Should You Have Long Bonds in Your Portfolio?
From a yield perspective, long U.S. treasuries (TLT) yield about 2.8 per cent and long Canadas yield about 2.00 per cent (ZFL). This compares to a less than two-per-cent yield for the U.S. equity (ZUE) market and a 2.7 per cent yield for the S&P TSX (ZCN).
From that perspective, the U.S. bond market is more attractive than the Canadian market and the Canadian equity market is more attractive than the U.S. market especially in a taxable account where the dividend tax credit offers a better after tax return. Of course, in registered accounts the tax implications are more muted, as returns are on account of income when the money is withdrawn.
From a risk perspective, long bonds (maturity of 20 years or more), are typically equal to or less risky than equities.
They are also the most negatively correlated with equities meaning they are your best way to diversify your portfolio. The table above shows the correlation between the four ETF asset classes over the past two years. A correlation of one means the assets offer zero diversification benefit and a correlation of -1 means they do the exact opposite. A correlation of zero means the returns of the assets have no correlation and that is the optimal form of diversification benefit. For longer-term investors, a low negative correlation is ideal to add a sleep-at-night benefit.
If we only looked at past returns we would have an all equity portfolio right now and that may not be good going forward. I suspect most investor only consider the returns because unless you really do your homework, the risk numbers are not well disclosed by the industry. I’ve been saying for years: This is the biggest tragedy in the investing world for do-it-yourself investors. We must have a way of estimating forward returns and risk before making an investment. Bonds are universally hated and most analysts expect bond yields to higher (prices lower) by the end of the year. The bearish bond trade is very overcrowded and the bond bears on average have been wrong for 15 years.
Being a contrarian is hard, but if you have a few tools to guide you, you can have an edge. This chart shows the net speculative position in the U.S. long bond futures compared to TLT over the past two years. At extremes, the net speculator is always wrong about their market bet and you want to be paying attention to this and go the other way. For those of you that want to follow at home, the Commodity Futures Trading Commission (CFTC) has the commitment of traders (COT) data on their website here. I’ve been adding to my long bond position (TLT) in recent months as a way to “lower” my sleep-at-night portfolio risk while not hurting my portfolio yield. Long bonds are far better at protecting your portfolio value than sitting in low yielding cash.
Tactical investing is an important skill when managing your own portfolios. Learn how to use techniques like this to evaluate risk and return in how to be a smarter investor in our 7th season across Canada speaking tour. Free registration at www.investorsguidetothriving.com. Help us raise money to fight Cancer and Alzheimer’s by making a voluntary donation with your registration. Over the past few years, Berman’s Call roadshows have raised over $230,000 for charity thanks to BNN viewers, our sponsors, and our partners.