAU ST COQUITLAM.

May 20:$1,375,000
Dec 7: $1,338,888
Change: – 36112.000. -2.69%

https://www.zolo.ca/coquitlam-real-estate/819-rondeau-street

https://www.bcassessment.ca/Property/Info/QTAwMDAzWE5WTg==

#5 Raddoc on 12.09.17 at 3:30 pm

Interesting take Ryan but I’m going to have to push back a little regarding Portfolio Managers pushing Bonds onto clients (read: savvy, steadfast, young-to-middle aged clients looking to maximize wealth potential – which would be a good portion of the audience here).

I know this opinion may be controversial but despite all of your data in support of reducing volatility by mixing bonds into your portfolio, volatility should not be a primary metric to determine asset allocation. I think the decreased volatility helps the advisor’s nerves more so than their clients (with fewer angry phonecalls, fewer people threatening to pull their money in a bear market, and longer uninterrupted relationships with clients).

You see, the same argument about decreasing volatility by adding a bond mix can be said about Mutual Funds – yes the very investment vehicle that is loathed by savvy investors and aptly torched by Garth just yesterday. How so? Well, the active management of a Mutual Fund (bearing equities) will reduce the peak highs of an ETF by vulturing off management fees while also reducing falling knife lows (like in 08/09) by being overweight cash and cycling out of cockroach equities circling the drain before they shrink evermore from the Index weighting until it goes to 0.

The Mutual Fund returns may (and do) correlate with Equity returns in contrast to Bonds but the net effect is the same for both asset classes to your portfolio: lower overall long-term returns.

If your strategy is capital growth appreciation and you have a long timeline and aren’t sensitive to market gyrations, holding virtually no bonds in your portfolio will yield better overall returns. Period.

I don’t care what my private investment council advises me at our quarterlies, he’s instructed to be at the lowest possible weighting of Bonds in my portfolio asset mix by default.

#6 technical analysis? on 12.09.17 at 3:31 pm

sorry. that’s just bad advice. especially when there is NO reason to sell stocks. all you are doing now is reducing a winning position to buy a losing position. bad strategy. all you’ve done is limit the upside.

#7 Ed on 12.09.17 at 3:31 pm

Everybody positioning for the upcoming recession leads me to believe I’m still OK with a 80/20 portfolio. At any rate the bull market in the TSX is only 2 years old so far.

#8 Parksville Prankster on 12.09.17 at 4:06 pm

Being a belts AND suspenders type of fellow, now retired, I’m spread out as follows: 10% cash USD, 20% ZPR, 15% XSP, 5% ZDM, 5% VWO, 5% PFF, 10% CBO, 10% XBB, 5% ZRR, 15% XTR.

All have been maximized for tax effectiveness over taxable, RRSP, and TFSA accounts. Cash flow yield of about 4.25%, and growth somewhere around 3 ish %

Some would argue that the XTR is a dog because it has an MER of .6% and buffs up the monthly cash flow with return of capital, but meh, it’s nice to get a cheque every month.

#9 Dave on 12.09.17 at 4:14 pm

Canada is planning to buy used military jets from Aussie:

Current: CF-18

Used Upgrade: F-18

Think Sajjan should hold a ladder and Morneau paints over the “C”. Save billions of tax dollars so no need to tax small corps

#10 Huiforturner on 12.09.17 at 4:15 pm

But corporate bonds have stronger correlation to equities than treasuries, especially during recessions. So they are not especially good for reducing volatility when it matters most.

#11 Leinnay on 12.09.17 at 4:26 pm

Great post Ryan.

Does this advice of keeping durations short apply to Canadian and Municipal provincial bonds as well? What about for junk bonds and real return bonds? What’s the sensitivity of these other types of bonds (provincial, municipal, junk, real return) to interest rates?

What about prepared shares? They are not bonds per say but are somewhat in between bonds and equities.

Thanks.

#12 Michael B Chew on 12.09.17 at 4:29 pm

I noticed that rising interest rates and CAD can clobber both bonds and foreign equities. Balance and global can’t hide from this.

#13 active on 12.09.17 at 4:30 pm

bonds are for wusses.

#14 Capt. Serious on 12.09.17 at 4:32 pm

You’d never talk me into adding higher duration bonds to a portfolio even if you think your crystal ball is clear. There is zero evidence you’re compensated for going out on the yield curve. 2 – 5 years is the sweet spot. If you want higher returns, add equities. Going out on the yield curve adds little in expected return and exposes you to interest rate risk, which is one risk you can actually remove though keeping duration short.

#15 Leinnay on 12.09.17 at 4:42 pm

“The best choice right now … is 10% in short government bonds, 6% in corporates, 3% each in high-yield and provincial debt, plus a little cash and about 15% in preferred shares.”

Garth provided the gem above last month (http://www.greaterfool.ca/2017/11/21/up-up-up/).

That means:
– 10% government bonds
– 6% corporate
– 3% provincial
– 3% high yield
– 15% preferred
– 3% cash.

Ryan, without getting into trouble with the boss, do you care to comment about the allocation above.

Why the need for provincials?

Is the 3% position in cash too much?

Given that you favorite corporate bonds in this environment, why to keep a larger allocation to government bonds?

Your wisdom is greatly appreciated. Even more because you share it for free :-)

#16 Jimmy on 12.09.17 at 4:50 pm

Bond….

James Bond

#17 Nick on 12.09.17 at 4:56 pm

Bonds are priced too high with too little yield. I’d rather put money in several HISAs than expose myself to the Inflated bond market. This is way different than 2008. The bonds are in a bubble too.

#18 graphically challenged on 12.09.17 at 5:06 pm

What do the numbers on the y-axis of the “Bonds/Equities Out/Underperform Over Time” graph indicate, and what are the time units for the data (months)? Is the graph showing the ratio of performance from month to month?

#19 burnaby south gardener on 12.09.17 at 5:08 pm

Good day Ryan and blog dogs,
I am looking for advise for a young 30ish co-worker with less than $ 15, 000 to invest once she can get the funds out of the clutches of a BC credit union. She is treading water with the credit union mutual funds, and just learned how much she is paying in MER.

She has zero experience investing and is understandably preoccupied with raising her elementary school aged son as a single mother. Most of her net worth is in her townhouse, but she now understands how risky that is and wants to diversify. Selling the townhouse is not an option for reasons of free child care. She wants to go back to paying herself first, putting the funds into a TFSA rather than an RRSP as she has in the past. Given her income, I think she is wise.

Two questions, who should she open an account with? And given the small amount she has to work with, should she stick with something like the TD E-series mutual funds with ~ a 1 % MER?

Thank you,

#20 Ryan Lewenza on 12.09.17 at 5:24 pm

technical analysis “sorry. that’s just bad advice. especially when there is NO reason to sell stocks. all you are doing now is reducing a winning position to buy a losing position. bad strategy. all you’ve done is limit the upside.”

We trimmed US small caps and our asset mix back to 60/40. We didn’t sell all stocks. And yes I’ve limited the upside but reduced the downside. Investing is all about risk and return. Investors often focus too much on return, often to their detriment. Bonds help on this front. – Ryan L

#21 Triplenet on 12.09.17 at 5:26 pm

#4 Flop
How long is it going to take you to figure out what’s going on?

#22 Ryan Lewenza on 12.09.17 at 5:28 pm

Heiforturner “But corporate bonds have stronger correlation to equities than treasuries, especially during recessions. So they are not especially good for reducing volatility when it matters most.”

Agreed which is why we will reduce corporate bonds for government bonds when we start to believe a recession is coming. – Ryan L

#23 Ryan Lewenza on 12.09.17 at 5:32 pm

Liennay “Does this advice of keeping durations short apply to Canadian and Municipal provincial bonds as well? What about for junk bonds and real return bonds? What’s the sensitivity of these other types of bonds (provincial, municipal, junk, real return) to interest rates? What about prepared shares? They are not bonds per say but are somewhat in between bonds and equities.”

Yes the duration call applies to all bonds. Duration is more about the maturity of the bonds rather than the type of bonds. And we like prefs since they are linked to a rising GoC 5-year yield. So have shorter duration bonds, corporate bonds, and preferred shares in a rising rate environment. – Ryan L

#24 Lost...but not leased on 12.09.17 at 5:39 pm

Real Estate, bitcoin etc

When’s the peak?

Years ago, in the 1980’s knew a builder who gave advice re his exit strategy..aka when housewives, firemen and telecom workers start getting into the spec housing..time to get OUT.

Also a tech guy with a YouTube series..he was an executive with Cisco…when he heard his plumber telling him he(plumber) was going to quit has day job and get into the stock market..that was the sign for him to cash out.

#25 PBrasseur on 12.09.17 at 5:55 pm

“You still need bonds”

No you don’t.

#26 El Joko on 12.09.17 at 6:23 pm

Sorry for going off-topic, but I’m not sure anyone has seen this yet:

https://twitter.com/SteveSaretsky/status/939007027925327874

There’s “a booming private industry in which ordinary citizens are borrowing money from their home equity lines to lend money to desperate borrowers.”

#27 Tony on 12.09.17 at 6:31 pm

Re: #19 burnaby south gardener on 12.09.17 at 5:08 pm

B.C. credit unions will be the first to go bust. Good luck with deposit insurance.

#28 Mandria on 12.09.17 at 6:34 pm

Hi Ryan,

Thanks once again for a great post. In our case we have two public sector DB pensions in our household and I consider this to be (fairly) equivalent to bonds. I take this into account in planning our self-managed portfolio and run at about a 20/80 mix (fixed income is corporate bonds and prefs). Am I making an error in this view? Should I be looking to increase my bond position…I’m not convinced.

#29 Jungle on 12.09.17 at 6:37 pm

Come on guys,, you really think this bull market will go forever?

In 2008 a portfolio with bonds reality helped to reduce the blow then recovered quickly, if you were smart then you sold bonds and bought equity cheap (rebalance)

It seems there is an efficient frontier and when stocks are added to bonds you can almost get a free lunch with less volatility. Remember losses and gains are not equal and it takes more return to come back after you lose.

Look at the 2o year cagr of couch potato, 25% and 10% bonds weighting returned almost the same thing but with 25% bonds you had same return with less risk, and much easier ride.

#30 TRUMP on 12.09.17 at 6:44 pm

Bonds are for gentlemen….

I wouldnt even come close to them with your !#&*.

#31 Ryan Lewenza on 12.09.17 at 6:45 pm

Leinnay “Ryan, without getting into trouble with the boss, do you care to comment about the allocation above. Why the need for provincials? Is the 3% position in cash too much?”

That’s close to our current breakdown. The short-term bond position also has some corporate bonds. So when you add up all the corporate bonds spread across our different ETF positions you get a higher weight of corporate bonds to Federal government bonds. We like provincials since we get a 1% higher yield without much more risk. And we still love those prefs. – Ryan L

#32 Loonie Doctor on 12.09.17 at 6:53 pm

I have admittedly been very low on the bond allocation for about a decade. I am slowly building it now aiming for the weighting you suggest. You and others have swayed me already and my main struggle has been how to stomach it in a rising rate environment. It’s kind of like when I had something I didn’t like for dinner as a kid. I am taking small bites and making faces. I’ll eat the government bonds last.

Volatility didn’t matter to me a decade ago, but I want the option to retire in about 8-10 years if I feel like it. When I start to draw money, volatility will matter and could affect my portfolio draw survivability if I had a bad luck sequence of returns. By then I’ll have “already won the game” (hopefully by a healthy margin), so no point in the ongoing risk of playing. The closer I get to that point, the less risk is warranted.

Thanks for your guidance and thoughts. It may not seem like it sometime, but they are being heard.

#33 AK on 12.09.17 at 6:56 pm

As of Friday, I am sitting at:

Reits 9.3%
Preffered Shares 2.7%
Bonds 2.7%
Stocks 85.3%

#34 Ronaldo on 12.09.17 at 7:07 pm

Million dollar poverty.

https://www.cnbc.com/2017/11/30/even-a-1-million-retirement-nest-egg-isnt-enough-anymore.html

#35 Frank on 12.09.17 at 7:11 pm

100% equities. Bonds you know in advance will decline because interest rates will rise. In the long run you need max returns for decades. Live with volatility.

There’s few Canadian companies to invest in, and those that are, are too small to be followed by analysts. Epicore Bionetworks for example 50% gain in 9 months but they’re being bought.

Small US companies give you an advantage over the funds. They’re too small for funds and ETFs. If you buy ETFs in an inflated market get small value funds such as XXM.b

#36 Stan Brooks on 12.09.17 at 7:13 pm

My thoughts:

1. Stock markets might be seen as growing too fast. Interest rate increases could drive declines.

2. Bonds have their value in an environment of rising rates.

But government bonds?
How increasingly indebted government can provide you with positive returns – real positive interest rates higher than inflation (vs increasing nominal rates where inflation is higher than the actual interest rate) in an environment of disappearing tax revenue and constant deficits is beyond my understanding of economics.

It is a highly unlikely possibility.

Don’t be fooled by the job reports. Quality jobs disappear, new jobs are low paid/minimum wage jobs and tax revenues decline, hence the deficit spending to continue at least in Canada for another 2 decades!

How can one count on real positive returns in such environment (consider also unfunded liabilities here) is a mystery to me.

Ability to further pile debt by governments is already severely limited.

When will the proverbial camel back of bonds/government debt be broken?

No one knows what will be the last straw to break it, but it could eventually break.

3. The likelihood of governments switching tax strategies to take more from the big businesses/the rich people instead of taxing the middle class and the poor is very low.

Don’t be fooled by the liberal lies that they are going after the rich, they are simply taxing the middle class more and will go extra mile to ensure the elite and the rich are protected (just look at wild bill’s personal wealth management ‘schemes’, he does not want you to have the same options as he has)

——————————-

So in such environment the stock markets rightfully rose in the last decade, the question is did they rise beyond the potential equilibrium value of expected future net returns considering other investment alternatives.

My answer on this is: No.

Emerging economies will continue to rise in long term, developed world could level (have real growth close to 0) but good companies from the western/developed world will continue to expand internationally.

Constantly rising dividends of 3-4 % from good companies will continue to outperform income from government bonds in the next decade or two.

preferreds and bonds from good companies are better option than government bonds.

So 60-70 % in stock market ETFs (some agriculture and moderate commodity exposure is a must), 20-30 in % preferreds and corporate bonds, 5 % in gold, 5 % in cash seems pretty good allocation to me.

It will give you a hedge against volatility in my mind better than a guaranteed loss in real terms from investment in government bonds.

Government bonds could rise marginally in value at times, but would you have the nerves to actively trade a guaranteed losing proposition?

I don’t.
When you see wild bill buying government bonds, call me.

#37 For those about to flop... on 12.09.17 at 7:13 pm

Pink Pumpkin Update.

This Pumpkin is back on the market for another try at getting their money back.

Two things of note.

One…that November 21st date below is from 2016 and so it is a long drawn out saga for a relatively affordable option.

Two …either the owners,realtor or both thought that taking $12 bucks off was going to snag someone into dropping 1.4 million on a 62 year old crapshack…

Put it back on the market again this time still at the reduced price.The number they are holding out for is classic Pink Draw material.

A prediction.

Will run around telling everyone that they made money on the flip.

Won’t disclose it was only 12 bucks…

M43BC

8455 14th Avenue, Burnaby paid 1.3 ass 1.35

Nov 21:$1,399,900
Jun 29: $1,399,888
Change.$12.00. 0%

https://www.zolo.ca/burnaby-real-estate/8455-14th-avenue

https://www.zolo.ca/index.php?sarea=8455%2014th%20Avenue,%20Burnaby&filter=1

https://evaluebc.bcassessment.ca/Property.aspx?_oa=QTAwMDAzV0tTRQ==

#38 Stan Brooks on 12.09.17 at 7:14 pm

#34 Ronaldo on 12.09.17 at 7:07 pm
Million dollar poverty.

https://www.cnbc.com/2017/11/30/even-a-1-million-retirement-nest-egg-isnt-enough-anymore.html

————————–

With measured ‘inflation’ 1-2 %, right?

What a scam.

#39 Ronaldo on 12.09.17 at 7:15 pm

#8 Parksville Prankster

Some would argue that the XTR is a dog because it has an MER of .6% and buffs up the monthly cash flow with return of capital, but meh, it’s nice to get a cheque every month.
==============================
Nothing wrong with XTR….a very good choice if you’re are into ETFs…..low volatility and steady return

#40 Ryan Lewenza on 12.09.17 at 7:18 pm

graphically challenged “What do the numbers on the y-axis of the “Bonds/Equities Out/Underperform Over Time” graph indicate, and what are the time units for the data (months)? Is the graph showing the ratio of performance from month to month?”

Numbers on the y axis are not that important. This is a relative chart so I divide the Canadian Aggregate Bond Index by the TSX Total Return Index. That’s it. A rising line means that bonds are outperforming the TSX and a declining line means bonds are underperforming the TSX. Across the x axis it’s just daily prices but over a 27 year period. Whenever looking at a relative chart where your comparing one asset to another, it’s the direction/trend that is important rather than the numbers. – Ryan L

#41 Dogman01 on 12.09.17 at 7:21 pm

TurnerNation

“The Agenda again? That most of rural area will become “no-go” zones for people. Oh there will be reasons given, forest fires, or in article it says “climate change” and water protection.

Watch their actions…and wait till electric cars with short ranges and no rural charging stations are forced. Then we’ll really be confined to the city. They are moving fast folks. Remember your old freedoms.”

The older I get the more I see patterns, are they patterns or are they plans? Now I know the Human mind (male mind) has evolved to see patterns, all the better to understand the story of where the antelope went (food) and what predator is following the antelope (danger).

I like conspiracy theories, not sure why others don’t question what is going on.

Arthur C. Clarke said : “Two possibilities exist: either we are alone in the Universe or we are not. Both are equally terrifying.”

I subscribe to the idea; if a secret group with a secret agenda is in place; is that not better then nobody being in charge?

There was a person here last week describing how modern nuclear war equals the end now.
Perhaps we are better off with someone “running the show”.

Anyway Turnernation; I like your comments\observations, are you a retired journalist?

#42 Ryan Lewenza on 12.09.17 at 7:27 pm

Jungle “Come on guys, you really think this bull market will go forever? In 2008 a portfolio with bonds reality helped to reduce the blow then recovered quickly, if you were smart then you sold bonds and bought equity cheap (rebalance). It seems there is an efficient frontier and when stocks are added to bonds you can almost get a free lunch with less volatility. Remember losses and gains are not equal and it takes more return to come back after you lose.”

Well said!! It’s human nature to pay little attention to risk during a bull market. But everyone rediscovers what risk means during bear markets. We’re still bullish, but this won’t last forever and hence why we believe in a balanced portfolio. – Ryan L

#43 Ryan Lewenza on 12.09.17 at 7:31 pm

Mandria “Thanks once again for a great post. In our case we have two public sector DB pensions in our household and I consider this to be (fairly) equivalent to bonds. I take this into account in planning our self-managed portfolio and run at about a 20/80 mix (fixed income is corporate bonds and prefs). Am I making an error in this view? Should I be looking to increase my bond position…I’m not convinced.”

As you know we’re big believers in the 60/40 model. But if you have good public sector DB pensions then you can tweak this and go a bit higher. I prefer 70/30 in this case but we’re splitting hairs. And I like your pref and corporate bond focus. – Ryan L

#44 HISA on 12.09.17 at 7:33 pm

Id like to see an article that explains why short term bonds are a better asset than a 2.3% federally insured savings account right now?

Short term bonds are never going to give you a material gain so you are only in it for the yield anyways. What short term government bonds are getting you that return?

HISAs are the real risk free rate of return right now.

#45 Jungle on 12.09.17 at 7:41 pm

XBB, a benchmark ETF with about 30% corp bonds and 70% gov bonds has returned 3.13% this year, (even with raising interest rates)

A 15 year shows annual return of 4.93%, according to morning star.

#46 Batman on 12.09.17 at 8:08 pm

Wait. Bonds have a negative/inverse correlation to stocks?
Is that tidbit sourced from “Old wives tales” 2000 edition?

#47 Re.,42 sorry Ryan on 12.09.17 at 8:45 pm

30 yr historical data :

A)100% stocks

B)60/40

Data ?

A) wins . Adding bonds deceases volatility AND returns . Fact.

Putting a well informed consumer in 60/40 with a time horizon of 30 yrs is playing to your fears

#48 Ponzius Pilatus on 12.09.17 at 8:47 pm

Birken stock, the largest shoemaker of top quality shoes in Germany gives Amazon the boot.
Apparently, Amazon sells too many fakes.

http://www.spiegel.de/wirtschaft/unternehmen/birkenstock-legt-sich-mit-amazon-an-a-1182571.html

#49 crossbordershopper on 12.09.17 at 8:47 pm

who cares about bonds, they have no place in most people conversation. i met a guy yesterday who has a 3700 loan with cashco. i said sure. he said he is paying 47.6 percent interest plus insurance. i was first shocked then i said dude, i would lend it to you for 10%. he said what? you can get a better deal than me? i said no you idiot, i would write you a cheque for 3700 and you go pay off those clowns.
and you pay me every paycheque bleneded over a year. same payment to them, they have him on the drip program
he said how do you have 3700 to lend me ? we work together and make the same money. what was i suppost to say i got couple hundred times that.
i have met millionaire who work at the gas station, and i have met guys who make 150 grand and dont have money for coffee if you meet them at the wrong time.
what has this got to do with bonds nothing, thats my point, there useless to 95% of people.

#50 Ronaldo on 12.09.17 at 8:50 pm

#101 Lost…but not leased on 12.09.17 at 2:32 pm

Totally agree with what you were saying. They’re playing with OPM so no loss to them either way. Interesting times ahead.

#51 Lee on 12.09.17 at 8:55 pm

#34 Rinaldo

That story is crazy. One million will generate a Sr $40000 per year in dividends, mostly tax free, and they’ll get $20000 per year from Feds tax free. $60000 per year tax free or virtually so is more than enough to live comfortably, especially outside the GTA or Vancouver. The writer is just trying to scare people into giving him a call.

#52 SF on 12.09.17 at 9:03 pm

Soooooo…. If my bonds go down in value, and I don’t sell them, I am still collecting monthly interest on those bond ETFs (sheltered in RRSPs & TFSA) doesn’t that mean my “loss” is only on paper, but I still have “cash flow”. If I just want the “cash flow” to withdraw once a year, then why would I bother ever selling the bond ETFs?

#53 Long-Time Lurker on 12.09.17 at 9:03 pm

#19 burnaby south gardener on 12.09.17 at 5:08 pm
Good day Ryan and blog dogs, I am looking for advise for a young 30ish co-worker with less than $ 15, 000 to invest once she can get the funds out of the clutches of a BC credit union. She is treading water with the credit union mutual funds, and just learned how much she is paying in MER.

She has zero experience investing and is understandably preoccupied with raising her elementary school aged son as a single mother. Most of her net worth is in her townhouse, but she now understands how risky that is and wants to diversify. Selling the townhouse is not an option for reasons of free child care. She wants to go back to paying herself first, putting the funds into a TFSA rather than an RRSP as she has in the past. Given her income, I think she is wise.

Two questions, who should she open an account with? And given the small amount she has to work with, should she stick with something like the TD E-series mutual funds with ~ a 1 % MER?

>You should take my advice with a grain of salt and get a professional’s opinion if you can. I’d just take the money and stick it in a high-interest savings account with one of the big banks. She’d have easy access to it for emergencies. The deposit is insured. The returns are puny but the money is very safe.

Preserving your wealth is just as important as growing it. In her situation and in the current environment, I think she’s just better off keeping her money safe.

I’ve read that around six hedge funds shut down this year because the managers are at a loss as to what to do in the current environment. Just this week I read one closed down because the manager doesn’t know what to do and if a market run occurs it’ll be difficult to get your money out. Buffett and El-Eirian are sitting on large cash positions.

In this kind of risky environment it’s more important to preserve wealth than to grow it. She can spend a year or so leisurely learning about investing and researching her options.

Anyway, that’s my opinion. Definitely get others.

#54 Ronaldo on 12.09.17 at 9:12 pm

#51 Lee on 12.09.17 at 8:55 pm

#34 Ronaldo

That story is crazy. One million will generate a Sr $40000 per year in dividends, mostly tax free, and they’ll get $20000 per year from Feds tax free. $60000 per year tax free or virtually so is more than enough to live comfortably, especially outside the GTA or Vancouver. The writer is just trying to scare people into giving him a call.
————————————————————
Your absolutely correct. This is what the industry does best. I recall vividly the “Freedom 55” chant back in the 80’s. That was never a reality even back then and even less so nowadays. Those with good pension plans manage quite well with much less than a million in their portfolio. In fact, many don’t even touch any of that as their pensions are adequate which is the case for my wife and I. The problem is with the 70% who have no pensions. That will definately be a problem for them and I know a few in that situation who can’t afford to retire and are forced to continue working. Some bad planning along the way or unforeseen circumstances such as marriage breakdown, illness or death of one of the spouses.

#55 TheSecretCode on 12.09.17 at 9:21 pm

So, in short, get ready for a recession.

#56 Kelsey on 12.09.17 at 9:39 pm

Ryan, what about the fact that Western governments are broke (particularly including unfunded liabilities), we have been in a 35-year bond bull market with interest rates near 5,000 year lows, and CPI systemically under estimates the true rate of inflation (hedonic price adjustments, substitution effect, etc.)? If you ask me, giving T2 money for 10 years with a nominal yield below 2% is madness, regardless of what Modern Portfolio Theory might tell us.

#57 Pepito on 12.09.17 at 10:03 pm

Non-resident Canadian, living overseas, fairly large portfolio almost all in provincial bonds, currently with a mix of 6 to 12 year durations left paying between 3-3.5%. No tax, minimal investment fees and combined with a small pension more than enough to live comfortably without touching the principal. Slept like a baby through 2008 and will through the next one.

#58 acdel on 12.09.17 at 10:19 pm

Interesting article! As mentioned many times it is always better to balance with so much uncertainty in the markets, who knows what the heck is happening out there.

Any chance you will get a Garth mosaic haircut on yourself as your picture illustrated of Trump? :)

#59 att on 12.09.17 at 10:48 pm

Two grammatical errors in the first two paragraphs makes you lose all credibility.

#60 Lost...but not leased on 12.09.17 at 11:24 pm

Re: data re: asking price.

On another blog a person made a good point re: asking price using $100 bill.

You can ask $150..even $200..but in the end it will only be worth what the given market decides.( in this case the obvious $100. )

The rest of the RE information simply clouds the discussion, which moreso builds the case for long overdue transparency.

#61 Leinnay on 12.09.17 at 11:33 pm

Thanks for taking the time to answer us Ryan.

#62 Newcomer on 12.10.17 at 12:16 am

#34 Ronaldo on 12.09.17 at 7:07 pm
Million dollar poverty.

https://www.cnbc.com/2017/11/30/even-a-1-million-retirement-nest-egg-isnt-enough-anymore.html
———–

This guy is mixing up retirement and financial independence. Sure 40 K is a bit tight, but if you only need it to last you 30 years and you don’t need to leave anything behind when you go, then (indexed at 2% inflation and 6% returns) you can draw about 60K/year. If you can count on 20 K/year from the government/pensions (which is not that unusual), you are up to 80K. Six and a half k a month just to spend (no need to save, no need to buy things for kids, go back to school, cover job-related moves, etc.) is hardly poverty.

If you want to drop out of the workforce at 35 and live a life of adventure then, yes, 1M is low, but for retirement, it’s fine.

#63 R on 12.10.17 at 6:18 am

#23 Ryan Lewenza on 12.09.17 at 5:32 pm

Liennay “Does this advice of keeping durations short apply to Canadian and Municipal provincial bonds as well? What about for junk bonds and real return bonds? What’s the sensitivity of these other types of bonds (provincial, municipal, junk, real return) to interest rates? What about prepared shares? They are not bonds per say but are somewhat in between bonds and equities.”

Yes the duration call applies to all bonds. Duration is more about the maturity of the bonds rather than the type of bonds. And we like prefs since they are linked to a rising GoC 5-year yield. So have shorter duration bonds, corporate bonds, and preferred shares in a rising rate environment. – Ryan L
Wow

“Now you know when recession is coming” Prem Watsa lost billions predicting recessions and market shock. May be He should come to you

#64 R on 12.10.17 at 6:21 am

#53

WHY NOT BUY BUFFET BRK-B AFTER ALL HE IS SITTING ON LARGE PILE OF CASH

#65 Kool Aid on 12.10.17 at 8:44 am

# 56 Kelsey

Ryan, what about the fact that Western governments are broke (particularly including unfunded liabilities), we have been in a 35-year bond bull market with interest rates near 5,000 year lows, and CPI systemically under estimates the true rate of inflation (hedonic price adjustments, substitution effect, etc.)? If you ask me, giving T2 money for 10 years with a nominal yield below 2% is madness, regardless of what Modern Portfolio Theory might tell us.
=====================================

Kelsey’s right, 5000 years Ryan, timing?

Are you having visions Ryan… war drums!

We’re missing some information, what are you not telling us.

#66 Another Deckchair on 12.10.17 at 8:48 am

@62 Newcomer:

“Sure 40 K is a bit tight”

Not disagreeing with you, but *somehow* a lot of Canadians are making this, or less, and are not dying of starvation or of cold living on the street.

How do they do it? Been keeping track of expenses for a while, and we’d have real difficulties; we “need” at least 2x that as before tax money.

Ontario’s $15.00 minimum wage, lets say 2,000 hours per year, that’s only $30,000.00.

What do these people do in, say, Toronto or Vancouver? One can see why so many adults live in their (or other) parents’ basements, or couples rent 2 bedroom apartments with other couples.

I won’t go into detail of where our money goes, but pets, booze, food, housing costs (a bungalow), do eat up a surprisingly large part of it. (only 1 car, minimal eating out, no TV…)

The Millennial Revolution couple are doing it, as are others, so all the more power (and respect) to them.

#67 Steven Rowlandson on 12.10.17 at 8:55 am

Bonds of any kind are only as good as the borrowers willingness and ability to honour their obligations.
Someone has to pay and it is either the borrower or the lender.

#68 I’m stupid on 12.10.17 at 9:09 am

Nice post Ryan.

I like to believe that I have a high tolerance for volatility, my wife not so much. Imagine having an all stock portfolio and trying to explain the wild price swings to your significant other. 60/40 portfolios were created to save marriages.

#69 Ryan Lewenza on 12.10.17 at 9:29 am

Kelsey “Ryan, what about the fact that Western governments are broke (particularly including unfunded liabilities), we have been in a 35-year bond bull market with interest rates near 5,000 year lows, and CPI systemically under estimates the true rate of inflation (hedonic price adjustments, substitution effect, etc.)? If you ask me, giving T2 money for 10 years with a nominal yield below 2% is madness, regardless of what Modern Portfolio Theory might tell us.”

I disagree with the premise that Western governments are “broke” and will ultimately default on their debt. But I do agree there is a lot of government debt sloshing around which should help to contain interest rates. Regarding unfunded pension liabilities I believe people overestimate this issue and I ultimately see this being address by lower pension payouts for retirees and higher pension payments from current contributors. To every problem there is a solution. I’m not saying it’s going to be easy and without casualties, but I do believe the high debt/unfunded pensions can be addressed in the decades to come. – Ryan L

#70 Shawn on 12.10.17 at 9:52 am

US small caps (i.e. IWM) completed a nasty bear market just recently. They declined 26% top to bottom in 2015-2016 – along with many other sectors and indexes (i.e. energy, biotech, EMs, oil, the NYSE composite, the TSX, etc).

A new bull market began Feb 2016. Small caps have demonstrated neutral performance relative to large caps (IWM:SPY) over both intermediate and longer term time frames. As the US economy heats up, they could actually outperform.

Don’t you think it’s early to cut this exposure?

#71 crowdedelevatorfartz on 12.10.17 at 9:54 am

@#59 att
“Two grammatical errors in the first two paragraphs makes you lose all credibility.”

++++++
This blog is free, without advertisements constantly bomdarding us……

Being a grammar nazi is childishly annoying…..so lets refund your money and you can go home.
This blog is free, without advertisements constantly bomdarding us……
Perhaps you could volunteer to spend all YOUR evenings and weekends creating, writing, posting and reading, editting all the comments?

Crickets.

#72 1st movers on 12.10.17 at 10:05 am

What about folks sitting on cash in a rising rate environment? e.g. #19 Burnaby

Moving from cash into a bond ETF now means seeing the market value of your position slide as rates go up. Smart guys like Ryan wouldn’t be recommending this if there wasn’t more to the story – what is it?

#73 crowdedelevatorfartz on 12.10.17 at 10:13 am

The bandwagon is going to get pretty full when all the Media start piling on……

https://ca.reuters.com/article/domesticNews/idCAKBN1E22KL-OCADN

And all the ‘you should have used a realtor” ads wont change a damn thing.

Happy Housing Crash Everyone!

#74 TurnerNation on 12.10.17 at 10:18 am

#41 Dogman01 human beings survived all these years on one thing: Instinct. (Which our teachers have bred out of us.) If your instinct doesn’t flinch when every year we get 1001 new laws restricting our movement, ThoughCrimes, nebulous heretofore unknown theories like “climate change” – all which require even more of our money taken from us – and so on. The car you own may overnight be declared an illegal polluter and sent to the crusher.

No I’m a 9-5er slave in the tax farm. But I also trade. A few trades each day, trusting my instinct and human behavior; money management. Slowing getting my instinct back.

#75 Freebird on 12.10.17 at 10:42 am

#31 Ryan Lewenza
That’s close to our current breakdown. The short-term bond position also has some corporate bonds. So when you add up all the corporate bonds spread across our different ETF positions you get a higher weight of corporate bonds to Federal government bonds. We like provincials since we get a 1% higher yield without much more risk. And we still love those prefs. – Ryan L
————————
Sounds like for those just starting/ with smaller funds and keeping it simple with 2-3 funds to look for a product with a higher ratio of corp to govt bonds (~5-7 yr maturity). From my own limited scans seems like they’re limited but a few could be close enough.Thx for covering the topic.

Does everyone have their scrapers and shovels etc ready?

#76 For those about to flop... on 12.10.17 at 11:03 am

I was trying to research something else and stumbled across this site.

Daily sales figures for Vancouver and The Valley.

I remember Myra Andrews used to post something similar occasionally.

Under each date click on the “read more” logo and it is all there to see.

I studied it ,but will keep my opinion to myself.

Some might say it’s relative,others rubbish…

M43BC

http://www.robchipman.net/category/daily-vancouver-sales-figures/

#77 Robert B on 12.10.17 at 11:16 am

Ryan

Thanks for the points on Bonds but…..

As we are going into a rising interest environment shouldn’t we be investing in raw Materials.

We could substitute some bonds for commodities like gold, oil, natural gas, forestry stocks and potash .

Your thoughts

#78 LivinLarge on 12.10.17 at 11:26 am

Ryan, this question may be premature but here goes.

With even senior Republicans like Lindsey Graham apparently resigned to at least a limited strategic nuclear engagement in DPRK, he’s advocating getting Americans out of the south now, what do you think is the sort rebalance plan when or if that happens?

I know you gnomes on 22 floor don’t like precious metals but I don’t know enough about investing in the aftermath of a nuclear conflict since the last one was 10 years before I was born and result in a huge bull market.

Since any conflict with be incredibly short lived and the north don’t have any stockpile of nukes to be a global threat, is this likely to be a flash in the pan and then back to a bull market?

#79 Gravy Train on 12.10.17 at 11:53 am

#59 att on 12.09.17 at 10:48 pm
“Two grammatical errors in the first two paragraphs makes you lose all credibility.”

What specifically about Ryan’s financial analysis do you take exception to? (I thought his analysis was excellent and thorough.)

Here’s something I just read in Ray Dalio’s Principles (New York, NY: Simon & Schuster, 2017, p. 226):
“… You get an idea of people’s preferences by observing what they focus on. For example, when reading, a sensing person who focuses on details can be thrown off by typos such as ‘there’ instead of ‘their,’ while intuitive thinkers won’t even notice the mistake. That is because the intuitive thinker’s attention is focused on the context first and the details second. Naturally, you’d rather have a sensing person than an intuitor [sic] preparing your legal document, where every ‘i’ must be properly dotted and every ‘t’ crossed just so.”

#80 D Swing on 12.10.17 at 11:55 am

Great post Ryan! Thank you

#81 Doug in London on 12.10.17 at 12:11 pm

It all makes sense to me. Sometime in the last week or so Garth mentioned a client that wanted to increase their exposure to equities to 75%. Now, as I read the comments here I see many posters think bonds are pretty much useless and equities are better. Once again I feel the time tunnel sucking me in and pulling me back to 2006-07 when that mentality was present. During this whole recovery from the crisis of 2008-09 I’ve heard and read a lot of fear of investing in stocks and equities and that seems to be subsiding now. No need to panic just yet, but it looks to me like an amber alert. I wouldn’t hurt to cash in some of those winning equities and put some of those profits into bond ETFs now. As I’ve said many, many , many, many, many , many, many times here you should invest like a governor. As the speed goes up, it closes the throttle to cut the power output. Just like that governor, don’t be afraid to cash in some of those stocks or equity ETFs (that you wisely scooped up when they were on sale) and move the money into bond funds. It’s so ridiculously simple.

#82 Kool Aid on 12.10.17 at 12:29 pm

Regarding unfunded pension liabilities I believe people overestimate this issue and I ultimately see this being address by lower pension payouts for retirees and higher pension payments from current contributors. To every problem there is a solution. I’m not saying it’s going to be easy and without casualties, but I do believe the high debt/unfunded pensions can be addressed in the decades to come. – Ryan L

——————————————————————–

Yes, the quickly approaching unfunded pension plunder that will decapitate workers that laboured a lifetime can be filed under “the facts of life.”

The generations below will pay more and those pensioners will receive less. I hope that is not correct, you’re right in noting a solution must emerge, when the math makes it so.

As consequence populism will expand and grow, you can bet the next federal election on it.

Keep wealth safe is paramount. Some how I feel this time is different historically, I’m not sure bonds will perform as in the past, which may put various bond classes in a precarious spot should a real financial flashpoint/crisis emerge.

I sense some central bank coordination during an impending crisis leading to sovereigns, institutions and cooperates doing what should have been down a decade ago, amputating the rotten limbs of debt to ensure survival.

This is peak debt.

#83 Spec on 12.10.17 at 12:33 pm

#72 fartz
“There is effectively no building ‘on spec’ in Canada, and this is a sharp contrast with the situation we saw in the United States,”

That’s food for thought…

In the US, they build for customers of shelter.
In the True North, they build for investors.
That should worry us.

#84 Kelsey on 12.10.17 at 1:19 pm

Thanks for the well thought out response and time you put into these posts Ryan. I do not agree that governments are not “broke” because they could in theory restructure their long-term obligations. If a company had to restructure long-term obligations to continue as a going concern, we would call that company bankrupt or insolvent (i.e. “broke”). However, I do agree that it is possible to find compromises that allow us to move forward. Nonetheless, I can’t imagine that the political will exists to cut government spending, pensions, etc., and raise taxes while leaving bondholders fully in tact. More than likely in my opinion though, and based on actions we have seen after ever crisis since 1987, the printing presses will run and bondholders will get their fiat back but with significantly reduced purchasing power.

#85 Ryan Lewenza on 12.10.17 at 1:45 pm

Shawn “A new bull market began Feb 2016. Small caps have demonstrated neutral performance relative to large caps (IWM:SPY) over both intermediate and longer term time frames. As the US economy heats up, they could actually outperform. Don’t you think it’s early to cut this exposure?”

We wanted to trim our US exposure given huge gains, premium valuations, and some concerns we have over this investigation into Trump/Russia. Also I believe we’re in the middle to late cycle of this bull market which is when small caps typically start to underperform. We’ve seen this YTD with small caps up only 10-11% versus S&P 500 up 17-18%. So given these two factors we decided to sell our US small caps. We’ll add this back during the next downturn. – Ryan L

#86 Ryan Lewenza on 12.10.17 at 1:52 pm

Robert B “As we are going into a rising interest environment shouldn’t we be investing in raw Materials.
We could substitute some bonds for commodities like gold, oil, natural gas, forestry stocks and potash. Your thoughts.”

Yes I agree with this and that is why we’re increasing our exposure to the TSX while reducing equity exposure to US. I think we’re in the later stages of this bull market (still has another few years left), which is when commodities do well so we’re adding to our TSX weight. From a stock/sector perspective you could start to overweight materials and energy. I think there is some good long-term opportunities in the energy space. – Ryan L

#87 Ryan Lewenza on 12.10.17 at 1:58 pm

LivinLarge “Ryan, this question may be premature but here goes. With even senior Republicans like Lindsey Graham apparently resigned to at least a limited strategic nuclear engagement in DPRK, he’s advocating getting Americans out of the south now, what do you think is the sort rebalance plan when or if that happens?”

I don’t think we see a war with North Korea. If US went to war, tens of thousands of South and North Koreans would perish on day one. The one thing I agree with Steven Bannon is his call that there will not be a war with North Korea. So I believe this will be addressed diplomatically and therefore little to no impact on bull market. – Ryan L

#88 Jungle on 12.11.17 at 7:08 am

@47 RE,. 42 Sorry Ryan 30 yr historical data :

A)100% stocks

B)60/40

Data ?

A) wins . Adding bonds deceases volatility AND returns . Fact.

Putting a well informed consumer in 60/40 with a time horizon of 30 yrs is playing to your fears

Using stingy asset mixer to test this some interesting data. Using TSX, S&p500, MSCI EAFE and All bonds (same as a couch potato)

I believe 25% weighing for bonds is the sweet spot to maximize gain and lower volatile.

Look at CCP model portfolio, it says 20 year GAGR for 10% AND 25% bonds IS THE SAME!! 6.63% annaulized

PS in the last 10 years, 07-2016, a portfolio with 25% bonds and those index above beat 100% equity portfolio. It’s only this year the 100% equity is just starting to beat that if we use 2007 as starting point.

Anyway

Now to stingy investor asset mixer for 30 years of data on benchmark return in CAD. Add your own trading cost and annual fees.

1987-2016, (30 years), all equity even split 8.37 % annal return

Same portfolio with 25% bonds, 8.36% annual 30 years!!

That’s how you get a free lunch with less risk. Now here’s how to boost returns: When stock market crashes really bad (like over -30%), sell all your bonds and rebalance into all equity. This will pull up your CAGR and recover MUCH faster from crash. Pull ahead for 5 years then after start balancing back slowly into bonds as bull market matures. Do this within 10 years and don’t get caught with your pants down (no bonds) as next market crash is coming