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How the Market Works

The Devil is in the Details

Posted by kdadmin on January 5th, 2014.

While I’m not usually a fan of the tripe dribbled out of the financial media, this article serves as a great summary about why my clients don’t own treasury bonds. (Primer: if bond yields are up, bond prices are down.) Although, I prefer the following chart: (Source. Yahoo Finance)

The Devil is in the Details

KEY:

The shaded area is the 20 year treasury ETF (TLT)
The green line is the 7-10 year treasury ETF (IEF)
The red line is the high yield bond ETF (JNK)
The purple line is the short term corporate bond fund (PSHIX).
The orange line is the short term higher yield corporate bond fund (PIFZX).
The yellow line is the S&P 500 Index.

Suffice it to say that over the last 6 months (actually about 16 months, but the analysis is clearer over this shorter period of time), owning treasury bonds was not a safe hedge against the stock market’s volatility. If you recall, back in September, 2012, with the announcement of QE3, we dropped our stake in TLT (since then it has plummeted roughly 20%).

So we dodged bullet, so what? Here’s what: In order to have a properly balanced portfolio, an investor needs some bond component. But what if the “safest” (treasury) bonds are dropping at the rate of 5% over six months? A shrewd investor will use a different hedge. In our case, we used corporate bonds and higher yielding bonds with shorter durations. As you can see, while the 20 and 7-10 year treasuries dropped in value (shaded area and green line), our high yield bonds (red line) made money, and our corporate bonds kept an even hedge (purple and orange lines).

I recently met a prospective client while on a break between Kiteboarding sessions in the Florida Keys. He summarized my profession as, “So, you just buy stocks and bonds, I can do that myself. I bought long term treasuries and the S&P 500. Done.” I replied, “Yes, but WHICH stocks and bonds. The devil is in the details. So in your accounts, in the last year, you made 28% in the S&P 500 and lost 18% in the long term treasuries, for a net of 10% right?” He agreed. I asked, “How much time did you spend doing this, researching, watching the market, et cetera?” He estimated about 5 hours a week.

I said, “Well, in 2013, we sold the S&P 500 after a 23% gain, skipped the long term treasuries, and bought high yield bonds. We’re up roughly 15%, on average, across the whole portfolio. We’re happy with those returns, but do you know what the best part is? My clients didn’t have to do anything. No research, no following market trends, no sweating about their investment choices, no nothing. They just lived their happy lives, left the hassle to me, and beat your simplistic approach by 50%. So, next year, maybe you could spend those 250 hours and that 5% in additional gains traveling to ideal Kiteboarding destinations instead …”

He had to agree.

But you’ve already learned all this. As our client (unlike this prospective client), you continue to be well positioned for the market cycle and are out performing your benchmarks on a risk adjusted basis. Excellent.

Happy New Year!

Sincerely,
Zurich Awes

P.S. Introduce us to your friends and help them make 2014 the year they learn how you continue to “Live the Life You Love.”

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