http://finance.fortune.cnn.com/2010/12/16/the-danger-in-bonds/ provides one of the best written pieces that I have read on the dangers of bonds. However, I believe the recommendation completely opposes the wonderful explanation.
Fighting bond risk with bonds does not solve the problem. The suggestions of high-yield and emerging markets might outperform other bonds through extra spread for currency and credit risk, but they still get clobbered by a big upward shift in interest rates, so risk still exceeds returns. All bonds are priced to US Treasuries, and US Treasuries are artificially low, so inflation, the core risk and biggest enemy of bonds, is not priced.
Return to bonds = Return for Credit Risk + Return for Currency Risk + Return for Illiquidity + Real Return – Inflation
so in my mind
Return to Bonds = (2% to 6% for Credit, Currency, and Illiquidity) + (0 to –10%) + (-2% to –10%) = 4% to –22% with what we already know.
With 4% to –22% best case real return over the next 10 years, risk clearly exceeds return. If the potential losses to bonds in a bad environment approach –20 to -50%, then the risk is the same as those “risky” asset classes of stocks and commodities, but these just might be the beneficiaries of a little inflation.
This poor recommendation explains why journalists might not make good money managers and why investors depending on tv and media for investment advice can make such bad decisions. I intend to be a good money manager that can also write. I would love to achieve this level of writing without impairing my ability to manage portfolios. I started writing to help me think. Paul Tudor Jones in his Foreword to Reminiscences of a Stock Operator Annotated Edition says
“While attending the University of Virginia, I took some summer courses at Memphis State in journalism and at the same time worked editing my father’s small business paper. Looking back at my education, I would say that journalism was the single most important element of my development as a trader and as a businessman, more so than any of the economics and business classes I took at the University of Virginia….Learning to report and communicate in this fashion is far and away the best training any businessman, investor, or trader can have. It’s a vital yet surprisingly underestimated skill that really enhances one’s ability to frame, analyze, and solve problems in the most expeditious fashion.”
This is a very powerful statement from one of the most successful money managers ever, and I listened.
If I cannot beat bonds over the next ten years, I need a new career if I have not had to find one already. I guess by then maybe writing might be an option.
Criticize me, so I can write better.