The Hated. The Feared. The Amazing. The US Treasury Bond.

The Hated. The Feared. The Amazing. The US Treasury Bond.

January 2, 2015 Brainwave, Macroeconomics, Tactical Asset Allocation Research
Print Friendly

As “everyone” seems to know, the US 10-year Treasury bond has a low relative yield and is “inevitably going to rise at some point in the future.”

We have no strong feelings one way or the other on the US Treasury. We simply aren’t smart (or perhaps arrogant) enough to make a strong call. We see compelling stories from smart folks saying it is a great investment and from smart folks saying it is a terrible investment.

But who really knows?

And while we don’t have a strong opinion on the future of bonds as a stand-alone asset class, we do have an ability to test how long-bonds can serve a portfolio.

The results below highlight the top 30 drawdowns in the S&P 500 Total Return Index from 1927 to 2013. Next to the S&P 500 return is the corresponding total return on the 10-Year (LTR) over the same drawdown period:

The Hated. The Feared. The Amazing. The US Treasury Bond.
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Long bonds are clearly interesting in a portfolio context. In addition to providing a real return, plus an expected inflation return, the asset serves as a quasi-insurance policy: When stock markets blow up, US long bonds do well, on average.

The resilience of this finding is remarkable. In the context of a traditional asset pricing model, such as the Capital Asset Pricing Model (CAPM), an asset that actually delivers returns when the rest of the world is blowing up (I.e., negative beta during treacherous times), should have a negative expected return because of the diversification benefits. But with US Treasury Bonds, we actually earn a positive expected return AND get the insurance benefit. One might even consider the US Treasury bond “anomalous.”

Of course, the hidden insurance benefit associated with US Treasury Bonds hinges on the assumption that the US will maintain its status as the king of the hill. When the world goes south, and everyone wants a stable asset, the US Treasury Bond is the only game in town.

There are many reasons why the US could lose its standing. But there are even more reasons why the US, while not perfect, is still light-years ahead of the competition. With 50+ year edges in education/research infrastructure, entrepreneurial culture, dominant military, endowed location, and so forth, we should continue to win the Tallest Man Award in the midget contest for the foreseeable future.

But things can–and do–change.

Happy New Year and Go America!

***

Please remember that past performance is not an indicator of future results. Please read our full disclaimer. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.

***

If you liked this post, don't forget to subscribe to our blog.




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.