- 02/13/2015 at 9:52 pm #17214
Can you please clarify how this strategy is expected to perform in a rising interest rate environment? If you expect the strategy to produce positive returns, that could be anything greater than 0%. If the strategy is only going to produce 1% returns, then it would not be worth investing in the strategy while rates are rising.
Sorry, this question is for Frank’s reply below.02/14/2015 at 1:41 am #17223
Ron, today had a discussion by email on the same topic and the ‘why’ of the recent dip in TLT/EDV/Bonds, maybe of help in addition to Frank’s reply.
Generally the market analysts seem to agree that the expected FED interest hikes are already properly priced into the Bond and Tsy instruments, at least to the ‘how much’ extend. Looking into the yield curves this seems understandable to me. What is happening right now is that the expectations of the ‘when’ these hikes are coming is moving the whole yield curve forward, last in early Feb with the FED statements. By my own logic – and assuming the ‘how much’ is priced in, this should then rather be a one-time movement, thus not affecting the further development this year. This might change by any next FED announcement, we’re really driven by the central banks right now, recall May 2013.
For yield curves see for example here: http://bondtutor.com/currentYC/currentYC.htm02/14/2015 at 12:07 pm #17257
This is a reply to Alexander’s reply to #17223. Hope it shows up in the correct placement
I would like to add to Alexander’s reply, if I may. He is spot-on in his assessment of EDV. I have no Idea on anyone’s Financial situation other than my own. Given my disclaimer, I will say that everyone “expects” interest rates to increase (I am constantly nagging my husband about this whenever we go shopping). The key word is “expects” and I can tell you bluntly without hesitation (even before he dials up our IB brokerage account) that we have been 100% EDV since Jan 2014 and it has returned over 35%. So, even if it drops another 10%. I am OK with this- we also, have a standing sell order GTC in place to preserve capital. I will add that here in the states like most of the global markets it would be reckless and catastrophic to raise interest rates without strong economic incentive to do so. When? Not any time soon. So, when EDV drops to an acceptable MOS (margin of safety) for me, I will get more.
Oh- on bond rates of return, an acquaintance and financial Advisor has had all his fixed income clients in short term bonds for 4 years now “waiting for interest rates to go up” So, compare 1 yr EDV returns with 4 years of ~4% total return for short term bond funds and ask yourself; “What’s the risk.”
Don’t get me started on the newly released “Ultra-Short Bond ETF”
Now, when/if our economy gets it’s mojo back and if I live to see it, there are plenty of other Bond ETF’s to go into, perhaps 35%/yr may be a stretch-but do you need this every year? and if so, get in while it’s there. Equity ETF’s may also be an option if you are not comfortable with 100% Bond ETF’s
Hope this gives you some perspective and Cheers.
Anna02/14/2015 at 4:38 pm #17260
Thank you, Anna.
(1) Are you 100% EDV as part of one of the LI strategies, or on your own?
(2) I’m not clear on how this strategy might perform in a rising rate environment. So that led me to think about Frank’s comment that this strategy should have a positive return in such an environment. A positive return is always wonderful, of course, but if that return is 1% (for example), then it almost becomes a question of why bother. In other words, I would have to turn to some equity component/strategy.
Ron02/14/2015 at 6:22 pm #17263
In answer o your questions:
1). I am never alone and LI has some great strategies
2). Other than what has already been said, you will need to dust off that crystal ball and wait for the future to be told-Just like QE, etc.
Hope this helps Cheers
Anna02/14/2015 at 7:58 pm #17265
Thank you, Anna.04/03/2015 at 9:13 pm #19155
As a foreign investor I always have to be mindful of withholding taxes on dividends (ie., 30% for me). For the BRS, some of the choices like CWB or JNK would go ex div on the first day of the calendar month. And these ETFs do have very high divs. If I know a day ahead of ex div that last month’s choice is going away, then I can try to sell it out on the month end date (ie., before ex div) and take a leg risk into buying the new choice the following day. Is this possible? I know there is a possibility that things may change at the last moment but that’s alright.
Simon04/03/2015 at 9:26 pm #19156
Simon, same thing for Frank, Vangelis and myself, and we’re looking into this also for our own account, and certainly there are other interested non-US investors. Selling off a day before exDiv might be an option, but the leg risk might eat your benefit away. Keep in mind that normally the allocation only changes gradually.. Might be worth a look in detail with a backtest, which we’ve not done.
We’re currently exploring futures, or ETF futures, but their price / signal behaviour is very different to the ETF because of rolls and other effects. So, we also have no clear answer to this… but keep exploring ourselves.04/09/2015 at 12:25 am #19273
Frank, Alex, comments from my blog post replicating/investigating this strategy:
Thanks for the post and nice job with the blog!
The missing piece is the tax rate applied to dividend. This seriously reduces the real amount available to investors. Worst case scenario is a foreign investor (like me) who has to pay a 30% tax on dividend: that changes dramatically the all picture. The rate applied to US resident is very different but it’s not nugatory either from memory.
The R Trader”
and this one (from Gerald M):
“I ran a bond rotation strategy for about 5 months last year. Being a foreign investor (like R Trader), it wasn’t worth it due to taxes. You are correct that dividends are a substantial portion of returns but if you have to pay significant taxes (or even regular taxes), the risk/reward changes – and not in a positive way! It would be interesting to try this on a quarterly basis using mutual funds. But as you have pointed out, the gap between closed and adjusted (not really achievable) is huge. I expect that to hold on a quarterly time frame.
Regarding those ratios, when using MF data back in the 90’s or pre 2007 for that matter, I think you should look at the risk free yields and not use RF=0%. From 1995 through to 2000, for example, 90 day yields were 5%. If you look at the return of these rotation strategies against a 5% RF yield, they will not look anywhere near as attractive. If you factor in inflation and then calculate the real returns, well, it gets worse. The 90 day monthly rates from 1934 are here: http://bit.ly/1IuEB9V
Finally, the post-2008 periods saw the Fed quadruple their balance sheet thereby lifting equity prices and bond yields got crushed at the same time (and of course the last 30 years saw the biggest bond bull ever on top of all that). So it was quite a distortion that was introduced in the markets (unprecedented in fact). You can see the effect of this intervention in your graphs above. There is a significant inflection point post 2008 (the same goes for the Universal Strategy). So the strategy is a curve fit because it is what worked well given the monetary policy. Walk-forward techniques don’t prevent curve fitting if the underlying strategy itself is a curve fit. It’s simply trying to optimize and already fitted algorithm. Going forward, I don’t expect interest rates to drop another 6% or more from here or for the Fed to quadruple their balance sheet again with QE5-8 thereby lifting prices through ten’s of billions of monthly purchases. CWB has a 60 day correlation of daily returns of 0.8 to the SP500. That’s very high so it’s like owning an equity index (although I haven’t tried it, I would not be at all surprised if you substitute SPY for CWB and get a similar result).
So basically, reality bites. Dividend taxes, inefficiencies in dividend reinvestment, trading fees, inflation, risk-free rates prior to 2007 and the curve-fit gains post 2008 makes me highly skeptical that this will actually yield any alpha going forward.”
Care to respond?04/19/2015 at 6:43 pm #19677
same as most (all?) other sites, we do not include the tax effects into our backtests, so returns are gross tax. Main reason being that the individual tax rate varies very much depending on your location and account used. As example, just for an US investor the tax exposure between a savings account, and a deferred account like 401k, IRA or special purpose vehicle can cary from 0 to 30%, and this is not considering any tax-loss-harvesting.. For non-US investors it further depends on double tax treaties, home country regulation and whether you can claim witholding taxes from the ISR… So this is something each investor has to calculate by themselves, or with the help of a tax consultant..
Another point I’m missing in the comments above, is what scenarios you are comparing. Example: If you decide to invest in bonds, you are subject to capital gain and dividend taxes, automatically. In this scenario, you’re still better off using our bond rotation strategy compared to a buy&hold approach, simply because returns gross and after tax are better. The tax excempt US muni bonds might aleviate some of the tax burden, but this is again somehthing which only applies to a section of our followers.
If you are an international investor then indeed the dividend withholding tax might scare you away… same for buy&hold or our suggested approach..
Hope this clarifies, happy to continue the discussion05/06/2015 at 6:00 pm #21660
I strongly suggest that this strategy be renamed from “Sleep Well” to something more accurate or simply “Bond Rotation.”05/06/2015 at 6:15 pm #21665
Using a brand name that is more quickly understood has merit :)
Scott06/15/2015 at 10:50 am #26495
Hi, folks. I am a new member and this is my first post. I am enjoying the site very much, especially tinkering with the Custom Portfolio Builder. I just have a question related to the Bond Rotation Strategy, particularly to CWB.
When I compare CWB to SPY over the last several years, it appears to me as though CWB is about as volatile as SPY, but long term, CWB underperforms SPY. For example, back in the summer of 2011, when SPY dipped by about 20%, CWB did also. Then, by February of 2012, SPY had recovered to even, but CWB was still underwater by about 6%. My question is, why do so many of the strategies seem to stay in CWB so much of the time? Wouldn’t it be better to simply use SPY when it is trending upward? Or, if the desire is to have a lower volatility position than SPY, why not use something like SPLV?
Thanks in advance for any clarification, and keep up the good work with the site.06/15/2015 at 6:37 pm #26496
Thanks for the suggestion.
To check, I just calculated the % Std deviation since CWB start vs same period SPY, and SPY has about 1/4 more volatility. Further, CWB reflects and captures a very different asset class that moves somewhat differently that the S&P 500.
I always urge subscribers to carefully consider and evaluate the underlying asset classes as one of the most critical steps when examining a strategy.
Scott09/13/2016 at 2:30 pm #35518
I know that your approach is very quantitate and data-driven (which I prefer as an investor). But, I’m genuinely concerned that bonds are no longer a reliable hedge due to monetary policies. Do you think this thesis holds water? If so, how will the strategies adapt?
If monetary policy is ever normalized (debatable), I’m sure the SPY/TLT correlation will come back down. I’m more concerned about what to do in the meantime.
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