This morning, we came across a piece by Fran Kinniry of Vanguard suggesting that bonds lack investors’ respect when it comes time to talk diversification, complete with the required Rodney Dangerfield/no Respect mention:
“Oh when I was a kid, I got no respect. I played hide and seek. They wouldn’t even look for me.”
– Rodney Dangerfield¹
Like the late comedian Rodney Dangerfield, bonds suffer from a chronic lack of respect. It seems that everyone is “playing hide and seek,” searching for the “best” diversifiers to include in client portfolios, and they aren’t even looking for bonds.
Now, saying bonds lack respect is a bit of a first world problem, the same way one might complain that they’re one iPhone model behind or can’t get that reservation to the hot restaurant in town until May (OMG), or this all too serious first world problem:
Now, what if, as Seahawks cornerback Richard Sherman says – Money equals respect. Just how much respect/assets are in the un-respected bond sector: try over $100 Trillion (with a ‘T’) in Corporate and Government debt worldwide…. Seems like more than a few people have “paid” their respect to the bond sector per this metric; more in fact, than have paid their respect to global stock markets – which have assets of “just” $69 trillion.
Source: MarketWatch
But maybe we’re confusing Mr. Kinniry’s message. Maybe he’s saying they lack respect as a crisis period performer. That they get assets because of income and all that boring stuff, but not because of their performance during poor stock market periods (what we call ‘down capture’) in the business. Investment grade bonds, it turns out, have very good ‘down capture’ abilities – posting positive returns (on the average or the median, actually) during the worst months for U.S. Equities (the bottom-decile). Here’s Kinniry’s analysis:
Specifically, if we sort monthly equity returns into deciles and examine the worst periods, we find that high-quality bonds² have proven to be one of the best diversifiers for a portfolio. That’s pretty impressive, especially compared with the other asset classes that I get asked about, none of which has provided downside protection when investors arguably needed it the most.
(Disclaimer: Past performance is not encessarily indicative of future results)
Chart Courtesy: Vanguard
Impressive numbers, to be sure… with investment grade bonds clocking in a monthly return of about 1% while US stocks were down about -6% on average. And done with a method we haven’t seen before – looking at the performance during the worst months versus worst string of months (aka periods). Our preference is to usually look at the periods themselves (see the investments in crisis periods infographic), as single months aren’t necessarily telling of the actual pain investors suffer through. And we couldn’t help but notice one investment class notorious for performing during stock market downturns was absent from the graph. Our specialty, managed futures.
Talk about no respect… managed futures got left out of a post about an investment class not getting respect.
Oh well, that’s easily corrected. We took the liberty of adding Managed Futures (via the Barclayhedge CTA Index) to the table just to see where it would land (full disclosure – we sort of knew it would be #1). Here’s the redrawn table:
(Disclaimer: Past performance is not necessarily indicative of future results)
Managed Futures = Barclayhedge CTA Index
Based on our view, with a +1.73% median monthly performance during stocks’ bottom-decile performance, Managed Futures is the best performing asset class on the table during these tough times. We’ll be the first to say that past performance is not necessarily indicative of future results, but with just a few hundred billion in assets versus the $100 Trillion in bond markets – we’re not sure bonds aren’t getting more than enough respect, and managed futures isn’t getting enough (as voted on by hard earned dollars, Euros, and Yen).
Kinniry goes further – showing some recent results of bonds as a diversifier…
The chart below presents the results for the six trading days between August 17 and August 24, when the U.S. equity market returned –11% and caused some investors to panic. It wasn’t surprising to me that, once again, bonds held up fairly well, mitigating some of the losses from the equity portion of balanced investor portfolios.
(Disclaimer: Past performance is not encessarily indicative of future results)
Chart Courtesy: Vanguard
And it’s almost like Vanguard was reading our minds on that one, because we posted some daily and monthly returns for Managed Futures as a whole, and some individual programs that did particularly well during that specific August tumble in the markets. If want true apples to apples, we turned to the Newedge CTA Index and found it recorded a +1.28% over the six days highlighted by Vanguard. Again, this puts Managed futures near the front of the line.
(Disclaimer: Past performance is not necessarily indicative of future results)
Managed Futures = Newedge CTA Index
One final note about diversification and crisis period performance. We know from 2007/2008 that crisis periods are caused by unknown factors, so called ‘black swans’; meaning, the next market crisis likely won’t look anything like the last one. It’s hard to envision what that would look like, but not hard to imagine a scenario where the next stock market crisis is caused by bond prices declining as interest rates rise. Bonds will always have a place in portoflios. Heck, with $100 Trillion of them out there, you’ll be hard pressed to avoid them even if you had the desire. But it’s a worthwhile exercise to ask yourself what will happen to your portfolio if bonds cause the next stock market decline, instead of cushioning it.
