Real Return Bonds

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ghariton
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Re: Real Return Bonds

Post by ghariton » 19 Aug 2012 23:22

zeno wrote:I guess what I struggle with is allocation. Most asset allocation models allocate no more than 5% to inflation protected securities. That's a tiny fraction of your wealth that's protected. It hardly seems worth it.
Well, I'm probably the wrong person to give advice. My allocation to RRBs is around 60%. But then my situation is probably very different from yours.

FWIW, during the early phase of accumulation, all my savings went to paying off the mortgage and student debts. That freed up cash flows so that I could invest in equities, and for a long time I had 0% fixed income. But now that I'm retired (as of two months ago), preservation of capital has become my priority. If I had many years in the work force ahead of me, my priorities would be different.

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Re: Real Return Bonds

Post by Bylo Selhi » 26 Sep 2012 15:34

More RRBs, Please! Why Ottawa Should Issue More InflationIndexed Bonds
CD Howe Institute wrote:Conclusion
The issue of RRBs by the federal government over the last two decades has been a welcome development for Canada’s savers and Canada’s economy. While investors reacted coolly at first, demand for RRBs has burgeoned since, outstripping supply.

Issuing more RRBs would yield several benefits to the federal government and the economy in general. Relatively low yields on RRBs would directly lower Ottawa’s borrowing costs. By reinforcing the credibility of low inflation, a larger outstanding stock of RRBs should reduce inflation risk premiums on other debt, which would amplify the government’s interest savings and cut costs to other borrowers as well. It would also better satisfy demand from investors with inflation-indexed liabilities and, especially if it led to real-return debt issues by other borrowers, more RRBs could foster the development of more price-indexed instruments that savers would find useful.

In short, we recommend that Ottawa issue more RRBs over the next five years: rather than the $2.4 billion annually now planned, we suggest $7.2 billion annually. We further recommend that the federal government diversify its RRBs – specifically, that two-thirds of new RRBs issues, over and beyond what is already planned, have 10-year maturities rather than the 30-year maturities exclusively issued to date. We think issuing the new bond in these quantities is possible without disrupting markets, especially if its introduction is syndicated rather than auctioned. A plausible estimate of the resulting interest savings on federal debt comes to $200 million in 2016/17 and $500 million over the period until then. Those savings would continue beyond that date and would grow if success to that point prompted the government to continue issuing more of its debt in this form.

The desirability of reinforcing the credibility of low Canadian inflation, the demonstrated success of inflation targeting, the appetite of Canadian savers for price-indexed debt and the prospect of further financial innovations make a strong case for larger RRB issues. Other countries have boosted their issues of price-indexed debt – the time is ripe for more RRBs here, too.
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ghariton
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Re: Real Return Bonds

Post by ghariton » 08 Feb 2013 17:01

I've decided to retire this April when I turn 67. The next contract would involve hearings in Inuvik and Whitehorse in June, and I'd really rather not. (I've always hated travel.)

When I determined the amount of RRBs we would need, fourteen years ago, I figured on retirement at age 62 and funding 30 years retirement. Retiring five years later means planning on funding 25 years instead. That's a reduction of one sixth, so I figure we'll need one sixth less RRBs as well.

So I've decided to sell one sixth of my RRBs, reducing the holding from 62% to 52% of our portfolio. Ideally we should give the proceeds to the children and in-laws, but the money is inside RRSPs, and the tax hit would be significant, not to mention claw-backs. Instead, I plan on splitting the proceeds and purchasing some VTI, VEA and VWO instead. I'll pay the money out to them when I am forced to take it out of the RRSP/RRIF.

Comments? Does this seem rational to people?

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Re: Real Return Bonds

Post by Dejavu » 08 Feb 2013 17:18

You coudn't pay me enough to go north to work again! Been there done that, so I quite understand your not wanting to go. ( And you don't seem to need the income). I am not sure why your RRB holdings are now excessive, if your not going to liquidate them, but just adjust your AA! It appears to me you are going to increase your risk appetite at just the time when the opposite would appear appropiate. Sitting on your hands might just do the job.
If your mandatory RRIF withdrawal is more than you require to live on, then excess amounts can go to your TFSA as well as the childrens TFSA,s.
I am certain I have offered nothing new in the way of information, rather another perspective. I appreciate your always thoughtful contributions to FWF,Dejavu.
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Re: Real Return Bonds

Post by Shakespeare » 08 Feb 2013 17:28

Not sure why selling RRBs is necessary - although the real yield is slightly negative, they continue to provide safety.
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Re: Real Return Bonds

Post by Bylo Selhi » 08 Feb 2013 17:36

I agree with Shales. What if you live longer than planned or you need to make unanticipated expenditures for stuff like extra home care, nursing, medications, etc. that aren't covered by CCAC or OHIP?

ISTM your first priority for RRSP/RRIF is to fund your retirement needs without becoming a financial burden on your kids. Why compromise that? What's left over when you and your spouse are gone can go to the kids then.
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Re: Real Return Bonds

Post by newguy » 08 Feb 2013 17:41

If you do make it to 92 there's a good chance that the equity will have outperformed over a 25 year time frame. ISTM that selling is the most consistent with your barbell strategy - enough RRBs for the important stuff and equity with the rest.

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Re: Real Return Bonds

Post by adrian2 » 08 Feb 2013 18:15

In your shoes, I would be looking at annuity quotes. No frills (guaranteed payout period etc), just the basics.

E.g., RBC shows $7,335 annual payment for $100k deposit (single life), or $5,621 for joint life (guessing your wife age the same as yours). It may sound low, especially the joint one, but even that is more than double what you were getting from your RRB's (and 7.3% for the rest of your life sounds pretty OK to me).
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Re: Real Return Bonds

Post by ghariton » 08 Feb 2013 18:31

Thanks, guys. I went to lie down for a while and I'm feeling much better now. I get these attacks every year or so. :roll:

Thank you FWF. (I'm still retiring, though.)

Newguy, yes, you're right that a barbell portfolio is my guiding principle. But if there is surplus money, I'm sure that the children and inlaws won't care what form it is held in. The only one in the two families that is financially literate is my daughter-in-law the actuary.

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Re: Real Return Bonds

Post by newguy » 08 Feb 2013 19:30

ghariton wrote:But if there is surplus money, I'm sure that the children and inlaws won't care what form it is held in.
That's another consideration. You don't really know how long you'll live but money earmarked for kids should be invested based on their time frames and situations.

newguy

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Re: Real Return Bonds

Post by Pickles » 09 Feb 2013 00:07

Congratulations on your upcoming retirement, George. I was a bit alarmed with your rationale to sell your RRBs, after hearing you extoll their virtues for so many years. I agree with Dejavu's comments. Also, IIRC, you planned to keep them until maturity. The "problem" of having a larger amount at maturity than you need does not appear to require a solution.
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Re: Real Return Bonds

Post by ghariton » 09 Feb 2013 00:40

Thanks, Pickles. My faith in RRBs continues unabated.

I was just reading a paper by John Campbell and Robert Shiller, saying that TIPS (the U.S. version of RRBs) are the safest long-term investment around. Nice to have one's biases confirmed, or at least reinforced. :wink: FWIW, the paper makes two points that are memorable: (1) Real returns on TIPS started very high because these were new and buyers were cautious (2) The temporary spike in real yields (and corresponding fall in prices) of TIPS in 2008 was due to a huge increase in the liquidity premium, much bigger than anyone had imagined possible. But we here at FWR had figured out both these points upthread. :wink:

Adrian, I have long planned on annuitizing at age 75, using RRBs that mature then. But it would have to be an inflation-indexed annuity. It is very difficult to get quotes on those in Canada, so I don't know whether the prices have become reasonable yet (they weren't a few years ago). I hope that, by the time I hit 75, they will be.

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Re: Real Return Bonds

Post by adrian2 » 09 Feb 2013 06:54

ghariton wrote:Adrian, I have long planned on annuitizing at age 75, using RRBs that mature then. But it would have to be an inflation-indexed annuity. It is very difficult to get quotes on those in Canada, so I don't know whether the prices have become reasonable yet (they weren't a few years ago). I hope that, by the time I hit 75, they will be.
I agree an inflation indexed annuity would be a good buy, at a reasonable price. OTOH, even a SPIA at 67, single life, would be quite acceptable IMO (check the implied inflation value in fixed income nowadays).

Let me add my belated congrats for your retirement, George!
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Re: Real Return Bonds

Post by Bylo Selhi » 09 Feb 2013 10:11

ghariton wrote:(1) Real returns on TIPS started very high because these were new and buyers were cautious
Also, TIPS were first issued in 1997 when no one in their right mind(!? ;)) would have settled for less than the double-digit returns available on the S&P and triple-digit returns on the NASDAQ. Day traders could do better in one day than TIPS could return in a year, etc.

Not to be too smug, I wasn't sure if the 3% or 4% real returns available from RRBs was a good enough deal to go "all in." After all they'd been selling with 5+% real yields just a few years earlier.
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Re: Real Return Bonds

Post by Norbert Schlenker » 10 Feb 2013 12:19

ghariton wrote:I've decided to retire this April when I turn 67... When I determined the amount of RRBs we would need, fourteen years ago, I figured on retirement at age 62 and funding 30 years retirement. Retiring five years later means planning on funding 25 years instead. That's a reduction of one sixth, so I figure we'll need one sixth less RRBs as well.

So I've decided to sell one sixth of my RRBs, reducing the holding from 62% to 52% of our portfolio...

Comments? Does this seem rational to people?
Unlike the other commenters, I think this would be a very reasonable thing to do. 62% of a portfolio in an asset with guaranteed zero to negative real returns is ridiculous IMHO, especially for 25-30 year horizons. Even if one restricts oneself to spending only the income, the current yield on the asset isn't much different than current yields on blue chip equities. Furthermore, because RRBs trade at such a huge premium to par, you're also guaranteeing a large real capital loss at maturity.

I see no upside to this, not at current yields and prices, not at that large a fraction of overall portfolio.
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Re: Real Return Bonds

Post by Pickles » 10 Feb 2013 13:33

Norbert Schlenker wrote: 62% of a portfolio in an asset with guaranteed zero to negative real returns is ridiculous IMHO, especially for 25-30 year horizons. Even if one restricts oneself to spending only the income, the current yield on the asset isn't much different than current yields on blue chip equities. Furthermore, because RRBs trade at such a huge premium to par, you're also guaranteeing a large real capital loss at maturity.

I see no upside to this, not at current yields and prices, not at that large a fraction of overall portfolio.
Presumably you thought this all along, since the only factor that has changed is that George's retirement was delayed 5 years?
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Re: Real Return Bonds

Post by ghariton » 10 Feb 2013 14:17

Norbert Schlenker wrote:62% of a portfolio in an asset with guaranteed zero to negative real returns is ridiculous IMHO, especially for 25-30 year horizons. Even if one restricts oneself to spending only the income, the current yield on the asset isn't much different than current yields on blue chip equities
I'm not averse to spending the capital as I go. But as it turns out, I won't need to touch that until I turn 75. So for me RRBs are primarily a vehicle to preserve capital until I get to 75,at which point I will use them to annuitize (or not). As things look now, I won't need all of them to provide a decent annuity. But I take Bylo and others' argument about a margin of safety.

Any fixed income investment today is plagued by low real returns. We have seen this before. Over the period 1945-1970, for instance, real returns on U.S. treasuries were negative about half the time. This was "financial repression", the result of government getting itself itself out from under the debt load it accumulated during World War II. (Any analogies to today would be purely fortuitous. :wink:)
Furthermore, because RRBs trade at such a huge premium to par, you're also guaranteeing a large real capital loss at maturity.
Not really. As you say, these are premium bonds, and the premium is gradually paid down each year. By the maturity date, they will be worth face plus accumulated inflation, and that's what I'll receive. If you mean "capital loss compared to what I would get if I sold today", that's just the amount of the premium -- more or less -- that I collect through the semi-annual coupons.

FWIW the coupons, and hence the cash payout, is running at about 3.1% of market value.
I see no upside to this, not at current yields and prices, not at that large a fraction of overall portfolio.
Agreed. But then I think that applies to all FI instruments today. You're not recommending 100% equity portfolios, are you? :wink:

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Re: Real Return Bonds

Post by ockham » 10 Feb 2013 14:53

newguy wrote:
ghariton wrote:But if there is surplus money, I'm sure that the children and inlaws won't care what form it is held in.
That's another consideration. You don't really know how long you'll live but money earmarked for kids should be invested based on their time frames and situations.

newguy
Isn't the interests of the kids the key consideration (as opposed to just "another consideration")? The premise of this whole discussion is that ghariton has some sum of money, $X, known (subject to some margin of safety quailing) to be surplus to his needs and hence being held for the benefit of his loved ones, and currently held in RRBs inside an RRSP. The question is, what to do with that $X? I don't know how that question is to be addressed without knowing quite a lot more about the needs, wants, interests, circumstances, etc. of those loved ones.

(Congratulations on your retirement, btw. Though I can't help but notice that upthread you already in April, 2012, IIRC, identify yourself as retired.....) :beer:

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Re: Real Return Bonds

Post by Lazy Ninja » 10 Feb 2013 19:11

Has anyone had any luck in finding a good source for online quotes for the 2041 or 2044 RRBs?

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Re: Real Return Bonds

Post by newguy » 10 Feb 2013 19:24

ockham wrote:
newguy wrote:
ghariton wrote:But if there is surplus money, I'm sure that the children and inlaws won't care what form it is held in.
That's another consideration. You don't really know how long you'll live but money earmarked for kids should be invested based on their time frames and situations.

newguy
Isn't the interests of the kids the key consideration (as opposed to just "another consideration")?
Well I guess it depends on the individual and how likely it is they'll outlive the money. The kids would normally only get the leftover.

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Re: Real Return Bonds

Post by Shakespeare » 13 Jun 2013 16:59

RRB prices continue to soften. The 2021 is off $9+ from its maximum.


ZRR (management fee=0.25%) may be useful for rebalancing.
getChartZRR.png
getChartZRR.png (8.54 KiB) Viewed 532 times
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Re: Real Return Bonds

Post by newguy » 13 Jun 2013 18:59

I keep reading how this rise in rates is a rise in real rates. Since bloomberg doesn't give me the BE spread any more I made a little r-script to download and plot some stuff. More as a learning project but it works well. I highly recommend R for data analysis (and it's free).
Rplot01.png
You can see real rates have risen a little faster than nominal but not by that much. The BE spread is about at it's lowest since the 08 crash. It seems to have a little predictive power for CPI as well, but I'm showing YoY so maybe the monthly CPI leads the RRBs a bit :?:

Here's the code to automagically extract the info from the BoC if anyone wants to play.

Code: Select all

dataM<-read.table("http://www.bankofcanada.ca/stats/results/csv?rangeType=range&rangeValue=1&rangeWeeklyValue=1&rangeMonthlyValue=100&lP=lookup_bond_yields.php&sR=2003-06-13&se=L_V122544-L_V122553&dF=&dT=u"
                 ,sep = ","
                 ,header = TRUE
                 ,skip = 13
                 ,fill = TRUE)
colnames(dataM)<-c("Date","nominal","real")
dataM$Date<-as.Date(paste(dataM$Date,"-28",sep=""), format = "%Y-%m-%d")
dataD<-read.table("http://www.bankofcanada.ca/stats/results/csv?rangeType=range&rangeValue=30&rangeWeeklyValue=1&rangeMonthlyValue=1&lP=lookup_bond_yields.php&sR=2003-06-13&se=L_V39056-L_V39057&dF=&dT="
                  ,sep = ","
                  ,header = TRUE
                  ,colClasses=c("character", "numeric", "numeric")
                  ,na.strings=c("Bankholiday")
                  ,skip = 13
                  ,fill = TRUE)
colnames(dataD)<-c("Date","nominal","real")
dataD$Date<-as.Date((dataD$Date), format = "%Y-%m-%d")
require(XML)
cpi = readHTMLTable("http://www.bankofcanada.ca/rates/price-indexes/cpi/")
cpi<-cpi[[1]]
cpi<-cpi[c(-1,-2),]
cpi<-cpi[,c(1,5)]
colnames(cpi)<-c("Date","CPI")
cpi$Date<-as.Date(paste(cpi$Date,"-28",sep=""), format = "%Y-%m-%d")
require(xts)
cpi<-xts(cpi[,"CPI"],cpi$Date)
data<-rbind(dataM,dataD)
data<-transform(data, BE = nominal-real)
data<-xts(data[,c("nominal","real","BE")],data$Date)
data<-merge(cpi,data)
data<- data[!is.na(data$nominal),]

colors=c("red","green","blue","black")
plot.zoo(data, plot.type = "single"
         , col = colors
         , xlab="", ylab="Yield", main="GoC long term bonds")
legend("topright", lty=c(1,1,1,1), lwd=c(2,2,2,2),col=colors, colnames(data))
grid()
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Re: Real Return Bonds

Post by tidal » 13 Jun 2013 21:00

Isn't this hinting at deflation?

(Oh wait, wait, what am I thinking???... NO WAY we can have DEflation. Didn't the omniscient Milton Friedman promise us that "Inflation is always and everywhere a monetary phenomenon"? So we could turn our brains off and spend all our time haranguing anyone who said different? Gold! Gold! Gold! They are debasing our money! Like those old Roman coins! GOLD!!! MASSIVE INFLESSION!!!) :roll:

M * V = P * Q

V is declining, on the back of substantive systemic forces. Q will also necessarily decline for physical reasons. No self-respecting neoconservative will let M grow -" For the Bible Milton Friedman told me so!". Whither P?
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Re: Real Return Bonds

Post by ghariton » 13 Jun 2013 21:08

newguy wrote:You can see real rates have risen a little faster than nominal but not by that much.
Consistent with Bank of Canada yoelds on long term nominal and real bonds.

Nominal:
untitled.png
Real:
untitled 2.png
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Re: Real Return Bonds

Post by newguy » 13 Jun 2013 21:52

ghariton wrote:Consistent with Bank of Canada yoelds on long term nominal and real bonds.
That's exactly what I was graphing but for 100 months instead of 12. I also like to see the difference between the two series as one proxy for inflation expectations. That's what I called BE, for break even.

So what do you think is driving the yield spike, real or nominal rates or declining inflation expectations? I know it's all related but I've read a few stories that say it's driven by a change in real rates.

Personally I think it's Japan. One other thing to watch out for is MBS hedging. It can be a positive feedback for a while as they have to increase their hedges in the same direction. I guess the buzzword nowadays is fragility.

newguy

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