After studying many years of historical performance and interactions between various asset classes, we here at BCM set up an All-Weather portfolio allocation as our flagship investment strategy. As you might know, this allocation gives an exposure to stocks, bonds, gold and cash. Regarding bonds, it specifically splits that exposure between intermediate-term government bonds (+/- 18%) and long-term government bonds (+/- 10%).
Over the last two years, as the FED raised interest rates dramatically, the long-term government bonds have dreadfully penalized total portfolio performance.
An obvious question we have been hearing from clients is “Why?”. 1) Why do we own any long-term government bonds? 2) Why didn’t we sell them last year when it became clear the FED was going to continue raising rates? 3) Why do we continue to own them now?
I’ll answer those questions in the following way:
1) We have allocated 10% of our portfolio to long-term bonds as a form of disaster insurance. Historically, when the world was in the act of ending (Crash of 1987, Dot.com crash of 2000-2002, Great Financial Crisis of 2008-2009, or Covid in 2020) those very same long-term bonds which have been so painful over the last two years were a welcome portfolio ballast against the turmoil. For example, during the 2008-2009 financial crisis, our long-term bond holdings (TLT) rose by 33.93%. During the Covid crisis year of 2020, those same holdings rose by 18.15%.
2) We didn’t sell them because last year it was anything but clear how long the FED’s policy of raising rates would last. Inflation (the culprit behind the tighter monetary policy) actually peaked last August. No one, not even the FED itself, knew how much longer or higher rates might have to go before everyone inside of the FED was satisfied.
Additionally, last year, the onset of a recession (a consequence of the FED’s rapid tightening policies) was a foregone conclusion. Not if a recession was in the offing, but when. That being the general consensus, when the recession arrived, the one asset class we absolutely would want to be holding would be – wait for it – long-term government bonds.
3) We continue to own them now for several reasons.
As stated, they are disaster insurance for when the world ends. They are currently offering a yield of roughly 4.6% or so. There is very low credit risk–they are unlikely to ever default. In fact, over time, all bonds within that TLT bond portfolio will mature at full value – par. And if/when that widely anticipated recession does occur, I would expect those bonds to again prove their mettle, as they have done so many times before. Recently painful, but long-term beneficial.