Bonds

A subscriber requested validation of the performance of a simple momentum strategy that each month selects the best performing debt mutual fund based on total return over the past three months. To investigate, we test a simple strategy on the following 14 mutual funds, most of which have long histories:

T. Rowe Price New Income (PRCIX)
Thrivent Income A (LUBIX)
Vanguard GNMA Securities (VFIIX)
T. Rowe Price High-Yield Bonds (PRHYX)
T. Rowe Price Tax-Free High Yield Bonds (PRFHX)
Vanguard Long-Term Treasury Bonds (VUSTX)
T. Rowe Price International Bonds (RPIBX)
Fidelity Convertible Securities (FCVSX)
PIMCO Short-Term A (PSHAX)
Fidelity New Markets Income (FNMIX)
Eaton Vance Government Obligations C (ECGOX)
Franklin Floating Rate Daily Access A (FAFRX)
Vanguard Total Bond Market Index Adm (VBTLX)
Principal Spectrum Pref&Cptl Scs IncA (PPSAX)

We consider a strategy that allocates funds at the end of each month based on total returns over a specified ranking (lookback) interval to the Top 1, equal-weighted (EW) Top 2, EW Top 3, EW Top 4 or EW Top 5 funds. We determine the first winners in November 1988 so that at least nine funds are available for lookback interval sensitivity testing. As a benchmark, we use the equal-weighted and monthly rebalanced combination of all available funds (EW All). Using monthly dividend-adjusted closing prices for the 14 mutual funds from inceptions through April 2024, we find that: Keep Reading

How should investors think about the correlation between stock market returns and bond market returns when constructing a diversified portfolio? In their April 2024 paper entitled “Stock-Bond Correlation: Theory & Empirical Results”, Lorenzo Portelli and Thierry Roncalli examine theoretical and empirical relationships between the stocks-bonds return correlation and other variables/conditions. They focus on:

• Monthly returns of long-term government bonds and country stock markets (for example 10-year U.S. Treasury notes and the S&P 500 Index for the U.S.), but consider other choices for bond duration and stock portfolio.
• 48-month rolling returns when assessing correlation dynamics.

Using government bond and country stock market returns for the U.S. during 1965 through 2023 and for other developed, developing and emerging markets across Europe, the Americas and Asian as available through 2023, they find that:

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After seeing “Review of the Quantified Market Psychology Strategy”, reader Steve Ruoff requested review of his U.S. Treasuries timing strategy as recorded at Timertrac (Duration Strategy), which approximately every four weeks generates allocations to: Direxion Daily 7-10 Year Treasury Bull 3X Shares (TYD); Direxion Daily 7-10 Year Treasury Bear 3X Shares (TYO); and cash, for which we use SPDR Bloomberg 1-3 Month T-Bill ETF (BIL). Strategy inputs encompass:

1. Current economic activity, inflation metrics and monetary policy factors.
2. Valuation estimates focused on long-term mean reversion thresholds.
3. Technical rules focused on price momentum.

To investigate, we download the Timertrac trade history for the Duration Strategy and replicate its performance using the selected exchange-traded funds (ETF). We look at average trading activity, average trade return, standard deviation of trade returns, trade reward/risk (average return divided by standard deviation), compound annual growth rate (CAGR) and maximum drawdown (MaxDD) at the trade frequency. We look at buying and holding iShares 7-10 Year Treasury Bond ETF (IEF) as an alternative and also look at buying and holding SPDR S&P 500 ETF Trust (SPY). Using the Duration Strategy trade history and daily adjusted opening prices for all specified ETFs during mid-January 2014 through early March 2024, we find that: Keep Reading

Does iShares 20+ Year Treasury Bond ETF (TLT) exhibit a predictable monthly pattern due to beginning-of-month dividends and mid-month U.S. government consumer and producer inflation releases? To investigate, we calculate average cumulative return for TLT across the month (from trading day 1 through trading day 23). We also investigate exploitability of findings. Using daily raw and dividend-adjusted levels of TLT from the end of July 2002 (inception) through January 2024 (21.5 years), we find that: Keep Reading

Which comes first, adjustments in U.S. Treasuries yields across the term structure, or government announcement of new U.S. inflation data? To investigate, we relate monthly changes in yields for 1-year, 2-year, 3-year, 5-year, 7-year, 10-year, 20-year and 30-year U.S. Treasuries (GS1 through GS30) to monthly change in overall raw Consumer Price Index (CPI) for various leads and lags. Using monthly yields (average daily yields during a month) for Treasuries as available and monthly CPI during April 1953 through December 2023, we find that:

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Do Federal Funds Rate (FFR) actions taken by the Federal Reserve open market operations committee reliably predict stock market and U.S. Treasuries yield reactions? To investigate, we use the S&P 500 Index (SP500) as a proxy for the stock market and the yield for the 10-Year U.S. Constant Maturity Treasury note (T-note). We look at index returns and changes in T-note yield during the one and two months after FFR actions, separately for FFR increases and FFR decreases. Using data for the three series during January 1990 through December 2023, we find that:

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Should investors consider portfolio volatility when choosing allocations to stocks and bonds in their retirement accounts? In his October 2023 paper entitled “Retirement Planning: The Volatility-Adjusted Coverage Ratio”, Javier Estrada introduces volatility-adjusted coverage ratio (VAC) as an alternative retirement portfolio metric. He defines this metric as coverage ratio (C, number of years of withdrawals supported relative to retirement period length) divided by annual portfolio volatility during retirement. He compares optimal stocks-bonds allocations for different fixed real annual withdrawal rates across 22 country markets and the world market using either C of VAC. For all markets and withdrawal rates, he uses historical returns for stocks and bonds with annual portfolio rebalancing and 30-year retirement periods. Using annual returns for stocks and bonds and annual inflation rates in the U.S. during 1872 through 2022 (Shiller data) and in 21 other countries during 1900 through 2019 (Dimson-Marsh-Staunton data), he finds that: Keep Reading

Is the the conventional retirement portfolio glidepath as recommended by many financial advisors, away from stocks and toward bonds over time, really optimal? In their October 2023 paper entitled “Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice”, Aizhan Anarkulova, Scott Cederburg and Michael O’Doherty present a lifecycle income/wealth model using stationary block bootstrap simulations (average block length 120 months to preserve long-term behaviors) with labor income uncertainty, Social Security income, longevity uncertainty and historical monthly returns for stock indexes, government bonds and government bills across developed countries. They apply this model to estimate outcomes for several age-dependent, monthly rebalanced portfolios of stocks and bonds, including a representative target-date fund (TDF), as well as some fixed-percentage allocation strategies. They focus on a U.S. couple (a female and a male) who save during working years starting at age 25 and consume Social Security income and savings starting at age 65 with constant real 4% annual withdrawals. They evaluate four outcomes: (1) wealth at retirement; (2) retirement income; (3) conservation of savings; and, (4) bequest at death. Using monthly (local) real returns for domestic stock indexes, international stock indexes, government bonds and government bills as available for 38 developed countries during 1890 through 2019, they find that:

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Does a simple relative momentum strategy applied to tradable U.S. Treasury term structure proxies produce attractive results by picking the best duration for exploiting the current interest rate trend? To investigate, we run short-term and long-term tests. The short-term test employs five exchange-traded funds (ETF) to represent the term structure:

SPDR Barclays 1-3 Month T-Bill (BIL)
iShares 1-3 Year Treasury Bond (SHY)
iShares Barclays 3-7 Year Treasury Bond (IEI)
iShares Barclays 7-10 Year Treasury Bond (IEF)
iShares Barclays 20+ Year Treasury Bond (TLT)

The second test employs three Vanguard mutual funds to represent the term structure:

Vanguard Short-Term Treasury Fund (VFISX)
Vanguard Intermediate-Term Treasury Fund (VFITX)
Vanguard Long-Term Treasury Fund (VUSTX)

For each test, we allocate all funds at the end of each month to the fund with the highest total return over a specified ranking (lookback) interval, ranging from one month to 12 months. To accommodate the longest lookback interval, portfolio formation commences 12 months after the start of the sample. We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Using monthly dividend-adjusted closing prices for BIL since May 2007, for IEI since January 2007, for SHY, IEF and TLT since July 2002 and for VFISX, VFITX and VUSTX since October 1991, all through September 2023, we find that: Keep Reading

What conditions affect the correlation between stock and bond returns, a critical input to asset allocation decisions? In their July 2023 paper entitled “Empirical Evidence on the Stock-Bond Correlation”, Roderick Molenaar, Edouard Senechal, Laurens Swinkels and Zhenping Wang relate changes in this correlation to economic variables and analyze the implications of such changes for stock-bond portfolios. They employ rolling 36-month Spearman rank correlations for stock market and 10-year government bond returns to detect correlation changes. While considering longer periods, they focus on post-1952 monthly and post-1978 daily U.S. data (after Federal Reserve independence) as most representative of the future. Using stock and bond returns and economic data starting 1875 for the U.S., 1801 for the UK, 1871 in France and 1987 for Canada, Germany, Italy and Japan, all through 2021, they find that:

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