Yield curve trap

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Feb 7, 2007 4:54 pm

[quote=AllREIT] [quote=BondGuy]Again, we could care less about total return. We only care about delivering income.[/quote]

That's silly. Give me $1000 and I'll guarantee I'll get you a 10% return for 10 years.

I can also do a 20% return for 5 years if you would prefer that.
[/quote]

Clearly, you don't get it.

Feb 7, 2007 4:58 pm

[quote=mranonymous2u]

"I have one client who will only buy the longest investment grade paper out there, tax free. Her attitude is "Just buy bonds" when she has the money to do so. She doesn't care about interest rate predictions. She's told me many times. nobody knows, so why worry about it. Just show her the highest yield paper within her default risk parameters." Bondguy

Net result? She has a defacto bond ladder. Maybe it's not exactly smooth, but she probably always has bonds maturing, being called, being Pre Re'd tons of interest each month. It's a wonderful thing! Short term rates? What does she care? Her six month paper is yielding 5.35% (at least that's what she told me!)

Mr. A

[/quote]

Defacto ladder, with the emphasis being defacto. She has no way of knowing rates would drop, nor does she care.

Feb 7, 2007 5:01 pm

Allreit strikes me as the guy who goes 76 in the fast lane on the interstate. "That's fast enough and if I slow people down, then they're finally doing it right."

Don't waste your time.

Mr. A

Feb 7, 2007 5:08 pm

[quote=Indyone]Certainly staying short has it's risks, and I'm not here to call the bond curve prediction wrong, but the curve notwithstanding, I have a pretty strong feeling that the risk/reward is in favor in keeping clients short.  Hopefully, this thread will be preserved and we can revisit the issue at the beginning of the next three years and see where things actually ended up.  Those are some of the best lessons we can get...the benefit of 20/20 hindsight...[/quote]

Indy, you know I have great respect for you. I wasn't asking you to defend your position. you may be right, however there is no right or wrong here, just opinions.

To all: Telling you about my client who does nothing but worry free buying of LT bonds whenever she has cash to invest wasn't to give you a strategy to challenge. It was to show that even the simplist of strategies can work. This woman has, over the 20 years we've been doing business, outperformed the best of the best on wall street. And she's done so without trying. She simply wants to maximize her income. The lesson is don't over think this.

Feb 7, 2007 5:13 pm

[quote=BondGuy]

Indy, you know I have great respect for you. I wasn't asking you to defend your position. you may be right, however there is no right or wrong here, just opinions.

To all: Telling you about my client who does nothing but worry free buying of LT bonds whenever she has cash to invest wasn't to give you a strategy to challenge. It was to show that even the simplist of strategies can work. This woman has, over the 20 years we've been doing business, outperformed the best of the best on wall street. And she's done so without trying. She simply wants to maximize her income. The lesson is don't over think this.[/quote]

Oh, and one other lesson. Don't think you know more than little old ladies. Chances are you don't.

Feb 7, 2007 5:17 pm

Actually, that thought crossed my mind as well when I read your post.



I don’t separate the price of the asset from it’s yield…unless you’re talking

about holding bonds to maturity exclusively. It’s not common, but it does

happen. I too had a client, who at 90 years of age, bought 20+ year bonds,

seeking only the highest available yield with no regard for asset price

volatility.



As far as “over thinking”, it was YOU who asked for our opinions on the

subject. I hope you enjoyed it, you sadist.

Feb 7, 2007 5:33 pm

Bondguy,

What I find fun about bond buying is finding the best deal, most times it's cashflow. Once in a while it's total return, like the Zeroes (but that's usually equity money, not bond dough) or premium bonds or low quality, high coupon Munis looking at a Pre Re (those are fun I love it when I'm right on those. Pre Re's seem to be more frequent in a rising rate scenario, so you have a winner in a losing bond market! Sweet!) Likewise, premiumed preferreds have a tendency to rise as the probability of their being called goes away too.

Not to hawk a name but the FredMac five year floater (fre.l) has done a good job for me and can continue to do so (if rates don't tank too much) as I recall, it reset in 05 and will reset again in 10 based on the 5yr Treasury (4.747 today). That implies a dividend of $2.36 which is 5.55% at this price and $56 based on today's yield. But let's say the preferred goes back to par for the reset. So I get $1.79/year income (4.215%) plus the growth from 42.5 to 50 ($7.5) in three years 5.88% per year. OK, it's not likely to get all the way to $50 if it goes to $45.5 I added 235 beeps, 6.5% not bad for government work. (BTW, I think there is much too much inflation in the world for rates to drop too much. Otherwise known as, at all.)

Mr. A

Feb 7, 2007 5:40 pm

Indy,

"....the benefit of 20/20 hindsight..."

It is my experience that, "Hindsight is 50/50 at best!"

That's mine, but you can use it!

Mr. A

Feb 7, 2007 6:43 pm

BG, I didn't post that last bit on the defensive (at least not consciously, anyway), and I'll say without hesitation that my knowledge of the bond world is nothing to brag about and certainly not in the realm of a veteran specialist such as yourself.  Likewise, I don't have any premonition about being right 1, 2, or 3 years out...I just like looking back later at predictions and seeing what view ended up being the right one and why...that is usually some very good information.  That's what I meant about 20/20 hindsight lessons.

Based on where rates stand today, I like my chances or I wouldn't skew my clients that way, although like many who lack the courage of strong convictions, I've outsourced most of the bond management to fund managers.

BTW, where did all the fat (8-9%+) yields go on 1-3 year US auto paper go?!!  I had a good thing there...even finding YTMs of up to 13% on Ford paper of less than three years last summer...man, is that stuff gone!

Feb 7, 2007 7:49 pm

[quote=BondGuy]

Defacto ladder, with the emphasis being defacto. She has no way of knowing rates would drop, nor does she care.

[/quote]



Most clients would be annoyed at all the fluctuation from having a high
duration portfolio. If 15bp pays for your zantac, so be it.



I still like my 20% for 5 years plan. High income and no risk, total return is pretty weak though.
Feb 7, 2007 7:58 pm

Reit,

It wasn't funny the second time someone told the "Double your money, fold it in half and put it your pocket" joke either.

I generally find that when people feel the need to put a laugh track on their own jokes, it's because the joke isn't funny, and the author is pretty dull.

Mr. A

Feb 7, 2007 8:02 pm

[quote=NOFX]

I second that.  I told my clients “We are probably
6 -12 months early moving out of floating rate, I’d rather be 6 months
early than a day late”  There is so much CD money that is in
floating rate because it was sold solely on the yield.  When NAVs
start to decline, and people head for the exits (and have to wait up to
90 days) at the same time, it will barely matter which fund company you
are with.  My clients appreciate that they were in floating rate
for the “easy money”  moved it all to  agencies and munis.

[/quote]



I’m waiting for one of the recent big LBO’s to flame out. That will put
some fear into the leveraged loan market.There is no such thing as a
partial default.



I just got off the Evergreen Asset Allocation fund CC, and Jermey
Grantham has made some good points about corporate profit margins being
at all time highs. Economic theory suggests that abnormally high profit
margins don’t last. So thost highly leveraged companies which are also
marginal participants, are going to eat dirt if the economy should slow
down.




Feb 7, 2007 8:10 pm

[quote=BondGuy]

[quote=AllREIT] [quote=BondGuy]Again, we could care less about total return. We only care about delivering income.[/quote]

That's silly. Give me $1000 and I'll guarantee I'll get you a 10% return for 10 years.

I can also do a 20% return for 5 years if you would prefer that.
[/quote]

Clearly, you don't get it.

[/quote]

Allreit, sorry, I must have missed something or I am too dumb to get your sense of humour here. You appear serious.

Feb 8, 2007 12:55 am

[quote=planrcoach][quote=BondGuy]

[quote=AllREIT] [quote=BondGuy]Again, we could care less about total return. We only care about delivering income.[/quote]

That's silly. Give me $1000 and I'll guarantee I'll get you a 10% return for 10 years.

I can also do a 20% return for 5 years if you would prefer that.
[/quote]

Clearly, you don't get it.

[/quote]

Allreit, sorry, I must have missed something or I am too dumb to get your sense of humour here. You appear serious.

[/quote]

I'm joking, Bondguy said the client was only concerned about income not total return.

So I was implying that in that case, I would just take the cash ($1000), and pay it right back to the client. Thus delivering high income but zero total return.

If I got paid to do this, I would be operating a closed end fund.


Feb 8, 2007 1:00 am

[quote=mranonymous2u]

Reit,

It wasn't funny the second time someone told the "Double your money, fold it in half and put it your pocket" joke either.[/quote]

I work on the principal that if you fold your money, you'll find it in creases.

Feb 8, 2007 9:45 am

[quote=Indyone]

BG, I didn't post that last bit on the defensive (at least not consciously, anyway), and I'll say without hesitation that my knowledge of the bond world is nothing to brag about and certainly not in the realm of a veteran specialist such as yourself.  Likewise, I don't have any premonition about being right 1, 2, or 3 years out...I just like looking back later at predictions and seeing what view ended up being the right one and why...that is usually some very good information.  That's what I meant about 20/20 hindsight lessons.

Based on where rates stand today, I like my chances or I wouldn't skew my clients that way, although like many who lack the courage of strong convictions, I've outsourced most of the bond management to fund managers.

BTW, where did all the fat (8-9%+) yields go on 1-3 year US auto paper go?!!  I had a good thing there...even finding YTMs of up to 13% on Ford paper of less than three years last summer...man, is that stuff gone!

[/quote]

I respect your opinion, even though I'm not in agreement with it. That's what makes a market. There is no wrong answer. Taking a strong position based on beliefs is exactly why all our clients are paying us.

Ah, the auto paper! Again this is the stuff that seperates the men from the boys(or the woman from the girls). Educating ones self to a level to take positions in this type of paper truely seperates you from the crowd. When we talk in terms of value added, this is what we're talking about. Not for the faint of heart or the weak willed.