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Bonds: Unwanted and Unloved
but not Unnecessary

May 30, 2018  | by Timothy T. Yates, Jr., Mark J.P. Anson

Fixed Income | Investment Strategy

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.

Well, guess what? Treasury bonds are still an important component of a well-diversified portfolio...

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.

Authors

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Mark Anson is the Chief Executive Officer and Chief Investment Officer of the Commonfund and Chairman of the Board of Commonfund Capital Inc. and Commonfund Asset Management Company. Previously, he was the President and Chief Investment Officer for the Bass Family Office of Ft. Worth, Texas which was recognized as Family Office of the Year for 2014 & 2015. He was the President & CEO of Nuveen Investments, and Nuveen Alternative Investments, a full service asset management company with over $250 billion in assets under management. Prior to Nuveen, Mark served as the Chief Executive Officer and Chief Investment Officer for the British Telecom Pension Scheme (BTPS), the largest institutional investor in the UK with assets of £65 billion. In addition, Mark was the CEO of Hermes Pensions Management in London, a £55 billion asset management company that is wholly owned by the BTPS. Prior to joining BTPS, he served as the Chief Investment Officer of the California Public Employees' Retirement System, the largest institutional investor in the United States with over $300 billion in assets. Mark is currently a Trustee for the $65 billion UAW Medical Benefits Trust. He also serves on the Law Board of the Northwestern University School of Law, the Board of the Toigo Foundation, and the Board of Panagora Asset Management. He is the only person to have served on the Board of Governors for both the CFA Institute and the CAIA Association.

Mark has published over 100 investment articles in professional journals and has won three Best Paper Awards. He is also the author of five financial textbooks including the Handbook of Alternative Assets, which is the primary textbook used for the Chartered Alternative Investment Analyst program. Mark earned a B.A. in Economics and Chemistry from St. Olaf College, a Ph.D. and Masters in Finance from Columbia University Graduate School of Business, and a J.D. from Northwestern University School of Law, all with honors. He has also received several industry awards in recognition of his leadership in asset management. Last, Mark has earned the Chartered Financial Analyst, Chartered Alternative Investment Analyst, Certified Public Accountant, and Chartered Global Management Accountant professional degrees, and he is a Member of the Law Bar of New York and Illinois.

Mark Anson, PhD, CFA, CAIA
Chief Executive Officer and Chief Investment Officer
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Timothy T. Yates, Jr. heads Commonfund Asset Management and is responsible for managing all aspects of Commonfund’s Outsourced Chief Investment Office (OCIO) business, which focuses exclusively on non-profit institutions. In this role, he leads a team of investment professionals that advise, implement and monitor custom investment solutions for institutions with total assets under management of more than $15 billion . Tim is a member of the Commonfund Asset Management Executive Group and serves on both the Commonfund Asset Allocation and Operating Committees. Additionally, he is a senior member of the firm’s emerging markets private equity portfolio leadership team with a focus on Latin America. Tim joined Commonfund as an associate in the Commonfund Capital Associate Program. In 2003, he was a founding member of Commonfund’s OCIO platform, where he was responsible for the design, tailoring and implementation of total portfolio solutions. Before joining Commonfund, Tim was an instructor of Spanish and Italian at Fordham Preparatory School in the Bronx, NY. He holds an M.B.A. in Finance with a designation in International Business from Fordham University and a B.A. in Modern Languages from Trinity College. Tim is a member of the investment committee for St. Paul’s Church in Fairfield, CT, the Advisory Board of Girls Who Invest, and the Board of Directors of Caroline House, a non-profit in Bridgeport, CT, focused on enabling women and children to reach the fullness of their potential through education in English language and life skills.
Timothy T. Yates, Jr.
President & CEO, Commonfund Asset Management

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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. 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. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. 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 Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or 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. Past performance is not indicative of future results. For more information please refer to Important Disclosures.