The Failure of Asset Allocation - Bonds Are An Imperfect Hedge

US investors were spoiled by US Treasuries which acted as a near perfect hedge to stocks during the 2008-2009 crisis.  However, in real crisis, bonds rarely offer any comfort, and asset allocation fails (see post Death Spiral of a Country and IMF paper Systemic Banking Crises Database: An Update; by Luc Laeven ... – IMF).  As a very timely example, we can examine Spain, which is not even to crisis level yet.

From TimelyPortfolio

In Spain, there is nowhere to hide, and allocation offers no comfort.

R code in Gist (click raw to copy/paste):

	#analyze asset allocation experience in Spain
	require(lattice)
	require(latticeExtra)
	require(reshape2)
	require(directlabels)
	require(quantmod)
	require(PerformanceAnalytics)
	require(RQuantLib)
	data <- read.csv("spain stocks and bond from bloomberg.csv",stringsAsFactors=FALSE)
	spainstock <- na.omit(as.xts(as.numeric(data[2:NROW(data),2]),order.by=as.Date(data[2:NROW(data),1],"%m/%d/%Y")))
	colnames(spainstock) <- "SpainStocks.IBEX"
	spainbond <- na.omit(as.xts(as.numeric(data[2:NROW(data),5]),order.by=as.Date(data[2:NROW(data),4],"%m/%d/%Y")))
	colnames(spainbond) <- "SpainBonds.10y"
	spainbondpricereturn<-spainbond
	spainbondpricereturn[1,1]<-0
	colnames(spainbondpricereturn)<-"SpainBond.10y.Price"
	#use quantlib to price the Spanish bonds from yields
	#these are 10 year bonds so will advance date by 10 years
	#we can just use US/GovtBond calendar
	for (i in 1:(NROW(spainbond)-1)) {
	spainbondpricereturn[i+1,1]<-FixedRateBondPriceByYield(yield=spainbond[i+1,1]/100,issueDate=Sys.Date(),
	maturityDate= advance("UnitedStates/GovernmentBond", Sys.Date(), 10, 3),
	rates=spainbond[i,1]/100,period=2)[1]/100-1
	}
	#merge returns
	spain.return <- na.omit(merge(spainbondpricereturn,ROC(spainstock,type="discrete",n=1)))
	#get drawdowns
	spain.drawdown <- Drawdowns(spain.return)
	#get in melted data.frame for lattice
	spain.drawdown.df <- as.data.frame(cbind(index(spain.drawdown),coredata(spain.drawdown)))
	spain.drawdown.melt <- melt(spain.drawdown.df,id.vars=1)
	colnames(spain.drawdown.melt) <- c("date","series","drawdown")
	spain.drawdown.melt[,"date"] <- as.Date(spain.drawdown.melt[,"date"])
	#plot drawdowns
	direct.label(asTheEconomist(
	xyplot(drawdown~date,groups=series,data=spain.drawdown.melt,
	main="Spain - Drawdown of Stocks and Bonds (source: Bloomberg)")),
	list("last.points",hjust=1,vjust=0,cex=1.2))

view raw spainallocation.r hosted with ❤ by GitHub