I don't get it with Index Linkers

[GoSeigen]

I should add that long dated nominal (rather than index linked) government bonds are the most likely to move in the opposite direction to equities in most market conditions.

Another theory. Equities have longer duration than most bonds but lower interest rates have tended to benefit both and vice versa.

Over say ten year plus periods inflation has bashed long bonds much more than equities.

If you think I am wrong, you explain to me why people buy them.

Profit share on investment of other people's money?

Who makes more money by investing their clients' money in bonds rather than equities? What does the FCA have to say about this? Here is a Vanguard article:

https://www.vanguardinvestor.co.uk/arti ... sification

They thought that a mixed portfolio of equities and bonds was a good idea, as did most of the financial services industry. It did not work out well recently. Could Vanguard have advised people to drop their bond holdings?

This is exactly what I did with my mother's investments which I managed until last year: absolutely no gilts and precious little cash. All was equity and corporate bonds. Then she handed the management to an "IFA". Of course first thing they did was liquidate eveything, i.e. 200% churn in the first year, and I bet you a million squid they put a significant amount into gilts/funds holding gilts and that there were significant commissions receivable. It makes my blood boil.

GS

[ChrisNix]

To quote a cliche, it is all in the price. Mr Market thinks that the relative pricing of equities and bonds is correct. Mr Market has average risk tolerance. If you are more risk averse, you will favour bonds and if you are less risk averse, you will favour equities. Mr Market sometimes gets it wrong. He usually assumes that the future will be like the past, and that the immediate future will be like the immediate past. That is usually right, but sometimes it is wrong. Nobody knows the future.

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

If you are the type of person who frets about consistent annual speed on their car journey, you set you cruise control to 10 mph under the speed limit and will achieve that objective. BUT you'll have to leave quite a lot earlier than someone who just drives as the road permits. Such people are likely to favour the lower short term volatility/lower expected return characteristics of a long and short term bond heavy portfolio.

If you hold short term bonds to cover short term funding needs but for ten year plus needs can live with greater short term market price volatility, you will probably favour the higher expected return/low risk of capital loss characteristics gained by replacing long-term bonds with index tracker funds of US/UK market equities.

In doing so you will reap the premium for absorbing the higher short term volatility. Most ex ante estimates put that at 3% p.a. plus, but as you Wiki article points out the measured ex post premium has tended to be 6% p.a. or more.

[GeoffF100]

Another theory. Equities have longer duration than most bonds but lower interest rates have tended to benefit both and vice versa.

Over say ten year plus periods inflation has bashed long bonds much more than equities.

If you think I am wrong, you explain to me why people buy them.

Profit share on investment of other people's money?

Who makes more money by investing their clients' money in bonds rather than equities? What does the FCA have to say about this? Here is a Vanguard article:

https://www.vanguardinvestor.co.uk/arti ... sification

They thought that a mixed portfolio of equities and bonds was a good idea, as did most of the financial services industry. It did not work out well recently. Could Vanguard have advised people to drop their bond holdings?

This is exactly what I did with my mother's investments which I managed until last year: absolutely no gilts and precious little cash. All was equity and corporate bonds. Then she handed the management to an "IFA". Of course first thing they did was liquidate eveything, i.e. 200% churn in the first year, and I bet you a million squid they put a significant amount into gilts/funds holding gilts and that there were significant commissions receivable. It makes my blood boil.

You are not Vanguard. Your clients do not have $trillions of bonds. If they tried to unload them, the impact on the global economy would be dramatic. IFA's are not allowed to receive commissions. They usually charge a percentage of the pot each year. However, if they do nothing, their clients say "what am I paying for?".

[ChrisNix]

Another theory. Equities have longer duration than most bonds but lower interest rates have tended to benefit both and vice versa.

Over say ten year plus periods inflation has bashed long bonds much more than equities.

If you think I am wrong, you explain to me why people buy them.

Profit share on investment of other people's money?

Who makes more money by investing their clients' money in bonds rather than equities? What does the FCA have to say about this? Here is a Vanguard article:

https://www.vanguardinvestor.co.uk/arti ... sification

They thought that a mixed portfolio of equities and bonds was a good idea, as did most of the financial services industry. It did not work out well recently. Could Vanguard have advised people to drop their bond holdings?

This is exactly what I did with my mother's investments which I managed until last year: absolutely no gilts and precious little cash. All was equity and corporate bonds. Then she handed the management to an "IFA". Of course first thing they did was liquidate eveything, i.e. 200% churn in the first year, and I bet you a million squid they put a significant amount into gilts/funds holding gilts and that there were significant commissions receivable. It makes my blood boil.

GS

Quite rightly!

Our corporate schemes largely held passive bond corporate bond of under 15 years maturities and index linked equity trackers.

No ratings below A-. Pure bonds, no alphabet soup stuff. Still earned tasty margin over gilts.

No defaults, and in 2008/9 Blackrock told us our portfolio was in top 10% of their UK pension scheme clients.

Chris

P.S. Most IFAs are incompetent parasites.

[ChrisNix]

To quote a cliche, it is all in the price. Mr Market thinks that the relative pricing of equities and bonds is correct. Mr Market has average risk tolerance. If you are more risk averse, you will favour bonds and if you are less risk averse, you will favour equities. Mr Market sometimes gets it wrong. He usually assumes that the future will be like the past, and that the immediate future will be like the immediate past. That is usually right, but sometimes it is wrong. Nobody knows the future.

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

As an aside, the focus on risk (i) to the near total exclusion of risk (ii), is why pension schemes/consultants were blind to the unpinned grenades which (twice leveraged) LDIs were in the last year or two at historically absurd real gilt yields. In fact, the only question was when the carnage would would occur.

[GeoffF100]

To quote a cliche, it is all in the price. Mr Market thinks that the relative pricing of equities and bonds is correct. Mr Market has average risk tolerance. If you are more risk averse, you will favour bonds and if you are less risk averse, you will favour equities. Mr Market sometimes gets it wrong. He usually assumes that the future will be like the past, and that the immediate future will be like the immediate past. That is usually right, but sometimes it is wrong. Nobody knows the future.

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

As an aside, the focus on risk (i) to the near total exclusion of risk (ii), is why pension schemes/consultants were blind to the unpinned grenades which (twice leveraged) LDIs were in the last year or two at historically absurd real gilt yields. In fact, the only question was when the carnage would would occur.

(i) It is short term volatility that loses you business or your job.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

[ChrisNix]

To quote a cliche, it is all in the price. Mr Market thinks that the relative pricing of equities and bonds is correct. Mr Market has average risk tolerance. If you are more risk averse, you will favour bonds and if you are less risk averse, you will favour equities. Mr Market sometimes gets it wrong. He usually assumes that the future will be like the past, and that the immediate future will be like the immediate past. That is usually right, but sometimes it is wrong. Nobody knows the future.

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

As an aside, the focus on risk (i) to the near total exclusion of risk (ii), is why pension schemes/consultants were blind to the unpinned grenades which (twice leveraged) LDIs were in the last year or two at historically absurd real gilt yields. In fact, the only question was when the carnage would would occur.

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences. Often involving debt covenants or liquidity crises. In some situations risk (ii) can destroy a business. Several LDI funds were nearly insolvent because of it.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

I concur that size is a crucial ingredient which must be weighed.

The problem is that put options are priced off risk (i) so it would be extraordinary if they did not overprice risk (ii). So not a risk neural investor, rather a risk (i) neutral investor.

Those who can structure their affairs appropriately and prudently are able accept to accept risk (ii) and reap the premium attached thereto.

[GeoffF100]

To quote a cliche, it is all in the price. Mr Market thinks that the relative pricing of equities and bonds is correct. Mr Market has average risk tolerance. If you are more risk averse, you will favour bonds and if you are less risk averse, you will favour equities. Mr Market sometimes gets it wrong. He usually assumes that the future will be like the past, and that the immediate future will be like the immediate past. That is usually right, but sometimes it is wrong. Nobody knows the future.

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

As an aside, the focus on risk (i) to the near total exclusion of risk (ii), is why pension schemes/consultants were blind to the unpinned grenades which (twice leveraged) LDIs were in the last year or two at historically absurd real gilt yields. In fact, the only question was when the carnage would would occur.

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences. Often involving debt covenants or liquidity crises. In some situations risk (ii) can destroy a business. Several LDI funds were nearly insolvent because of it.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

I concur that size is a crucial ingredient which must be weighed.

The problem is that put options are priced off risk (i) so it would be extraordinary if they did not overprice risk (ii). So not a risk neural investor, rather a risk (i) neutral investor.

Those who can structure their affairs appropriately and prudently are able accept to accept risk (ii) and reap the premium attached thereto.

Any option position can be replicated with a dynamically changing stock and bond portfolio, as Black and Scholes showed in the Nobel Prize winning work. If stocks overprice risk, options will do too.

If you believe that put options are overpriced, why don't you sell them? You can sell very long dated puts (called Leaps) on the US market. You can use equities as collateral. Dennis Eisen recommended that in his book Using Options to Buy Stocks.The longer the time period, the smaller the probability that equities will lose money, but the bigger the likely loss when that happens. Eisen focused on the probability of loss, rather than the size of the loss. He said that he did not have downside protection (i.e. use bull spreads). Rather him than me.

[ChrisNix]

In fact there is no Mr Market, merely the marginal buyer and marginal seller.

Risk tolerance can be expressed in many ways, but two germane ones are (i) standard deviation of short term returns, and (ii) probability of capital loss over ten year plus periods.

The volatility figures bandied around as risk metrics do not adjust for regression to the mean and if extrapolated are not remotely representative of risk (ii).

As an aside, the focus on risk (i) to the near total exclusion of risk (ii), is why pension schemes/consultants were blind to the unpinned grenades which (twice leveraged) LDIs were in the last year or two at historically absurd real gilt yields. In fact, the only question was when the carnage would would occur.

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

(i) It is short term volatility that loses you business or your job.

Only likely if you are in position where there are actual economic consequences. Often involving debt covenants or liquidity crises. In some situations risk (ii) can destroy a business. Several LDI funds were nearly insolvent because of it.

(ii) Probability of loss is only part of the story. The size of the likely loss is the other part. The probability of loss for equity investments goes down with time. The cost of insuring against loss (by buying put options) increases with time. Equity fans like to forget about that. (Options are priced by reference to a risk neutral investor: i.e. one who is equally content to hold the equity or the bond.)

I concur that size is a crucial ingredient which must be weighed.

The problem is that put options are priced off risk (i) so it would be extraordinary if they did not overprice risk (ii). So not a risk neural investor, rather a risk (i) neutral investor.

Those who can structure their affairs appropriately and prudently are able accept to accept risk (ii) and reap the premium attached thereto.

Any option position can be replicated with a dynamically changing stock and bond portfolio, as Black and Scholes showed in the Nobel Prize winning work. If stocks overprice risk, options will do too.

If you believe that put options are overpriced, why don't you sell them? You can sell very long dated puts (called Leaps) on the US market. You can use equities as collateral. Dennis Eisen recommended that in his book Using Options to Buy Stocks.The longer the time period, the smaller the probability that equities will lose money, but the bigger the likely loss when that happens. Eisen focused on the probability of loss, rather than the size of the loss. He said that he did not have downside protection (i.e. use bull spreads). Rather him than me.

Any option position can be replicated with a dynamically changing stock and bond portfolio, as Black and Scholes showed in the Nobel Prize winning work. If stocks overprice risk, options will do too.

I'm saying that the risk of holding equities, which in almost all markets have more short term volatility than longish bonds, is compensated with a premium return.

I should have no interest in seeking to replicate an options position.

If you believe that put options are overpriced, why don't you sell them? You can sell very long dated puts (called Leaps) on the US market. You can use equities as collateral. Dennis Eisen recommended that in his book Using Options to Buy Stocks.The longer the time period, the smaller the probability that equities will lose money, but the bigger the likely loss when that happens. Eisen focused on the probability of loss, rather than the size of the loss. He said that he did not have downside protection (i.e. use bull spreads). Rather him than me.

I don't hold with the idea that the loss will be bigger, at least on an annualised basis. In fact held long enough, major equity indices in US and UK have always gone up at some point.

If the put options are less than a decade and subject to margin calls they bring short term volatility risk into the equation. If not (and can't imagine anyone would buy such instruments nowadays) they could have attractions. I believe Berkshire Hathaway did that before margin calls became required.

I see options trading as a different beast. A good friend who is brilliant at this explains that what you are really trading is volatility. Much too arcane for old codgers like me!

[ChrisNix]

https://www.levendi-im.com/views/buffet ... ling-puts/

[GeoffF100]

I don't hold with the idea that the loss will be bigger, at least on an annualised basis. In fact held long enough, major equity indices in US and UK have always gone up at some point.

That is the nub of the issue. If you hold a stock for a day, the price is likely to move a few percent, but a complete wipe out is unlikely. If you hold it for ten years it is much more likely. If you hold it for a hundred years it is very likely. (Over 50% for whole stock markets historically.) The longer you hold a stock the more the price is likely to move. Interestingly, the price of a put option does not depend on the underlying growth rate of the stock. It cancels out in the derivation of the Black-Scholes formula. As I have said, if you believe that the market prices options incorrectly, you can bet against it. I have mentioned Eisen. Taleb is at the opposite end of the spectrum:

https://en.wikipedia.org/wiki/Nassim_Nicholas_Taleb

He advised hedge funds to buy up way out of the money options because he believed that they under-priced the impact of extreme events:

https://nassimtaleb.org/tag/hedge-funds/

He won big time on that occasion.

[ChrisNix]

I don't hold with the idea that the loss will be bigger, at least on an annualised basis. In fact held long enough, major equity indices in US and UK have always gone up at some point.

That is the nub of the issue. If you hold a stock for a day, the price is likely to move a few percent, but a complete wipe out is unlikely. If you hold it for ten years it is much more likely. If you hold it for a hundred years it is very likely. (Over 50% for whole stock markets historically.) The longer you hold a stock the more the price is likely to move. Interestingly, the price of a put option does not depend on the underlying growth rate of the stock. It cancels out in the derivation of the Black-Scholes formula. As I have said, if you believe that the market prices options incorrectly, you can bet against it. I have mentioned Eisen. Taleb is at the opposite end of the spectrum:

https://en.wikipedia.org/wiki/Nassim_Nicholas_Taleb

He advised hedge funds to buy up way out of the money options because he believed that they under-priced the impact of extreme events:

https://nassimtaleb.org/tag/hedge-funds/

He won big time on that occasion.

Geoff,

I never mentioned single stocks. I mentioned indices.

If you read the Buffett material via the link I posted I think you'll find his explanation will help you to understand.

He notes that Black and Scholes realised that their model wouldn't hold for medium and long term periods.

I think I can say with certainty that Taleb wouldn't take the other side of a BH put.

Apologies, but I'm not inclined to indulge further in this dialogue (on risk (ii) matters) until you get up to speed.

Happy reading!

Chris

[GeoffF100]

I have read your link and the other document linked from it. Firstly:

Are Puts the Wrong Price?

We know that markets are efficient, and that these premiums are “correct” from a hedged or risk neutral perspective. As we will look at below, the price of these options reflects the forward value of the equity indices and implied volatility. These are values that can be hedged or replicated by market participants.

Before we look at the investment solution it is worth delving a bit more into the nature of the opportunity. The basic thesis is that put premium looks to be too high. Part of the premium is because of a well-documented premium of implied volatility over historic volatility.

That is all fair enough. It does not invalidate my point that the cost of ensuring against loss increases with time. The market applies various adjustments to Black-Scholes. Notably, BS clearly underestimates the probability of extreme movements, e.g. 2008. Nobody disputes this. Provided that the volatility has not been underestimated, the market maker can generate the premium risk free by trading the stock or index in the market, given the downside protection.

The 2008 letter tells us that BH sold shed loads of 15 to 20 year S&P 500 European exercise put options. The numbers here look genuine. BH has always leveraged up, others are more risk averse.

The preamble says that WB thinks BS is wrong, but WB does not have evidence and cannot give alternative numbers. The numbers here are balmy. If put options were that cheap everyone would buy them. As I have said, about 50% of national stock markets have been wiped out in less than 100 years. The risk is real.

I have sold puts, by the way, and used to know all the maths.

[ChrisNix]

I have read your link and the other document linked from it. Firstly:

Are Puts the Wrong Price?

We know that markets are efficient, and that these premiums are “correct” from a hedged or risk neutral perspective. As we will look at below, the price of these options reflects the forward value of the equity indices and implied volatility. These are values that can be hedged or replicated by market participants.

Before we look at the investment solution it is worth delving a bit more into the nature of the opportunity. The basic thesis is that put premium looks to be too high. Part of the premium is because of a well-documented premium of implied volatility over historic volatility.

That is all fair enough. It does not invalidate my point that the cost of ensuring against loss increases with time. The market applies various adjustments to Black-Scholes. Notably, BS clearly underestimates the probability of extreme movements, e.g. 2008. Nobody disputes this. Provided that the volatility has not been underestimated, the market maker can generate the premium risk free by trading the stock or index in the market, given the downside protection.

The 2008 letter tells us that BH sold shed loads of 15 to 20 year S&P 500 European exercise put options. The numbers here look genuine. BH has always leveraged up, others are more risk averse.

The preamble says that WB thinks BS is wrong, but WB does not have evidence and cannot give alternative numbers. The numbers here are balmy. If put options were that cheap everyone would buy them. As I have said, about 50% of national stock markets have been wiped out in less than 100 years. The risk is real.

I have sold puts, by the way, and used to know all the maths.

The 50% of national stock markets perishing sounds about right but isn't relevant, because an informed investor is going to stick to very developed markets.

BH only sold puts in four markets: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan.

It appears you don't grasp the significance of the European, unmargined nature of such puts. That takes short term vol out of the game.

Why isn't everyone doing it? Because very few, if any other entities have the financial standing which would allow them to secure such terms.

In fact, I understand that under current regulation the counterparties which bought such puts no longer can count them as hedges, so I expect no more will be written.

It seem you should focus on risk (i) style option strategies. Best to stick to ones knitting!

Chris.

[ChrisNix]

P.S. BH hasn't done too badly: https://www.risk.net/risk-quantum/79418 ... ld-pre-gfc!

[GeoffF100]

It appears you don't grasp the significance of the European, unmargined nature of such puts. That takes short term vol out of the game.

American exercise does not increase the price of an option, because assignment before expiry throws away time value. Publicly traded Index options are usually (always?) European exercise. I do not expect that Buffet's options were publicly traded (i.e. they were over the counter options). That would be bad news for us. A two way market ensures fair prices, but I expect that Buffet was able to get near to the theoretical price. The market maker does not need a counter party, he can hedge by trading the index, which will generate the premium he has paid by buying low and selling high as the market price jiggles about. If it is an OTC option Buffet can have whatever exercise he wants.

Why isn't everyone doing it? Because very few, if any other entities have the financial standing which would allow them to secure such terms..

You and I can do it with Leaps. You can use your stock as collateral.You do not need to put up additional margin (unless the market really crashes, which would give Buffet problems too.) (You may have problems with the nanny state in the UK, but that is another issue.) You do not need cash margin. Leaps are currently limited to 39 months, according to this:

https://www.investopedia.com/terms/l/leaps.asp

...but you can roll them over.

In fact, I understand that under current regulation the counter-parties which bought such puts no longer can count them as hedges, so I expect no more will be written.

As I have said, counter-parties are not needed, but I expect that there are plenty of traders who want to short stock and indexes with limited liability.

[GeoffF100]

A few more observations.

Compare selling a put option with borrowing the money to buy the underlying stock (I will not bother keep saying or index). Because of call put parity, a sold put is equivalent to a covered call. The sold put has the same downside as the stock, but the upside has been sold for a fixed price. If the market maker has to hedge, he can borrow money to buy the stock at the risk free rate. You cannot. (Actually, he hedges his whole book, rather than individual trades.)

If you think that puts are overpriced that is equivalent to saying that the Implied Volatility (IV) is too high. If you believe that the IV is too high, it makes sense to sell calls covered by your stock.

[ChrisNix]

I think you’re right to be a bit ‘anti-bonds’, but……

I like the analogy of a football team, one needs both attackers (equities etc.) AND defenders (bonds). Each has a separate job to do.

‘for spending expectations greater than 12 years a long bond portfolio can be expected significantly to underperform one of equities ‘
I think it can be useful to distinguish ‘expected returns’ in the mathematical sense ie some measure of central tendency like average, and ‘expected’ returns in the common parlance sense that this is what we expect to happen. Most of us would read your sentence in the latter sense, and if so I think it’s useful to keep in mind that we should really expect other outcomes to occur as an alternative although less commonly. So, equities could do terribly for decades while bonds chugged along; in truth this seems very unlikely if you diversify enough, but French equities started going backwards in about 1918 and took a century to recover. In short, if you choose ‘no bonds’ you need to be prepared to face a lower return than having some bonds. Many of us will give up on ‘likely doing better’ for avoiding something avoidable. Brains are strange things.

The expectation is in the sense of very likely but not certain. So exceptions will occur, though much less probable as period lengthened.
We did extensive studies of UK and US markets, so am really talking about them. Between 1900 and 2005 equities in US and UK always beat bonds by at least 3% p.a. at some point during periods of twelve years (or more).
I don't invest in geopolitically unstable regions. Of course, if one went back to 1900, one would have probably seen Russia, Germany and France as very stable. So vaguely aware of the French example, which might be seen as an anachronism.

‘I'd keep my durations to say seven years unless you have a strong view on falling interest rates.’

If you are going to hold bonds, then duration matching makes sense, so ‘staying at 7 years’ doesn’t manage interest rate risk as well as owning a long and a short duration bond fund which vary in their proportions according to your own timeline.

I agree if one is prepare to sacrifice expected return by holding long bonds. But if holding equities for returns (attackers), I'd hold shortish duration bonds for liquidity (defenders).

‘(excluding for retirees or those nearly at that point) why would someone own a long-term bond fund ahead of a soundly based stock portfolio, or index tracker?’

Having a regular income from a secure job which delivers a DC pension is like owning a massive bond fund; so, for those without such a job bond holdings are an alternative source of comfort.
Secondly, if you can’t stomach the volatility of stocks then bonds help you avoid capitulating at the wrong time.
Thirdly, one might be building a bond ladder of inflation linked bonds.
Lastly, you’re reasonably talking about 12 years as a ‘safe’ timeframe for equities, but 11 years from retirement is not ‘nearly at retirement’.

In recent times I've earned a much higher yield on my equities than most bonds!
I'm assuming most will live to 80 years plus, so can see them being 100% bonds by 70 if they don't like equity volatility.
By the same token, I consider a healthy 54 year old can quite safely hold a decent swag of equities.

‘Over say ten year plus periods inflation has bashed long bonds much more than equities.’

You’ve committed a common sin here of ignoring inflation linked bonds in your reasoning. Perhaps most bond holders don’t hold a substantial proportion of the their bonds as linkers, but there’s a good argument that they should.

Over the 100 or so years we studied linkers were only around for the last 20 or so, and that wasn't when the worst bashing occurred. I readily accept the attractions of a linker yielding 3% real, which they did in the first half of their existence.

I have a memory that there have been 3 or 4 decades in the last century during which stocks returns have not kept up with inflation, but it doesn’t invalidate your argument.

Equities are not a great short term hedge for inflation, but over decades dividends (in particular U.K. ones) have tended to grow by at least inflation plus the GDP growth rates. Longer TOTAL returns in US and U.K. have been around inflation plus 5%.

Lastly, I feel the argument against bonds, or anything else, is less persuasive when that asset class is doing poorly. If you can win the argument when they’re doing well, you’ve really won.
After lastly, if you think you get the best risk adjusted return from investing according to market capitalisation, as per Sharpe, then you need a ‘market’ portfolio which includes a lot of bonds. Clearly, every individual’s circumstances don’t seem well suited to that, but there it is.

My views are long standing, and not really formed by the last year.

Modern portfolio theory majors on returns measured against short term volatility. For short term timeframes I accept the validity of that.

However if we're taking ten to 30 year periods vol extrapolations substantially overstate the risks of holding diversified equities of the major developed regions, e.g. US, U.K. and EU.

That said, at the end of the day one pays ones money and takes ones choice!

[Newroad]

Morning All.

It looks like Unhedged don't get it with Linkers either

https://www.ft.com/content/8ee9bee2-eae9-4840-b44c-90967eb72ce0

From the article

"UK 10-year inflation-linked gilt yields rose 64 basis points yesterday, hitting 1.24 per cent. This is an absolutely bonkers move. In price terms, the 10-year linker fell 5.5 per cent; developed world sovereign bonds are not supposed to move like that (the 30-year linker was down 16 per cent on the day)."

As they say, somewhat bonkers.

Regards, Newroad

[1nvest]

Since a bond fund’s duration usually stays unchanged, but your spending duration naturally keeps getting shorter, in order to ‘duration match’ your bonds with your spending you might need/want another (bond) fund (could be cash) which when ‘mixed’ with your long (18 year) bond fund in their relative proportions gives a combined duration that matches your spending horizon.

As I understand it you can use that dynamic to use a fund such as INXG to near replicate a ladder. The more recent duration of INXG is close to 17 years, so for instance instead of a new retiree opting to drop £3000 of their total pot into 17 individual linkers maturing in 1, 2, 3, ... 17 years time, £51,000 in total (of perhaps a £100,000 retirement pot value) that yields one bond maturing each year to provide a inflation adjusted £3000 for yearly spending (assuming each bond had a real yield to maturity of 0% as is close to present), they might instead use a combination of cash and INXG to replicate that (reasonably closely), that compares in also having a recent real yield of 0%.

At the start, a ladder would have 17 rungs, average of 9 years to maturity. So £51,000 initial total bond allocation split 9/17=53% INXG, 47% cash. A year later and assuming INXG average duration remained at 17 then as a ladder would have 16 rungs of 8.5 years average maturity remaining adjust the exposure to 8.5/17=50% INXG, 50% cash. Another year later and 8/17=47% INXG, 53% cash. Another year later and maybe INXG duration had increased to 19 so 7.5/19=40% INXG, 60% cash ....etc. Where in each year you also draw/spend the inflation adjusted initial £3000 amount, and where after 17 years all of bonds would have been spent, yielding a similar overall outcome to had you actually bought/used a actual ladder of 17 individual bonds (Index Linked Gilts). Interest rate and inflation risks neutralised.

At the start the other £49,000 might have been invested into a global stock index tracker fund for growth, set to auto accumulate dividends, that might net a 4.3% annualised real rate of return such that the £49,000 grew in real terms to £100,000 over those 17 years. Started with near 50/50 stock/bonds, ended 17 years later with all of bonds spent to leave 100/0 stock/bonds, averaged 75/25 stock/bonds. With a simulated non-rolling ladder using a bond fund such as INXG (and cash (1 year Gilt, high street cash deposit account/whatever)).

I believe that such provides a consistent inflation adjusted income independently of changes in yield curve and/or interest rates (and hence changes in INXG price)
https://www.bogleheads.org/forum/viewto ... 8#p3771938 As though you'd bought a actual ladder, or at least a viable 'close enough for a average investor' proxy of such.

Historic chances of the near 50% in stock/growth doubling in real terms over 17 years (4.3% annualised real)? Pretty good, doing so in the median case for all 17 year periods (calendar yearly granularity) since 1896 for a general global stock index fund. Best case saw a 5.8x increase, so the 50% initial stock grew to getting on for 3 times the inflation adjusted total start date portfolio value. Worst case and 17 years of total return accumulation ended with 90% of the inflation adjusted amount, stock total returns (accumulation) didn't even keep up with inflation, such that will all of bonds spent after 17 years you were left with around 45% of the inflation adjusted portfolio value remaining, but after such a bad 17 years generally the subsequent years tend to be above average, so likely that 45% in all-stock and drawing income from that might reasonably have sustained through another 13 years i.e. got you to the 30 year time-frame that SWR type measures tend to be based upon. Bad case and no better than had you just bought a 30 year ladder and spent it all over the 30 years. Average case and after 17 years you still had around the same inflation adjusted portfolio value as at the start (maybe rinse and repeat). Good case and after 17 years you had multiples more than the inflation adjusted start date amount.