One of the effects of PBSS (Post-Bear Stress Syndrome) has been the flood of money into fixed income over the last couple of years. According to the Investment Company Institute, from October of 2007 through May 2010 there have been net inflows into bond funds of $230 billion while there have been net redemptions from equity funds of $553 billion. After going through two major bear markets in 10 years, investors want less risk. It is only understandable that investors have reacted this way. Over the last ten years, investor’s focus has steadily moved from investing in order to achieve long-term financial goals, like providing for a comfortable retirement, to a focus on avoiding short-term portfolio losses. However, the further that we get from the last bear market the more investors are going to remember the whole reason for investing in the first place. Once again, they will start looking at their current assets and deciding whether or not they will have enough money to maintain their lifestyle throughout their lives. When those shifts in focus start to take place, more and more investors are going to take a closer look at their current asset allocation and wonder if their giant bond portfolio is going to get the job done.
For many investors today, their view of bonds has been colored by the performance of this asset class over the last thirty years. Over this period of time, the wind has been at the back of bond investors as the yields have steadily declined from their peak in 1981 (bond yields and prices move inversely).
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Data courtesy of The Leuthold Group.
However, the experience of fixed income investors was something entirely different prior to 1981. As seen in the chart above, from 1957 until 1981 bond yields trended higher (and bond prices declined.)
The chart below shows the real (net of inflation as defined by CPI) return of the 10 year Treasury Note Total Return Bond Index from 1969 to April 2010.
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Data courtesy of The Leuthold Group.
A lot of investors may be surprised by this chart. All of a sudden bonds don’t seem quite so safe when considered in the context of real (after inflation) returns. I have real return data for the 10-year Treasury Note Total Return Index from December of 1969 through April 2010. From December 1969 through December of 1981, when yields were rising, the average 12 month real return of bonds was -3.16%. From January 1982 through April 2010, when yields were declining, the average 12 month real return of bonds was 7.18%. The question now is what comes next for bonds. They have been excellent for 30 years, but we have also seen periods where they were dreadful.
Harold Parker, one of our senior portfolio managers, entered this business in the late 1970s and offers some perspective on investor sentiment towards bonds both then and now:
One of the problems with getting older is that you start to lose some of your old friends. I have been experiencing that in my life. The friends who are being called back to their maker were born in the early 1980′s and one by one they are disappearing. These friends, these remnants of a bygone era, are not people; they are Treasury bonds. They are some of the last survivors of a time when double digit yields on long term Treasurys were there for the taking. Locking in a “risk free” double digit yield for decades seems so attractive now, yet investors could hardly be persuaded to take long term bonds by anything short of a gun.
It was a different world when these old friends were born. Bonds had been in a decades-long bear market. Inflation was running at double digits. The conventional wisdom was that nobody in their right mind would buy a long-term bond. Real estate and gold were booming and it took yields of over 13% to entice buyers.
But alas, our old friends are leaving us. As they leave, we find ourselves in a very different world. We have enjoyed a decades-long bull market in bonds as interest rates have declined to levels not seen since our grandparent’s days. Inflation rates are low and and most non-bond asset classes look volatile and risky.
Nobody in their right mind would buy anything but a bond now.
With interest rates and inflation at rock bottom levels, every investor should be asking the question of what comes next for bonds. In order to achieve long-term financial goals, and with risk management still a priority, I would suggest that there are much better investment options than bonds right now. One such option would be our Global Macro strategy (available as a separately managed account and as the Arrow DWA Tactical Fund - DWTFX). This strategy can invest in bonds, but only does so when the relative strength of bonds is strong. The strategy can also invest in U.S. equities, international equities, currencies, commodities, real estate, and inverse equities.
The chart below shows the allocation of our Global Macro strategy to fixed income over the period of its testing and live performance. You will notice that the exposure to fixed income tends to pick up during major bear markets, but is reduced or eliminated when there is better relative strength in other asset classes.
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Investors have no desire to jump from the frying pan and into the fire in their search for safety. Yet, that may be exactly what they are doing by piling into fixed income right now. I would suggest that a global tactical asset allocation strategy would give them the comfort of knowing that it can be allocated very conservatively at times, but it will systematically move to other asset classes when needed.
To receive the brochure for our Global Macro strategy, click here. For information about the Arrow DWA Tactical Fund (DWTFX), click here.
Click here and here for disclosures. Past performance is no guarantee of future returns.
From the best I can tell, your global macro is a serious laggard and the others have earn no return in five years?
http://www.dorseywrightmm.com/downloads/mi_articles/DWA%20Manager%20Insights%202010Q1.pdf
Global Macro has not been around long enough to make a performance judgement. For our other products with somewhat longer track records, International is well ahead of its benchmark, Aggressive is on top of it, and Core and Balanced are running behind at the moment. If you looked at performance from inception to mid-year 2009, it would look terrible; if you looked at it from inception to mid-year 2008, it would look fantastic. Obviously, there is a lot of variability depending on the time frame used. Since all strategies have bad periods, I guess if you cherry-pick performance periods you can make any manager look like a hero or a loser. We are quite confident in the long-term performance potential of all of our relative strength-based strategies-potential backed up by a lot of outside research.