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Defensive portfolio my derrière
March 21, 2020
9:07 pm
picassocat
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After the inverted yield of May 2019, I went about building a defensive portfolio in case of a recession. I invested 50% in investment grade bonds and 50% in defensive funds, namely real estate, healthcare, consumer staples, utilities, commodities and technology. I know technology is not a traditional defensive sector, but it’s more and more considered so, the thinking is, even if there was a recession, people would still buy their gadgets. I worked hard and on it and then came the black swan, Covid-19. My portfolio didn’t hold up. Yes, maybe it was more resilient in losing less then say the S&P, but it still lost considerably. First, the equity portion fell from the sky, then corporate bonds fell and days later government/treasury bonds. Nothing held up. I wonder now if there is such a thing as a defensive portfolio?

March 21, 2020
9:33 pm
AltaRed
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It is all relative. A temporary decline of -15% is twice as good as -30%. Unless you want to cocoon yourself in simply HISAs and GICs, you will have periods of negative returns.

March 21, 2020
10:03 pm
picassocat
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I don’t disagree with you AltaRed, but what I’m especially disappointed in is bonds. Bonds are not usually that volatile, I had US, Canadian and international investment grade corporate bond funds and they fell hard, very hard. Government bonds held up better, but still lost, but I didn’t mind that part very much. I guess that investing in corporate debt is risky even you keep at BBB + levels. I learned a valuable lesson.

March 22, 2020
4:48 am
Norman1
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What you describe doesn't make sense.

US and Canadian bond yields are down from a year ago, all the way out to 30 years bonds. How did anyone holding Canadian government bonds lose money? Bond prices go up when interest rates drop.

Similar with corporate debt. Unless there is a default, there isn't much significance to the daily price fluctuations of a corporate bond. What matters are the interest payments and the payback at maturity.

Are you really investing in bonds or are you really speculating in bonds, like a Bill Gross?

March 22, 2020
5:14 am
savemoresaveoften
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I believe picassocat is talking about corporate bonds.

Norman1, during extraordinary times like now, while gov yield helps corp bonds, the widening in credit spread is much severe and corp bond price WILL go down hard. This is especially true given the current stock selloff is due to the existence doubt, and under that scenario, the bonds of the same company wont fare much better. Look at the collapse of LTCM in the 90s and how a nobel prize winner's hedge fund blew up due to a 6 sigma event.

As for defensive sector, groceries and pharmacies are the no.1 sector for the obvious reason. And Amazon !

As for bounce back candidates, just have to own cad banks and utilities.

This is also a good read below and explain why corp debt are hit hard as well

https://ca.finance.yahoo.com/news/exclusive-goldman-injects-1-billion-200915647.html

March 22, 2020
6:06 am
Norman1
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Like I said, that's just the current market value of the corporate bonds. Does one really believe several months of reduced economic activity would torpedo those companies?

Maybe people should start marking-to-market the value of their GIC's monthly as interest rate fluctuate instead of believing in their artificial price stability!

March 22, 2020
6:21 am
Norman1
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savemoresaveoften said
… Look at the collapse of LTCM in the 90s and how a nobel prize winner's hedge fund blew up due to a 6 sigma event.

LTCM blew up because they got a margin call that they could not meet. Yes, one really does need to worry about current market bond prices if buys bonds on margin and only one puts 10%, 5% or even less down.

Again, they were bond speculators. LTCM wasn't a buy-and-hold-until-maturity bond investor.

March 22, 2020
7:10 am
picassocat
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March 22, 2020
7:39 am
picassocat
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savemoresaveoften said
As for bounce back candidates, just have to own cad banks and utilities. 

savemoresaveoften you may want to read this article before you buy-in even more into Canadian banks.

https://www.bnnbloomberg.ca/think-twice-before-increasing-exposure-to-canadian-banks-analysts-warn-1.1408141

March 22, 2020
7:53 am
Doug
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AltaRed said
It is all relative. A temporary decline of -15% is twice as good as -30%. Unless you want to cocoon yourself in simply HISAs and GICs, you will have periods of negative returns.  

+1 to this. picassocat, defensive portfolio doesn't mean lossless portfolio. It sounds like your portfolio has gone down less than a standard balanced fund portfolio, so, in my view, it sounds like it's doing exactly what you wanted to do. Good work. sf-cool

Remember, corporate bonds, though not equities, have other risks besides interest rate risk. They have market, liquidity, potentially currency, and credit risk. On the latter, remember that investment grade includes those on the border of investment and non-investment grades. In a market downturn, there will be downgrades, and the fund may be forced to either (a) alter its investment objectives (usually requiring a unitholder vote) or (b) sell its previously investment grade bonds, crystalizing a loss for unitholders. Moreover, liquidity risk is, I think, an understated risk, particularly in bonds. As the credit and other markets seize up, price discovery of bonds becomes even more opaque. There will be wide bid/ask spreads so, when they need to sell, which could be just to cover redemptions, they may be forced to sell the bond well below its fair value.

In my view, you should either (a) keep your portfolio and ride it out, (b) rebalance into a balanced or balanced conservative fund portfolio, or (c) research the low volatility premium anomaly that sees low volatility funds outperform, despite academic evidence to the contrary, comparable balanced funds. They'll still go down, too, but not by as much.

Cheers,
Doug

March 22, 2020
9:47 am
Norman1
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If one had bought bond mutual funds or bond ETF's, then one is screwed. A bond mutual fund or a bond ETF doesn't have a maturity date.

As Doug mentioned, if the fund or ETF is restricted to investment grade bonds only, then it will be forced to sell bonds that get downgraded below BBB- at a loss.

March 22, 2020
10:29 am
Doug
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picassocat said

savemoresaveoften said
As for bounce back candidates, just have to own cad banks and utilities. 

savemoresaveoften you may want to read this article before you buy-in even more into Canadian banks.

https://www.bnnbloomberg.ca/think-twice-before-increasing-exposure-to-canadian-banks-analysts-warn-1.1408141  

One, Veritas is a noted bearish analyst firm. Always has been. Two, there will always be those with bearish and bullish views on companies and whole industries, including the Canadian banks—after all, that's what makes a market. sf-cool

If your time horizon is only a year or two, then I would say you'd probably want to avoid buying any Canadian banks (arguably, any stocks, period). But, if you have a time horizon of at least five years, the probability of your portfolio of Canadian bank common shares increasing between 30-100% over the next 5+ years has increased dramatically. They are trading at, or near, arguably stupid cheap levels. Their revenues could decline by 50% near-term, without any expense reductions, and they could still maintain their dividend. The longer this goes on, they will increase their expense reductions by increasing the number of branches temporarily closed and modifying their hours at open branches. Longer term, they may actually accelerate the annual rate by which they close physical branches permanently, particularly those which see most of their traffic volumes for in-branch cash services. So, longer term, despite all their cost cutting, this can motivate them to basically "double down" on the cost cuts and drive profit growth.

Cheers,
Doug

Full and Fair Disclosure: Prior to this week, I owned only CIBC, TD, Scotiabank, and HSBC. From this week forward, I own all of those, and now own Canadian Western Bank and Genworth MI Canada* (*Not a bank, but the largest private sector mortgage insurer). I would be careful with Equitable Group and Home Capital Group; they are higher beta bank stocks and rely, even moreso, on net interest income, which will be compressed significantly as rates drop and mortgage volume growth slows. Look at Equitable's stock price over the last two weeks; it's fallen from $105-110 per share to the low $50s. It will probably whipsaw around into the $60s, but also to the $30s-40s. You really want to see it base for a long term and then start to break out from recent highs before you step in, I think. I'm also a bit "gun shy" on smaller publicly-traded banks, having lost a few thousand on Street Capital Group (now part of RFA).

March 22, 2020
1:42 pm
picassocat
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Here is a short term example (1 month) of a US treasury bond ETF performance, losing 19.3% (ZTL.F.TO)

US-treasury-bond-ETF-1.png

March 22, 2020
2:54 pm
Norman1
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The BMO Long-Term US Treasury Bond Index ETF (Bloomberg quote: ZTL:CN) is supposed to track the performance of the Bloomberg Barclays U.S. Long Treasury Bond Index. That index is for US government US$-denominated bonds 10+ years to maturity.

People putting money into 10+ year bonds really should have a time horizon significantly longer than one month.

Year-to-date return is around +25%! One year return is around +37%! Lots of happy campers who had a longer time horizon.

March 22, 2020
3:31 pm
picassocat
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It’s all about vision Norman1 and mine is short term and when you accumulate short-term vision, you get long term, in other words, I live in the now. I sold it when it was falling and I will buy it back when it starts to recover. It’s a great ETF and it’s hedged to the US dollar.

I chose this graph simply to illustrate that bonds, even US Treasury bonds, can fall hard, but it will recover soon enough.

March 22, 2020
4:46 pm
savemoresaveoften
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picassocat said

savemoresaveoften said
As for bounce back candidates, just have to own cad banks and utilities. 

savemoresaveoften you may want to read this article before you buy-in even more into Canadian banks.

https://www.bnnbloomberg.ca/think-twice-before-increasing-exposure-to-canadian-banks-analysts-warn-1.1408141  

Yes I read that article this morning. It is pretty useless as it does not offer anything insightful in my mind ("tell me something I dont know")

One thing I learned over the years is there will always be people with polar difference opinions on all sorts of things, investments included. Its more important to formulate decision making and action based on the information presented, not on reporters or even analysts recommendation. Analysts are the most shameless bunch and gets paid no matter how shitty their calls or recommendations are.

March 22, 2020
5:12 pm
picassocat
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savemoresaveoften said

One thing I learned over the years is there will always be people with polar difference opinions on all sorts of things, investments included. Its more important to formulate decision making and action based on the information presented, not on reporters or even analysts recommendation. Analysts are the most shameless bunch and gets paid no matter how shitty their calls or recommendations are.  

I definitely don't disagree with you; we all have the same numbers but different direction or philosophy. Having a good education doesn’t mean you are smart.

March 22, 2020
5:26 pm
Doug
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picassocat said

I definitely don't disagree with you; we all have the same numbers but different direction or philosophy. Having a good education doesn’t mean you are smart.  

Not necessarily defending equity analysts, but, go figure, long-time Canadian bank equity analyst for National Bank Financial's Equity Research team, Peter Routledge, was recently named President & CEO of the Canada Deposit Insurance Corporation. sf-cool

I wonder if Barclays Canada equity research analyst John Aiken will be named the next Commissioner of the Financial Consumer Agency of Canada... 😉

Cheers,
Doug

March 22, 2020
9:48 pm
AltaRed
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The OP has a legitimate beef with corporate bonds. Been a lot of discussion on Financial Wisdom Forum the last week or two about bond ETFs and more specifically corporate bonds. The corporate bond market literally froze over the past two weeks with virtually nothing in the Bid column. IOW, there were no buyers to even establish liquidity or FMV. The AP (Authorized Participant) or market makers were also unable to keep the Bid/Ask spread at a decent level, or to even keep the spread close to NAV, assuming one could get a NAV, especially for BBB bonds.

The rude awakening is the chase for yield from good ol' 5-10 year government bonds into the murkier waters of corporate bonds at A and AA, and worse into BBB, comes with a nasty price. Bottom line: If you want certainty of Return OF Capital rather than Return ON Capital, don't chase yield into the corporate sector, and especially below the level of AA banks, etc.

The good news is that bond ETF Bid/Ask spreads and discounts to NAV have been shrinking as the market settles down, barring another crazy week in the equity markets this coming week. Longer term, e.g. months, or perhaps a year, it will self-correct to some degree, but it is painful in the interim, and the new normal may be that corporate bonds are in the penalty box. Corporate debt levels have gotten way out of normal levels and so the quality of corporate debt in troubled times has deteriorated, or at least way more sensitive to market turbulence.

Not that it matters but by 2015, I was getting very uncomfortable about the amount of debt corporations were adding to their balance sheets and some of the bond experts were starting to get worried about it. I decided then that my holding of ZCM (medium term corporate debt with about 50% of it BBB) was way too risky for my liking. I dumped it at that time and not sorry I did.

Moral to story: Your fixed income allocation really shouldn't be chasing yield, especially if one has a high equity allocaition. Corporate bonds start behaving more like equity in troubled times. Keep your fixed income in safer securities.

March 22, 2020
10:11 pm
picassocat
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Great post AltaRed. I had ZLC a long-term Canadian corporate bond ETF, better credit quality and yield, but it crashed with the rest of them.

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