Are Bonds Uninvestible?

After seeing a quick video hit about a new ETF that benefits from rising rates, it got me to thinking about the current bear market in bonds. It's been going on a little longer than you might think. Here's a jam packed chart with all sorts of fixed income related funds.

The funds that are down a lot are some of the bigger, more benchmarky types of trackers ranging from longer dated treasuries to broader bond proxies like AGG and LQD. Longer dated TIPS are down 7%, Risk Parity RPAR down almost 9% while an inverse fund and a fund that benefits from rising inflation expectations are both up a lot. I could have thrown in funds that benefit from a flattening yield curve or steepening yield curve too. There's a lot of plain vanilla and a lot of complexity too in bond land. RINF is an example of complexity, at least for me. If gaming what breakevens will do is your trade, go for it. Totally out of my league. 

For years and years, I've avoided long term treasuries and other long dated paper. Rates have been so low for so long that the risk seemed sky high. The thing about bond funds is that there's no par value for them to return to. If someone bought a ten year treasury below a 1.00% yield two years ago, at least you'll get your par value back in eight years but that is a long time to hold onto a bond that is down a lot in price with a below market yield. 

A lot of the lines on that chart look pretty equity-ish to me. Trading bonds for equity-ish capital gains has never been my trade. If that's for you, there's plenty of products to choose from. My primary goal with fixed income is to buffer equity market volatility, then add some income in, depending on the exposure. 

So longer bonds are now down a lot, what do you do? This chart of the last few years of the yield for the ten year treasury is interesting. 

 

That's a ten year channel. It panicked outside of the channel during the pandemic. What comes next? If generally higher inflation persists even if not as high as it is now, would yields have to bust out of the top of that channel? I don't know but it seems plausible.

Bonds are not like equities that go from the lower left to the upper right over longer periods of time. Whatever comes next for the ten year yield, lower or higher, after that it will go the other way. The channel may get wider or narrower. What are the odds of a decisive break lower in yields? What is the risk of yields going meaningfully higher? Going meaningfully higher would be a bloodbath, worse than the 25% or so declines for TLT and TLH versus what, the potential for a 10-12% gain in those funds if yields drop 100 basis points? The risk reward that far out doesn't make sense to me. There's no guess there on what rates will do, just a belief that the risk reward tradeoff is not good. 

Short term bonds don't confront this issue, bank loans don't confront this issue, short term TIPS don't confront this issue. If you own any actively managed funds, not a bad thing, then you're putting your faith in the manager's ability to navigate this environment. Where most of what we just mentioned look more like horizontal lines with slight tilts one way or another, there are plenty alts that also look like horizontal lines with slight tilts one way or another. You might find equity products that do this too. Utilities (funds and individual issues) come to mind, they're generally doing well despite rates going up. I'm wary of low volatility funds. They each do slightly different things and don't always look alike. 

I think longer bonds are uninvestible. There are plenty of alternatives for yield and low volatility without taking on interest rate risk. I'd much rather just avoid that risk and volatility altogether and I think that's easy to do. Without getting tricky at all, a few short dated treasuries, like 2-4 years, a couple of CDs even have good yields and maybe a strategy fund or two can go a long way to building out a portfolio sleeve to buffer equity volatility.