Provincial Strip Bond Ladder-Liquid?

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Park
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Provincial Strip Bond Ladder-Liquid?

Post by Park » 14 Aug 2011 13:30

The purpose of my fixed income is to provide equity risk diversification. To do this, my plan is to have a ladder of government strip bonds, with the ladder being in the 5-10 year range.

In a stock bear market, I want to be able to sell my bonds if necessary. To do that, there has to be sufficient liquidity.

My guess is that a ladder of Government of Canada strip bonds (Canada bonds) would have sufficient liquidity. I speculate that this would especially apply to the individual investor, who usually invests in smaller amounts than the institutional investor. I wonder if a Canada strip bond provides more liquidity than the individual investor needs.

I would be interested in a ladder of provincial strip bonds. You can get a modestly greater yield with provincial, as opposed to Canada bonds. Part of the increased yield though is due to the increased liquidity risk.

Provincial crown corporation bonds would give a better yield yet, but once again, with a higher liquidity risk.

In the stock bear market of 2008, if one wanted to sell a provincial strip bond with a value in the $10K-$60K range, would liquidity have been an issue? I would also be interested in the answer to the same question, but with a provincial crown corporation strip bond.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by like_to_retire » 14 Aug 2011 14:20

, as opposed to Canada bonds. Part of the increased yield though is due to the increased liquidity risk.
Yeah, but I don't feel the Canada bonds liquidity is required by the individual investor. The Canada liquidity is there to provide purchase or sale of bonds in the tens of millions with a single phone call. You're paying for that as an individual investor.

ltr

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Re: Provincial Strip Bond Ladder-Liquid?

Post by Park » 14 Aug 2011 14:51

ltr, I believe that you're referring to the liquidity of unstripped Canada bonds. The trading volume of unstripped Canada bonds is about 65 times greater than that of all stripped bonds (Canadas, provincials, crown corporates etc) combined.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by queerasmoi » 14 Aug 2011 18:30

I don't know much about the bond market, but I do know there is always going to be a considerable spread for the average retail customer trying to unload their bonds, especially after your brokerage marks it up. And since you're going with provincial not federal, and stripped in particular, that will probably widen the spread.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by Park » 14 Aug 2011 23:41

Unstripped Canada bonds would be liquid during bear market. Unstripped crown corporates, provincials and municipals have a trading volume about 23% of unstripped Canada bonds. So my guess is that unstripped provincial bonds (and crown corporates?) would also be liquid during a bear market. But I'm starting to wonder whether strips bonds would be liquid. Trading volume for Canadian corporate bonds is 5 times that of Canadian strip bonds.

http://www.bmonesbittburns.com/IA/IAHom ... NEWS_ID=54

The above link is from Nesbitt Burns. It states Canadas have the highest liquidity, considers provincials and NHA mortgage backed securities as having high liquidity, and government strip bonds as having moderate to high liquidity. Something more quantitative, especially as to what happened in 2008, would be preferable.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by ghariton » 15 Aug 2011 01:03

Park wrote:Trading volume for Canadian corporate bonds is 5 times that of Canadian strip bonds.
I hope you are not treating all Canadian corporate bonds as interchangeable. They differ wildly in bells and whistles and, more importantly, in credit risk. As a result, the markets for most of them are very thin. Indeed, most trade OTC rather than in organized exchanges, through dealers rather than brokers. That leaves small individual investors at the dealers' mercy.

If I were to invest in corporates (which I don't), I would do it through an ETF.

George
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Re: Provincial Strip Bond Ladder-Liquid?

Post by Park » 15 Aug 2011 01:50

No, I'm stock heavy in my portfolio, so corporate bonds make less sense. If I need to liquidate part of my portfolio during a bear market in stocks, I don't want to lose money on that liquidation. The following are quotes from Hank Cunningham's book:

"Furthermore, the less-liquid, bonds, such as corporates and zero-coupons, are most frequently quoted on a matrix basis."

"To speculate in bonds means you should trade the most active and liquid issues. In so doing, you will have a tight bid-ask spread and the assurance that there will be a bid and an ask. Therefore, you will be trading and charting the benchmark Government of Canada bonds, the key trading issues in the market at different maturities."

I'm not interested in speculating in bonds. But I think what is written above applies to my situation. For me, it sounds like Canada bonds are a good idea; possibly some of the larger provincial issuers could be considered. But I'm starting to doubt the wisdom of a strip bond ladder, federal or provincial.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by like_to_retire » 15 Aug 2011 08:06

If I need to liquidate part of my portfolio during a bear market in stocks, I don't want to lose money on that liquidation
Since strips will have a higher duration than a coupon bond they will be more sensitive to interest rate changes. If rates rise and you're trying to liquidate some of your strips, would there perhaps be a larger loss than with a coupon bond.

ltr

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Re: Provincial Strip Bond Ladder-Liquid?

Post by Park » 15 Aug 2011 10:22

From Hank Cunningham's book, provincials yielded about 65 basis points (0.65%) more than Canadas at the time the book was written. Obviously, that spread can vary.

I did some rough calculations for 2008; if someone has better numbers, please post them. Canada bonds returned 13.7%, provincials 4.5%. So if you had to sell your provincial bonds in 2008, you could easily have lost the increased yield of provincial bonds versus Canada bonds.

But inflation was 2.8% in 2008. So you still beat inflation in 2008 with provincial bonds, and did much better than stocks.

My bonds are an insurance policy against bear markets in stocks; the probability that I will have to use the policy is small. One could make the case that I'm overinsuring myself with Canada bonds, and that provincial bonds will give me adequate insurance at a lower cost.

It may depend on what portion of your portfolio is in bonds. If you're 100% bonds, then provincial bonds, as opposed to Canada bonds, results in a 0.65% increased portfolio return. But if you're 10% bonds, then the same strategy results in a 0.065% increased portfolio return.

But the more I think about strip bonds as my insurance policy, the more that coupon bonds appear the better choice.

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Re: Provincial Strip Bond Ladder-Liquid?

Post by Shakespeare » 15 Aug 2011 10:54

But the more I think about strip bonds as my insurance policy, the more that coupon bonds appear the better choice.
They are more liquid, have shorter duration, have lower commissions, and give cash flow which is useful in withdrawal phase.
“A wise man should be prepared to abandon his baggage at any time.” -- R.A. Heinlein, The Door Into Summer.

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