Author Topic: Long-term treasury bonds (or similar) for negative correlation?  (Read 277 times)

Vorpal

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I'm considering RE within the next 12-24 months. Everything has kind of been on autopilot for years, and so my asset allocation is still 100% stocks (S&P 500 index) as is typical during the accumulation phase. I've been reading and listening a lot about sequence of return risk lately, and realized that I'm pretty vulnerable to that with my asset allocation. Has anyone shifted a portion of their portfolio to an asset with negative correlation to the stock market, specifically long-term treasury bonds? I'm considering a big move (in my 401k, to avoid taxes) of 20-25% of my overall portfolio value into PRULX or something similar (preferably with a lower expense ratio), and wanted to make sure that I'm on the right track strategy-wise. Thanks in advance!
« Last Edit: July 02, 2021, 11:21:26 AM by Vorpal »

ChpBstrd

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Re: Long-term treasury bonds (or similar) for negative correlation?
« Reply #1 on: July 02, 2021, 12:04:08 PM »
The thing that would cause stocks to fall is higher interest rates.
Higher rates is also the thing that would cause long-term bonds to crash.

Thus in today's ultra-low-rate environment, I don't think bonds offer the same diversification they once did. I would be hesitant to extrapolate the low and positive, not negative, (+0.20) average correlations of the past with the future starting from this point. Most of those numbers came from eras with 5-7% yields on treasuries!

https://movement.capital/analyzing-bond-performance-in-stock-corrections/

Instead you need to quickly get up to speed on portfolio hedging using options. Instead of a bond tent, I recommend a long-duration - e.g. use options with 2.5 years duration and roll annually - collar or protective put, with the options entered during a period of low volatility as we are experiencing now.

https://www.optionseducation.org/strategies/all-strategies/protective-put-married-put
https://www.optionseducation.org/strategies/all-strategies/collar-protective-collar?source=ff07eb67-094d-45a8-a0cd-ed2a948c063d

Like a bond allocation, these strategies will lower volatility and provide rebalancing opportunities. Unlike a bond allocation, they will cushion the blow if interest rates or inflation rise and they offer a firm, 100% certain floor on your maximum losses no matter what happens. Another positive is that either strategy allows you to keep a much larger allocation to stocks than you could have with a traditional stocks/bonds portfolio mix. That means more upside if the early 2020's turn out like the early 2010s, or if markets are only slightly up.

Finally, if you go from 100% stocks to, say, a 70/30 stock/bond mix, you'll have to sell 30% of your stocks. If this happens in taxable accounts, you'll incur high capital gains. A protective put, on the other hand, could be bought with maybe 10% of your assets, especially while volatility is low and options are cheap. With the collar strategy, you could optionally set it up to have even less cost than that, maybe even zero net cost, and this would hedge you while deferring capital gains.

MustacheAndaHalf

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Re: Long-term treasury bonds (or similar) for negative correlation?
« Reply #2 on: July 02, 2021, 12:38:49 PM »
I'm considering RE within the next 12-24 months. Everything has kind of been on autopilot for years, and so my asset allocation is still 100% stocks (S&P 500 index) as is typical during the accumulation phase. I've been reading and listening a lot about sequence of return risk lately, and realized that I'm pretty vulnerable to that with my asset allocation. Has anyone shifted a portion of their portfolio to an asset with negative correlation to the stock market, specifically long-term treasury bonds? I'm considering a big move (in my 401k, to avoid taxes) of 20-25% of my overall portfolio value into PRULX or something similar (preferably with a lower expense ratio), and wanted to make sure that I'm on the right track strategy-wise. Thanks in advance!
Vanguard Long-Term Treasury ETF (VGLT) has a 0.05% expense ratio.  If you can buy stocks/ETFs in your 401k, you should be able to buy that.  When your employment ends, you can transfer the 401k into a Traditional IRA at a brokerage of your choice (Vanguard, Schwab, Fidelity have good fund choices - low expenses).

Bond funds used to be 1/3rd of my portfolio, but I currently have 0% bonds.  I'm currently afraid of rapid interest rate increases hurting the value of bonds.  The impact is smallest in short-term bonds, and greatest in the long-term bonds you're considering.  I also have a sneaking suspicion I'm wrong.  I've seen this scenario before, where most people avoid bonds, and bonds tend to do better than expected.  What you said is also accurate - long-term bonds have lower correlation to stock returns, which means overall portfolio volatility will be less when you add them to your portfolio.

Look at the correlations to the S&P 500 (IVV) in this chart.  The 3 negative correlations are all bond funds.  But there's one surprise: short-term treasury bonds have the deepest negative correlation to the stock market.  You can also look at March 2020 performance to see it for yourself: everything crashed, but short-term treasuries went up in value.
https://www.portfoliovisualizer.com/asset-class-correlations

Radagast

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Re: Long-term treasury bonds (or similar) for negative correlation?
« Reply #3 on: July 02, 2021, 10:24:39 PM »
Long term bonds have not always been negatively correlated with stocks, that has been a trend that started during the dotcom bubble. Historically it has varied and you should expect the correlation will become positive for some decade within your lifetime. Bond yields historically low right now, which may indicate more risk or less return.

Which isn't necessarily a recommendation against. I keep 5% in long term treasury bonds, but would recommend not more than 10-20% at most. VLGSX is a nice low cost option if you prefer a mutual fund. Otherwise I suggest GOVZ (if it keeps its low fee), ZROZ, or EDV. These are extremely long term bond funds because they own bonds which have been stripped of their interest payments, but it means you can get a similar size effect in terms of price movement while risking a smaller portion of your money.

There are lots of other options which I would recommend at least as highly, since you are currently S&P500 only. For example S&P600 value, such as SLYV. International funds are a big part of the investable universe. Other bonds, such as Series I saving bonds. Generally I would recommend the S&P500 be not more than 40% of the investments of someone in your position (50% if VTI). My recommendation:
50-90% stocks
Not more than 50% total US stocks
International 20-50% of stock allocation
Not more than 40% bonds
A real asset, eg real estate, is nice.