Again, Diversify Your Diversifiers

Barron's had an article about the recent attractiveness of short term debt after the recent jump in interest rates. The article is fine, I suppose I agree as I bought a couple of short term things for clients in Q2 yielding 2.4x% and then again this past week I bought a year treasury yielding 3.8x%. The real yields are unfortunately negative still but these are cash proxies, money I do not want to chase yield with or expose to risk. 

More interesting than the articles sometimes are the comments as was the case today with the following comment: What is really wacky is the Modern Portfolio Theory promoted use of bonds in a portfolio...ballast (or theoretical risk-reducing agent). How is that ballast thing working so far this year? Yes, bonds absolutely provided ballast for equity market volatility for decades, there's no question they reduced portfolio risk for decades. 

Bonds though simply ran out of room to keep going up. Even for people who weren't engaged in markets in the 80's or before, we can look at charts, we can take time to understand what yields did during other shock events. Since July of 2011, the yield on the ten year US Treasury has been below 3% other than for a couple of months. A couple of months out of a decade. Three years of that decade had been under 2%. The yield on the ten year was also crazy low for a while in the early 1960's. During that stretch though it was on either side of 4%, not below 3% and then below 2% on its way to sub-1% for about a year during the pandemic. 

Some understanding of history as well as what the price does for that kind of duration when rates rise are all learnable without needing to have any sort of insight. Maybe a little more insightful, or not, is to ask the question "do I want to lend money at 2% or 3% for ten years, longer even, does that make sense?" If asking that question does take insight, ok but it certainly doesn't require being gifted in some way, it's a very obvious thing to ask. 

We've been asking that here for many years and the answer here has been no. The risk, regardless of when the consequence came, was not worth it. 

Today's post inspired by the Barron's reader comment is a chance to reiterate the important point of diversifying your diversifiers. A little exposure to interest rate risk isn't the end of the world even if it's done badly this year but 40% in long bonds creates a big hole. Individual bonds at least have a par value to return to but funds do not. The iShares 10-20 Year Treasury Bond ETF (TLH) closed Friday at $113. The all time high appears to have been in July 2020 at $171. 

It is difficult to see the yield on the ten year treasury going back down to a level that could get TLH anywhere close to $171. If the yield on the ten year churns and chops between 3-5% over the next 7 or 8 years, which is far from the worse case scenario, then the person who bought at $171 has permanently impaired their capital.  

A little exposure to something like TLH, that's merely unfortunate kind of like the person who put a little into Cisco Systems (CSCO) above $70 back in 2000 and still holds it today at $43. Small allocations don't become impediments to portfolio growth, simply they are laggards. 

Try to figure out the simple and obvious questions and risks, make sure you're not over exposed to those risks and then diversify your diversifiers. Here's a MarketWatch article quoting me in 2007 about managed futures. I think we have the cred to say this because we've been doing it in the real world and writing about it since before Obama was elected.