Real Return Bonds

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Re: Real Return Bonds

Postby newguy » 11 Aug 2011 14:11

ghariton wrote:I would not make such a bet. In fact, scanning the various nominal yields available on Globe Investor, I don't see why anyone is purchasing any of them at this point.


Not quite. You have to look at the yield curve. When a bond moves down the steep part you make cap gains in addition to yield. A ten year becomes a 9 year after 1 year etc.. Another thing is it may be a bet on the yields to keep falling.

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Re: Real Return Bonds

Postby jiHymas » 11 Aug 2011 15:47

ghariton wrote:
Bylo Selhi wrote:The 2021s are down to 45bp real :shock:

Compare to a nominal gov't bond maturing in June 2021, yielding 2.41%. An investor in the nominal bond is betting that inflation for the next ten years will average below 2%.

I would not make such a bet. In fact, scanning the various nominal yields available on Globe Investor, I don't see why anyone is purchasing any of them at this point.

YMMV

George

Some investors have very stringent credit quality and duration requirements; it will be remembered that pension liabilities are discounted at the long term government rate.

Another class of buyer are retail investors buying index funds.
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Re: Real Return Bonds

Postby Shakespeare » 18 Aug 2011 16:29

2021 yield now down below 0.2%! :shock:
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Re: Real Return Bonds

Postby tidal » 18 Aug 2011 16:54

Shakespeare wrote:2021 yield now down below 0.2%! :shock:
The low yields on both nominal and real government bonds are ominous.

There is a strong case to be made that these yields are suggestive of extended poor economic growth rates going forward (link below).

If that holds we are in deep trouble on the equity side. I would think you could see bonds beat equities by a wide margin*, as hard as that is to apprehend. People who are looking at the dividend- or earning-yield versus, say, the 5- or 10-year bond and saying "bargain!" essentially need the economy to grow unexpectedly fast to make those a winning investment. But, in aggregrate, the very firms that they are implicitly betting on to grow that economy are not finding growth opportunities sufficient to invest in even at these exceptionally low borrowing rates.
"Think of this measure as an asset valuation model with the asset being the entire economy. If the asset, as measured by nominal GDP, returns a rate higher than the prevailing interest rate (the five-year Treasury note), then it makes sense for a business to borrow and expand. One can make money in such an environment because the asset has a higher return than the cost of borrowing. This will cause an increase in the demand for credit thus putting upward pressure on the price of credit—interest rates. This will last as long as yields are below the year-over-year change in nominal GDP (or at least the perception that interest rates are below nominal GDP). On the flip side, if interest rates (five-year Treasury note) are higher than the returns provided by the economy (nominal GDP), then borrowing to "buy" is a money-losing proposition. In this case the demand for money will fall because the profit incentive is not present. This will drive the price of credit (interest rates) down so long as yields are above the growth rate, or perceived growth rate, of nominal GDP."
*If you look at the expected equity return in the same article, it's "corporate dividend rate + treasury yield (or gdp growth)", which would still give equities the better expected return (say 4.5% versus 1.5% for 5-year bonds), but if an idea of longer-term growth rates of 1.5% nominal or less ever gripped the market, the price/dividend or price/earnings ratio would compress. A lot.
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Re: Real Return Bonds

Postby AltaRed » 18 Aug 2011 17:33

tidal wrote:If you look at the expected equity return in the same article, it's "corporate dividend rate + treasury yield (or gdp growth)", which would still give equities the better expected return (say 4.5% versus 1.5% for 5-year bonds), but if an idea of longer-term growth rates of 1.5% nominal or less ever gripped the market, the price/dividend or price/earnings ratio would compress. A lot.

If the idea of longer term growth rates of 1.5% nominal or less ever gripped the market, the denominators in those ratios would drop a lot too.
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Re: Real Return Bonds

Postby ghariton » 06 Sep 2011 22:30

It seems that real return bonds are currently yielding 0.27% in the U.K., 0.12% in Germany, and close to zero in the U.S. By comparison the Bank of Canada reports that Canadian RRBs yielded 0.77% as of yesterday -- a veritable windfall.

Of course, Canadian government nominal bonds of 5 years or less all show negative real yields, again as reported by the Bank of Canada.

Not an easy time to be retired, unless you're rich.

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Re: Real Return Bonds

Postby ghariton » 21 Sep 2011 16:20

According to the B of C, as of yesterday, long Canada nominal bonds were yielding 2.86% and RRBs were yielding 0.81%, for a spread of 2.05%.

Would this be a good time to institute a position long RRBs and short nominals? (Purely speculative, of course.) Or would the transaction costs kill you?

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Re: Real Return Bonds

Postby newguy » 21 Sep 2011 17:07

ghariton wrote:According to the B of C, as of yesterday, long Canada nominal bonds were yielding 2.86% and RRBs were yielding 0.81%, for a spread of 2.05%.

Would this be a good time to institute a position long RRBs and short nominals? (Purely speculative, of course.) Or would the transaction costs kill you?

George

I think this picture will update automatically, so we'll see (BB says it's 2.125).

20 yr breakeven

Image

I don't think the spreads are too bad with xlb and xrb so another pic but with a longer time frame.

xrbxlb.png
xrbxlb.png (8.81 KiB) Viewed 1046 times


The trend is down and nowhere near the lows of '08. I would bet on the trend continuing.

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Re: Real Return Bonds

Postby ghariton » 21 Sep 2011 20:32

newguy wrote:The trend is down and nowhere near the lows of '08. I would bet on the trend continuing.

Hmmm. Are you predicting another severe liquidity crunch? That's what happened in 2008 -- the liquidity premium, normally less than 10 basis points, increased to somewhere in excess of 80 basis points.

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Re: Real Return Bonds

Postby newguy » 21 Sep 2011 20:49

ghariton wrote:
newguy wrote:The trend is down and nowhere near the lows of '08. I would bet on the trend continuing.

Hmmm. Are you predicting another severe liquidity crunch? That's what happened in 2008 -- the liquidity premium, normally less than 10 basis points, increased to somewhere in excess of 80 basis points.

George

Well I'm showing graphs of xrb and xlb back in '08. I'm not sure one is more liquid than the other. I haven't checked the nav's so I'm not sure how far out of line they got. I guess they could be reflecting the underlying rrb's illiquidity but I'm not sure how to measure the premium.

How do you know is wasn't just that people preferred nominal bonds over rrb's? It could be people thought deflation was coming. Maybe the chart is really about inflation expectations and not a liquidity crunch. How many rrb investors like yourself are prone to panic and dump their only secure holding?

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Re: Real Return Bonds

Postby ghariton » 21 Sep 2011 21:03

newguy wrote:Well I'm showing graphs of xrb and xlb back in '08. I'm not sure one is more liquid than the other. I haven't checked the nav's so I'm not sure how far out of line they got. I guess they could be reflecting the underlying rrb's illiquidity but I'm not sure how to measure the premium.

Yes, I was referring to the underlying. I should have made that clear.

How do you know is wasn't just that people preferred nominal bonds over rrb's?

Federal Reserve Bank of Cleveland used tp publish an analysis that decomposed the spread between TIPs and U.S. nominals into expected inflation, insurance against unexpected inflation, and a liquidity premium. From their web site:

October 31, 2008

We have discontinued the liquidity-adjusted TIPS expected inflation estimates for the time being. The adjustment was designed for more normal liquidity premiums. We believe that the extreme rush to liquidity is affecting the accuracy of the estimates.

I would guess that the same was true in Canada, only more so, given the relative thinness of our markets.

How many rrb investors like yourself are prone to panic and dump their only secure holding?

:)

I used the occasion to add to my holdings. Indeed, I bought right up to my long term target for the amount of RRBs I want to hold. (I finally did something right. :wink:)

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Re: Real Return Bonds

Postby newguy » 21 Sep 2011 22:12

ghariton wrote:
October 31, 2008

We have discontinued the liquidity-adjusted TIPS expected inflation estimates for the time being. The adjustment was designed for more normal liquidity premiums. We believe that the extreme rush to liquidity is affecting the accuracy of the estimates.

Here's the paper describing their methods.
http://www.clevelandfed.org/research/wo ... wp1107.pdf

Unlike most studies, we use three different sources of data to estimate our model’s parameters: nominal Treasury yields, survey forecasts of inflation, and inflation swap rates.

But they don't say why inflation swaps (otc traded afaik) are a better estimate of inflation expectations that the tips spread. Maybe the swaps just have the opposite of liquidity premium. Pretty intense paper though, I gave up here
Consider a discrete time environment with multiple periods, each of length ∆t measured in years. Let Mt be the nominal pricing kernel with dynamics Mt+∆t Mt = e−it∆t−12P4j=1 φ2jh2j,t∆t−P4j=1 φjhj,t√∆tj,t+∆t


Anyway they say "latest estimate of 10-year expected inflation is 1.37 percent." The breakeven spread then was 1.97%, so 0.6% of something else. It could be insurance or liquidity premium or mostly just supposition from the model.

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Re: Real Return Bonds

Postby Taggart » 22 Sep 2011 04:05

I can't pretend to understand what George and Newguy are talking about (because I don't). Instead of an investor trying to put a new hat on and all of a sudden try to become an instant hedge fund manager, by determining whether he/she should be shorting RRB's or going long, wouldn't it be a bit simpler to always go long and let the portfolio determine which asset class extra cash should be invested, instead of the market leading you astray?
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Re: Real Return Bonds

Postby DavidR » 22 Sep 2011 08:47

Taggart wrote:... wouldn't it be a bit simpler to always go long and let the portfolio determine which asset class extra cash should be invested, instead of the market leading you astray?

Or, as George (IIRC) sometimes says, "lie down until the feeling passes"?
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Re: Real Return Bonds

Postby ghariton » 22 Sep 2011 21:42

newguy wrote:Here's the paper describing their methods.
http://www.clevelandfed.org/research/wo ... wp1107.pdf

Thanks for the link. That's a very interesting paper. But it doesn't describe the model the Cleveland Fed was using prior to the 2008 crisis. Rather, it is a new model that some staff members are advocating. In particular they want to use the inflation expectations inherent in inflation swaps instead of TIPs to measure expected inflation (and real yields).

I must say that I hadn't heard of inflation swaps (essentially forward contracts on inflation) until now. But then I lead a very sheltered life.

Anyway, their main claim is that expected inflation calculated from inflation swaps is a better measure than that calculated from TIPs data. They support their claim in part by comparisons to surveys of expected inflation held by real humans.

A major problem with TIPs data is that it includes all sorts of things, such as liquidity premia. From page 18 of their paper:

Use of data on TIPS yields is problematic not only for the recent financial crisis. Studies by Sack and Elsasser (2004), Shen (2006), and D’Amico, Kim, and Wei (2008) reveal that the TIPS breakeven inflation rate consistently fell below survey measures of inflation expectations and that TIPS yields contain a liquidity premium that, in the time period prior to 2004, was unreasonably large and difficult to account for in any rational pricing framework. Shen (2006) finds evidence of a drop in the liquidity premium on TIPS around 2004 that he attributes to the U.S. Treasury’s greater issuance of TIPS around that time, as well as to the beginning of exchange traded funds that purchased TIPS. This accumulated evidence on the distortions to TIPS yields led us to employ inflation swap rates and survey inflation forecasts as a more reliable reflection of real yields and expected inflation.

They have this very interesting conclusion:

Comparing our model prices of inflation-indexed bonds to those of Treasury Inflation Protected Securities (TIPS) suggests that TIPS were
significantly underpriced prior to 2004 and again during the 2008-2009 financial crisis.

I had reached the same conclusion as regards Canadian RRBs, by intuition rather than by learned models. It's the main reason why I loaded up on RRBs at the end of 2008.

I gave up here
Consider a discrete time environment with multiple periods, each of length ∆t measured in years. Let Mt be the nominal pricing kernel with dynamics Mt+∆t Mt = e−it∆t−12P4j=1 φ2jh2j,t∆t−P4j=1 φjhj,t√∆tj,t+∆t

That's the equation of a generalized Weiner process, with four factors driving volatility instead of the usual single factor. The math is pretty heavy (although not for this type of literature). But it hardly gets used in the empirical part -- you can just skip over it.

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Re: Real Return Bonds

Postby ghariton » 22 Sep 2011 21:45

Taggart wrote:an investor trying to put a new hat on and all of a sudden try to become an instant hedge fund manager

I can dream, can't I? :wink:

Of course I'll never actually act on this. Still, it's fun dreaming up arbitrage schemes. After all, my style of investing is pretty damn boring, even in these times...

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Re: Real Return Bonds

Postby soloman » 23 Sep 2011 12:06

ghariton wrote:[url=http://www.ft.com/intl/cms/s/0/9cbe577a-d872-11e0-8f0a-00144feabdc0.html#axzz1XEUioz9k]

Not an easy time to be retired, unless you're rich.

George


You're telling me ! I'm not what I would call rich. I guess I'll just have to die younger ! :>) I think the grim reaper could be calling at my door in 10-15 years time any rate, if I don't rust up with Arthritis before that at any rate !

I'm in the unhappy position of having $50,000 of Bonds mature yesterday, and today, I'm scratching my head as to what kind of Fixed Income to buy now ! (Currently, I have no equities at all in our portfolios). Should I keep going with my 5 year ladder, wait a while in Bankers Acceptance, invest in XSB, XLB, or what !! RRB's are down and out for at least 5 years IMHO. The world's in a financial mess.
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Re: Real Return Bonds

Postby scomac » 23 Sep 2011 12:42

soloman wrote:
I'm in the unhappy position of having $50,000 of Bonds mature yesterday, and today, I'm scratching my head as to what kind of Fixed Income to buy now ! (Currently, I have no equities at all in our portfolios).


Then perhaps now is a good time to ease into equities. A nice broadly based large cap ETF like XIU purchased in several tranches over the course of the next 6 months if you are worried about buyer's remorse. It would be a simple and easy addition to make that would at least have the potential to provide some sort of inflation protection that bonds have no hope to provide at current prices. You'll even get a quarterly dividend of 2.6% or so that is likely to be comparable with bond interest at current rates and taxed much more favourably.
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Re: Real Return Bonds

Postby ghariton » 23 Sep 2011 22:07

According to the B of C, as of yesterday, long Canada nominal bonds were yielding 2.68% and RRBs were yielding 0.75%, for a spread of 1.93%. Good thing I went to lie down after getting my brilliant idea.

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Re: Real Return Bonds

Postby Mike Schimek » 24 Sep 2011 02:00

I'm in the unhappy position of having $50,000 of Bonds mature yesterday, and today, I'm scratching my head as to what kind of Fixed Income to buy now ! (Currently, I have no equities at all in our portfolios).


If you have an appetite for risk like me, you could try Lakeview D debentures, some are available at 61.45, mature in 20 months, 8.5% yield on face value, 13% yield on discounted value, 51.47% payout on maturity. These aren't forcibly convertible into units by the debtor like many debentures are, which is a positive. These are my top pick and I own a mountain of these.

Lakeview's hotels turned the corner 3 quarters ago and have kept on improving. I spoke with IR last week and they say Q3 will be better than Q3 of last year, which was already good and showing the recovery, and they said it looks like Q4 will be an improvement year over year as well.
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Re: Real Return Bonds

Postby adrian2 » 24 Sep 2011 19:16

Mike Schimek wrote:
I'm in the unhappy position of having $50,000 of Bonds mature yesterday, and today, I'm scratching my head as to what kind of Fixed Income to buy now ! (Currently, I have no equities at all in our portfolios).

If you have an appetite for risk like me, you could try Lakeview D debentures, some are available at 61.45, mature in 20 months, 8.5% yield on face value, 13% yield on discounted value, 51.47% payout on maturity.

WADR, the guy is talking about bonds maturing, and he has no equities at all. You're suggesting super junk with a yield-to-maturity of around 50%. It's not apples to oranges, it's apples to cannon balls.

Mike Schimek wrote:I spoke with IR last week and they say Q3 will be better than Q3 of last year, which was already good and showing the recovery, and they said it looks like Q4 will be an improvement year over year as well.

Of course they will tell you nice things, they are salesmen at IR. Would you ask a Ford salesman how good Hondas are?
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Re: Real Return Bonds

Postby ghariton » 25 Sep 2011 02:11

Mike Schimek wrote:If you have an appetite for risk like me, you could try Lakeview D debentures, some are available at 61.45, mature in 20 months, 8.5% yield on face value, 13% yield on discounted value, 51.47% payout on maturity. These aren't forcibly convertible into units by the debtor like many debentures are, which is a positive. These are my top pick and I own a mountain of these.

:D
You might want to diversify into Greek government bonds. The two-year bonds are yielding almost 70%.

And what's more, Venizelos is telling investors that Greece will not default. He should know -- he's the Finance Minister after all.

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Re: Real Return Bonds

Postby George$ » 25 Sep 2011 02:55

Off topic.
George: It is not yet 4 AM. Are an early riser or a late sleeper? :)
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Re: Real Return Bonds

Postby schmuck » 25 Sep 2011 14:13

scomac wrote: Then perhaps now is a good time to ease into equities. A nice broadly based large cap ETF like XIU purchased in several tranches over the course of the next 6 months


Couldn't agree more (with emphasis on "ease") and I'd probably choose a couple of dividend ETFs that favor utilities, pipelines and telcos. I'm no expert here, but It seems to me that XDV might be a bit heavy on financials, and CDZ on small caps, so it might be wise to diversify.

I think div stocks have a long ways to go before facing much competition from bond yields, and int rates would have to double or even tripple before any serious impact.
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Re: Real Return Bonds

Postby Taggart » 25 Sep 2011 14:35

schmuck wrote:
scomac wrote: Then perhaps now is a good time to ease into equities. A nice broadly based large cap ETF like XIU purchased in several tranches over the course of the next 6 months


Couldn't agree more (with emphasis on "ease") and I'd probably choose a couple of dividend ETFs that favor utilities, pipelines and telcos. I'm no expert here, but It seems to me that XDV might be a bit heavy on financials, and CDZ on small caps, so it might be wise to diversify.

I think div stocks have a long ways to go before facing much competition from bond yields, and int rates would have to double or even tripple before any serious impact.


I'll be interested to see how these dividend ETF's do against a broad based index once they've been around for at least ten years. So far none of the U.S. based dividend ETF's have beat VTI. Not even close. If these dividend ETF's can't do it in this environment, then I question when can they outperform? I know, because I've owned a few since 2008.
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