CAPE weighted portfolio, junk bonds vs emerging markets bonds, negative rate mortgages, safe saving ETF & short term investment.
Could you share several strategies that are likely to provide decent returns or at least protect the downside for the next 2-3 years, please?
If you watch my video “Portfolio Inspiration” by clicking here it talks about robo fund fixed allocation portfolios and how to cheaply mimic LifeStrategy returns with either Vanguard or iShares funds which are cheaper.
- A horizon of 2 to 3 years is very short
- You can’t have decent returns and protect your downside
- If someone says you can have both they’re lying a reliable scam keyphrase
- If you want to protect against downside increase your bond allocation
- Over a 3-year to 5-year horizon equities (in the US) fell with a probability of about 25% and bonds fell with a higher probability of about 30%.
- The typical loss when equities fell was larger (about -15%) over a 3-5y horizon than it was for bonds (about -7%)
What are the pros and cons of a market-weighted portfolio vs a region-by-region value-weighted one?
- CAPE is the
- Cyclically Adjusted which means it smooths volatile earnings over a whole business cycle of ten years
- Price because it’s the number of dollars you pay…
- To Earnings ...divided by the earnings averaged over the last decade
- This is one of the best predictors of future long-term returns I know of
- To use the information you increase your equity allocation (buy equity and sell bonds) when CAPE is low and decrease it when CAPE is high (sell equities and buy bonds)
- This takes iron discipline!
- I have had a low equity allocation since 2017 and had to put up with comments like “you’re too cautious”, “I’ve made over 20% while you missed out” etc.
- FOMO (fear of missing out) is your enemy
- Then you have to buy equity when every news story is talking about how markets are doomed
- At the moment CAPE in the US is high 30.5 for the US
- The best research I’ve seen on this is by Star Capital here
Could improve returns if the future resembles the past
Cognitive biases make this approach very difficult indeed
CAPE is one of the few predictive variables for equity returns
Anchors equity values: cheap or expensive
It takes a decade to see the results
I'd like to get up-to-date on what government or corporate bond ETFs I might consider as an alternative to 1-3-5 year fixed rate cash savings accounts.
- Cash is like a bond with a very short duration, or a floating rate bond which has almost zero duration
- A money market fund, which is now offered by Vanguard, is cash-like but has some duration risk
- MoneySavingExpert has a list of the best instant access cash accounts available here
- It might be helpful to look at how much return you get for every unit of risk (volatility) as demonstrated in this spreadsheet: here
Junk bonds or emerging market debt? Both seem to be on comparable high yield but the risks may be quite different?
- EM debt risks
- Default risk is higher than developed market government bonds
- The danger is greatest for double deficit countries where there is a fiscal deficit (the government is spending more than it’s earning in taxes and plugging the gap with debt issuance) and a current account deficit (it imports more than it exports)
- The triggers for an EM crisis can be a combination of
- A currency crisis
- A banking crisis
- A debt crisis
- Political instability
- See IMF Global Financial Stability Report here
- Junk bond risks
- Defaults are rare when rates are low but spike when there’s a big market move in, say, commodity prices
- This happened when the price of oil fell from $105 to $30 in 2015/2016 and “zombie” US oil companies started to default much more rapidly
- Covenants have weakened, these are designed to protect investors against things like issuance of more debt, calling the bond (redeeming early) such as a 5NC3 bond which has a maturity of 5 years but cannot be called in the first three years after issuance, monitoring the health of the company via automated reporting if certain balance sheet measures hit warning limits, paying a dividend to equity investors…
- Bond Indentures & Bond Characteristics article here
- Moody's Analytics article is here
Are negative interest rate mortgages a possibility in the UK and what are the implications on the property valuations/market?
- Currently, Bank Rate is 0.75% in the UK so we’re quite a long way from negative rates
- Denmark’s Jyske Bank (their Nationwide or Halifax equivalent) offers negative rate mortgages
- Negative interest rate mortgages are common in Denmark, and this is also why Jyske issued a negative coupon AAA-rated covered bond here
- In practice, although interest on the mortgage is negative the borrower still ends up paying back more than they borrowed due to fees
- The negative rate is like a rebate on the mortgage fees borrowers don’t get paid to buy a house
- This is what Jyske says on its website (thanks to Google Translate)
- Jyske Realkredit is ready with a fixed-rate mortgage with a nominal interest rate of minus 0.5%.
- Yes, you read right. You can now get a fixed-rate mortgage with a maturity of up to 10 years, where the nominal interest rate is negative. However, you are not exactly going to make money borrowing. Namely, there must also be paid, among other things, establishment fees and contributions, and there will be a loss of prices.
- "Practically, it will be experienced that the mortgage loan repayment will be greater than it would be with a positive interest rate. The negative interest rate will act as a 'subsidy' to the repayment. And the repayment portion will become smaller and smaller as the debt is reduced," explains Jyske Banks. housing economist Mikkel Høegh.
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