Strategy: Bond Rotation “Sleep Well”

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  • #35520
    Ivan Fisher
    Participant

    I would also like to echo this concern, however I come it it from a slightly different angle.

    Here in Australia, our equities market is tiny compared to the USA and for the retail investor the workings of the bond market is largely not understood.
    At best I think the average person here might know the rule of thumb which states that when yields drop, prices go up… that’s about it.

    I don’t mind so much investing in instruments which I don’t entirely understand , as long as the backtesting looks plausible, which of course there is a long history of bond prices for the USA so this is no problem.

    However , with the global interest rate environment at record low yields or even negative , in my mind we are in largely uncharted waters , so I also share concerns about the historic correlations between stock and bonds given the copious amounts of central bank activity in many countries.

    Given this , would be nice to also see some strategies based upon different hedging mechanisms , such as inverse stock ETF’s and the like. I realise one problem with this is that many ETF’s haven’t been around sufficiently long to enable backtesting with confidence , unless some synthetic ones can be used. Or maybe strategies with some other market neutral abilities. I will leave it to the smarter ones to figure that out !

    regards
    Ivan

    #35532
    Vangelis
    Keymaster

    Dear Evan & Ivan,
    If you are worried you could increase your cash allocation or choose strategies that are less affected by a possible correlation break-down, possibly the BUG, GLD-USD, maybe the World Top 4.

    That being said, near zero yields have been a concern since 2012. I remember reading an article back then about the ‘no-brainer’ opportunity of a lifetime: Short Treasuries. The market defies logic. Bonds continue to perform exceptionally well while holding their negative correlation to equities. The only exception was 2015. That year is a good and real example of what happens when nothing works (equities, bonds, gold and everything else fell). We did go through it, survived adapted and are continuing into a profitable 2016. If this or a similar scenario materializes again we will adapt again. We do have strategies that hedge with Gold (the BUG) as well as exposure to foreign markets, which in turn have exposure to commodities, that may be positively affected by rising rates. Gold is always a prime candidate for an alternative ‘safe heaven’ hedge to rising rates so it could become a useful additional hedge to us in the future.

    #35534
    Ivan Fisher
    Participant

    HI Vangelis,

    given my lack of knowledge about how bond pricing works ( I know there are many inputs into the various bond ETF pricing), is it fair to say that once interest rates start rising ( and they will at some point ) then “in general” bond ETF’s will start declining in price ? I’m hearing so many conflicting statements , seems nobody can agree on what they expect will happen

    thanks
    Ivan

    #35679
    Michael Parzen
    Participant

    How sensitive is this strategy to the monthly rebalancing? that is, say i was super lazy and did 50/50 in the top two picks each month. would the returns and risk be absolutely different? i imagine for other strategies on here it would but curious about this one. thanks!

    #37441
    Michael Parzen
    Participant

    hi-very interested in subscribing but….i found the following article which replicates the original strategy in R
    https://quantstrattrader.wordpress.com/2015/04/08/the-logical-invest-enhanced-bond-rotation-strategy-and-the-importance-of-dividends/#comments

    the author goes on about the importance of dividends and the potential dangers of using yahoo’s adjusted data. he also says he was essentially able to replicate the SA results and it seems like a sound system..but warns about dividends on the etf’s used.

    can someone smarter than me (so that means almost anyone) explain if his argument is valid and dividends are a concern? to me it seems they are simply reinvested so why does it matter?

    thanks

    #37449
    Alexander Horn
    Keymaster

    Hi Ben,

    yes, Ilya of QuantStratTrader is a sharp guy and has replicated several of our strategies, mostly at least.

    Dividends can be a concern due to their different taxation in the US if bond ETF are held outside a tax deferred account. This is especially true for the Bond Rotation Strategy, as dividends make a good chunk of the performance. This is NOT an issue if held in a tax deferred account (IRA, Roth, etc).

    The second comment regarding dividend adjusted data from Yahoo is really less of a concern. What happens is that after a dividend distribution the past prices are adjusted to eliminate the price drop which follows any dividend payout. This adjustment can go back weeks, sometimes even months. The first trap some people fall in is that they do not consider this and do not “refresh the past” in their data when calculating signals. The second trap is that data is adjusted only some hours after the market close, this is the reason why we do our signals overnight and not right after the closing.

    So yes, there are traps related to dividend adjusted data, but we feel we have addressed them in our calculations. Generally we do not think Yahoo price data to be less confident when working with monthly strategies as ours, but indeed some people do not share our opinion here.

    Hope this answers, if not please let me know,
    Alex

    #37450
    Alexander Horn
    Keymaster

    Hi Ivan,

    pricing of bonds indeed is all a science, here a good compendium: http://www.investopedia.com/university/advancedbond/

    What we´ve seen recently are two effects:
    1) Increase in rates due to the (anticipated) Fed hike. This affected the whole curve, e.g. from short term to longer duration.
    2) Increase in expected inflation due to Trump’s announcement of heavy public spending. This effects more the longer dated bonds, and is one of the reasons we moved to the new approach incorporaing TIPS (inflation protected) ETF.

    Where will this go, especially if the FED indeed hike three times in 2017? There are manhy conflicting voices (lock 5 economists into a room and you get at least 10 opinions…)

    -As the current 10 years yield is above or at least around the S&P500 dividend yield some people do not expect the 10ys yield to rise significantly.
    – For Foreign buyers the US bonds are a paradise considering very low yields in Europe and Japan, so they are buying heavily, especially if current USD strenght should continue.
    – If the Trumponomics due not work as expected (or only partially and delayed), inflation might my overestimated, so bond prices might fall.
    – In case of any major trouble, bonds are still a reliable safe haven, e.g. in a crisis they will rise due to money flow.

    With our broader bond strategy we feel to be fine in any outcome, but also our glassbowl is not big enough to make a call right now.

    #37656
    Michael Parzen
    Participant

    repost-this question was never answered last year- thanks.

    How sensitive is this strategy to the monthly rebalancing? that is, say i was super lazy and did 50/50 in the top two picks each month. would the returns and risk be absolutely different? i imagine for other strategies on here it would but curious about this one. thanks!

    #37661
    Vangelis
    Keymaster

    If you did 50/50 in the top two picks each month the returns and risk would be similar to the current BRS strategy (where current max/min allowed allocations are 60/40). The best way to try these scenarios for yourself and really see how the strategies work is to try QuantTrader.

    #41045
    trr
    Participant

    What’s your take on the debate on potential structural problems of high-yield bond ETFs such as JNK (and similarly, PCY and CWB, I assume) stemming from the illiquidity of the underlying holdings? Anyway, don’t these funds behave very much like corresponding equity funds watered down with appropriate amounts of cash? If so, why use them at all?

    #42347
    trr
    Participant

    Sorry not to get a reply to my question of 04/29/17. To clarify, the structural problem I refer to is that described by Howard Marks here.

    #42771
    Alexander Horn
    Keymaster

    Sorry for the delayed response, somehow missed your question. We´re aware of the ongoing discussion regarding liquidity concerns in especially bond ETFs, where it seems the tail is whagging the dog, that is trading in the ETF surpasses the underlying instruments, thus potentially leading to pricing effects and concerns regarding liquidity in case of a market correction. Personally I´ve not been aware of the discussion you mention about high-yield bonds, but it seems related.

    My take is that while such concerns might be reasonable and probably further increasing due to the ongoing rise in popularity of ETFs vs. underlying instruments and MF – what would be a valid alternative for passive investors? Investing directly into (high-yield) bonds of 30-50 companies, futures or more exotic and less liquid instruments? Completely staying away from (high-yield) bonds?

    Following the discussion and being aware of the potential impact is important, but as long as there are no valid alternatives I´d not take an aggresive stance.

    Not sure if this is what you´re looking for, happy to continue discussion,
    Alex

    #42792
    trr
    Participant

    Thanks.

    BRS uses JNK and PCY, which I assume have high correlations to SPY and EEM, respectively. Instead, why not just use the equity funds, dampened with cash? That would probably avoid the potential liquidity problems (and also might be better tax-wise)? Is the point that JNK and PCY trend especially well, so as to be well-suited to rotation strategies? Do they meaningfully give exposure to risk factors not available through equities and treasuries? I am concerned that instead of providing a cushion in the event of a crisis, which substantially I look for a bond allocation to do, JNK, PCY and CWB could be the epicenter of a crisis.

    Here’s another way of looking at it. What role does BRS have in a portfolio that couldn’t be replaced by some combination of equities and treasuries/AGG? For example, perhaps you could replace BRS with a blend of (the pre-December 2015 version of) GMRS and cash (or GOLD-USD, likely better).

    #44721
    Mike
    Guest

    Hi there

    feeling my way around the site and strategies – extremely comprehensive and thought provoking.

    Quick question – in the returns reported for each of the strategies covered, are dividends included, or is performance calculated solely on the ETF opening vs closing price?

    Thanks

    #44722
    Alexander Horn
    Keymaster

    Hi Mike, welcome to Logical Invest!

    we take dividends into consideration, as we use dividend and split adjusted prices for our algorithms. When investing current market prices are used.

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