Bonds: Unwanted and Unloved but not Unnecessary

May 30, 2018 |
2 minute read
|

Well, the party may finally be over. Like the college dean who shuts down the campus party, the Fed has finally taken away the interest rate punch bowl that investors have enjoyed for so long. It may be hard to believe, but we have been in a secular interest rate decline for over thirty years. In fact, we have been in a declining interest rate environment for so long that for most of us (the authors included!) that is all that we have known.

This benign and beneficent market is portrayed in Exhibit 1, which plots the yield on the 10-year US Treasury bond dating back to the 1980s. We can see that interest rates peaked in the early 1980s near 16 percent and then began a long and consistent decline to 1.4 percent in June of 2016.

Exhibit 1: Yield (%) On The 10-Year Treasury Bond

And, declining interest rates translate into rising prices for bonds. Over the last thirty years, the average annual return to the 10-year Treasury bond has been about 6.3 percent. Bottom line, it has been a great time to own bonds.

Importantly, we should not overlook that Treasury bonds are an economic “shock absorber”; they play a critical part in modern portfolio construction. In times of stress, investors have historically flocked to Treasury bonds as a natural hedge when the financial markets become more volatile or suffer a market downturn.

Exhibit 2 demonstrates the return to the 10-year Treasury bond during times of stress and recession in the U.S. financial markets. We can see that Treasury bonds outperformed stocks during the Great Financial Crisis of 2008, the popping of the Tech Bubble in 2000 – 2002, and even in the brief recession of 1990.

CH2_Exhibit2_TreasuryBonds_vs_Stocks

For an equity-oriented long-term portfolio, Treasury bonds are an insurance policy. The fascinating observation is that over the past 30 years we were all paid to own this insurance. The consistent and continual decline of interest rates over this time period meant that we got to have our cake and eat it, too. We got to own an insurance policy — Treasury bonds — and we were compensated with rising bond prices.

Unfortunately, most insurance policies don’t work this way. Typically, we aren’t paid to own insurance but rather we have to pay for that protection. Whether it is car insurance, home insurance, or some other form of protection, we all pay annual premiums to the insurance company to guard against a loss.

Well, guess what? Treasury bonds are still an important component of a well-diversified portfolio. The catch is that with interest rates near 30-year lows and headed up, we now have to pay for this economic insurance. We have had it so good for so long that we have come to expect that we should be paid for putting an insurance policy into our portfolios. Unfortunately, the economic reality of the financial markets has finally caught up to us — even if it did take the Dean of our monetary college 30 years to shut down the party.

Mark J.P. Anson

Author

Mark J.P. Anson

Chief Executive Officer and Chief Investment Officer, Commonfund

Mark J.P. Anson

Author

Timothy T. Yates, Jr.

President and CEO, Commonfund OCIO

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.