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Portfolio Update – August 2020 – How downgraded credit ratings may impact your portfolio

Portfolio Update – August 2020 – How downgraded credit ratings may impact your portfolio

  • Monthly portfolio update: Fairly stable month: bonds down on Fed policy shift, but offset by K-shaped recovery in stocks and commodities
  • Book tip: The Everything Bubble: The Endgame For Central Bank Policy by Graham Summers (link at the bottom of the post)
  • In case you missed it: I have ditched all intermediate-term bonds (post from 3 August 2020)
  • Coming soon: a post on real estate investing and how it fits in the All Seasons Portfolio. Stay tuned, and subscribe to newsletter for notifications!

Buongiorno!

I hope you have had a great summer under the circumstances, and are ready for the next (non-economical) season!

When posting this article, I have just come home to Sweden after a few weeks of visiting my girlfriend’s family in Italy. For sure, the virus has put a great strain on the country, but it is good to see that things are moving in the right direction with society opening up. With few exceptions, new cases have been declining in Italy and Europe, which has bolstered investors with renewed confidence the past months.

Our vacation this year was not as we had initially planned (beaches in Sicily), but of a less touristy, and much more responsible, sort. Instead, we have stayed with her family and taken a few day trips to selected non-crowded destination (Venice has not been this empty for centuries). While more and more flights are opening up across Europe, it is still important to be cautious and not take unnecessary risks. One should not think that the danger is over, just because travelling is again somewhat possible. We can just hope for a full recovery as soon as possible.

But this is not a travel blog, but a financial blog, even though I wish to one day be able to sustain a life abroad thanks to my finances.

Credit Ratings and how Covid-19 may impact them

In this light, I have lately been thinking about how Covid-19 has affected the financial stability of countries, and how that in turn will impact sovereign credit ratings. For example, if debt-to-GDP would increase too much, if the affordability of the debt would fall, or if the economic outlook or stability of a nation would decrease, it will impact the country’s ability to service its debt.

The ability to service debt – or a sovereign state’s credit worthiness – is what the credit rating agencies Fitch, Moody’s and Standard & Poor, are all analysing and rating. If a sovereign state has a good credit rating (AAA, Aaa etc.), this gives great comfort to the investors who purchase the country’s bonds that there is a low risk of that the state defaults on its debt.

The credit rating also is a risk gauge for the bonds. With a higher rating, and thus lower (assumed) default probability, the lower risk premium is paid for holding the bonds. Thus, yields will be kept lower for highly rated issuers, and will be higher for issuers with lower credit rating.

This also means that if a state would be downgraded by credit agencies, for example as a result of pressure on the economic outlook caused by Covid-19, this will impact the yields of the outstanding bonds issued by that state. Because the credit rating is a measure on default probability, with a downgrade, the risk for the bond has increased. A downgrade will directly affect the yields on the bonds when a higher risk premium is discounted, and the value of the bond will decrease.

Why is this relevant for an investor?

In the All Seasons Portfolio, bonds issued by sovereign states take up 55% of the portfolio. For me, those 55% are split between 40% Long-Term U.S. Treasury Bonds, and 15% U.S. Inflation-Linked Bonds (TIPS). Bonds are held as a hedge against lower economic growth, as yields will generally fall when investors seek lower risk investments.

In June, Moody’s published a report on their view on the Covid-19 impact on the credit ratings of major economies. It is a short and good read (7 pages), but you may need to register for a free account to be able to access the report. Moody’s concludes that the pandemic will markedly increase the debt burden of advanced economies, and their maintained credit ratings are contingent on their ability to reverse the debt trajectories as soon as possible after the crisis. Of the analysed advanced countries, the United States is in the worst position when considering debt affordability (cf. page 5).

What does this mean? It means that the countries that will not be able to 1) increase their GDP, 2) decrease their deficits, and/or 3) maintain strong debt affordability, will be at risk of having a negative economic outlook, and thus risking being downgraded. For example, Fitch downgraded Italy to BBB- in April following the shock that the coronavirus had on its economy, which is just one notch above junk.

IssuerFitchFitch OutlookMoody'sMoody's OutlookS&PS&P Outlook
Ratings as per 4 Sep 2020
United StatesAAANegativeAaaStableAA+Stable
GermanyAAAStableAaaStableAAAStable
ItalyBBB-StableBaa3StableBBBNegative
FranceAAStableAa2StableAAStable
SpainA-StableBaa1StableAStable
NetherlandsAAAStableAaaStableAAAStable
UKAA-NegativeAa2NegativeAAStable
SwedenAAAStableAaaStableAAAStable
ChinaA+StableA1StableA+Stable

How does downgrades impact investors using the All Seasons Portfolio strategy?

As just discussed, when the perceived risk for default of a government increases – a perception that can be confirmed by a rating agency downgrade – is very likely increase yields of the issuing country’s outstanding bonds. Such downgrades are more likely during times of increased levels of distress, putting greater strain on the sovereign’s national finances.

As long-term government bonds are included in the portfolio as one of several hedges against lower economic growth, they may not be able to fully offset all challenges of a negative environment if the economic crisis causes a strain on the bond issuer. It does not necessarily mean that bonds are useless as a hedge, as they are likely to perform much better than stocks under such circumstances, but it is wise to bear in mind that credit ratings will impact the value of your bonds.

So what to do? I think it may be wise to 1) be aware of your geographical exposure and the outlook for credit ratings, and 2) diversify issuing countries of government bonds.

For example, my bond part of the portfolio is 100% allocated to the United States, which, traditionally, is a strong economy and the home of the world’s reserve currency. But it is not immune to downgrades, as was very evident during the great financial crisis of 2008. Moreover, as late as on 31 July 2020, Fitch changed the outlook of the United State’s credit rating to Negative from Stable (while maintaining its AAA rating). Read this together with the Moody’s report I linked to further above, and you can see a trend on where we may be heading.

What will this mean for me? I will keep an eye out for further signs on the development of the health of the American economy. It is however not as simple as reading if the U.S. GDP would fall further or if the deficits would rise. It gets more complicated to predict downgrades because the economic health of a sovereign when determining credit rating is relative to that of other nations, as affirmed by Fitch in a recent article:

“Rating changes also need to account for not only absolute deteriorations in credit metrics but also sovereigns’ relative changes.”

Fitch, 25 August 2020

This means that even if the health of the United States’ economy deteriorates, it may still maintain its current rating if the economies of peer nations perform similarly.

All this considered, if I see signs that may increase the probability of a downgrade of U.S. debt, for example, GDP numbers, increased deficits, or further large stimulus, I will sell my IS04 ETF (iShares $ Treasury Bonds 20yr+ UCITS ETF), and instead buy a global long-term treasury bond ETF, for example the iShares Global AAA-AA Govt Bond UCITS ETF (IS0Z). The risk of being exposed to only one country may be too high.

(The main difference between the iShares Global AAA-AA Govt bond ETF and a European equivalent ETF like the Xtrackers II Eurozone Government Bond 25+ UCITS ETF for example is that you also gain access to sovereigns such as Sweden, Denmark, Unite Kingdom, United States, Australia, New Zeeland, and Canada, but not to Italy, which, as disclosed in the table above is rated below AA).

This ETF includes bonds issued by several European governments. I would still have exposure to the United States, but to a much lesser extent. Moreover, there is of course the risk of the other governments being downgraded as well. In a global crisis, which this may turn out to be, no one country is likely to be 100% safe.

And in any event, if the shit hits the fan (in the lack of a better expression), bonds issued by downgraded sovereigns are likely to still outperform stocks by a lot. Thus, the theoretical protection against lower economic growth provided by government bonds will remain.

I would love to hear your thoughts on this topic and how you have positioned your bond part of your portfolio in the light of the credit worthiness of the issuer. Happy to discuss in the comment section.


Portfolio Update August 2020

While it is on my radar to perhaps change focus with my bonds in the future depending on the development with respect to credit rating, I have yet to make any adjustments in my portfolio. Thus, during August, my portfolio stayed the same.

In case you missed it, I have ditched my mid-term bonds which I wrote about in a post from beginning of the month. Here I discussed further why I had sold my intermediate-term bonds in July and switched solely to long-term alternatives.

As a heads-up, I have another Deep Dive post lined up, where I will be discussing real estate investing and how that can fit into a balanced portfolio with respect to risk and seasons. I am planning to publishing it next weekend (around August 13th) so keep an eye out, and make sure to subscribe to the newsletter to get a notification as soon as new posts are made available.

What has happened on the markets during August?

On the stock markets, a new letter for describing the recovery has been launched, namely “K”(in addition to the V, W, U, L shaped potential recoveries). The K-shaped recovery describes the very different outlook for companies that have benefited from the pandemic (tech stocks such as Amazon, Alphabet, Zoom, etc.) and those that have been hit hard (cyclical companies in for example manufacturing). While the S&P 500 index is now above where it started the year, this has been driven by a very small amount of companies (mainly the FANGMAN companies) while other companies have not seen the same development in their share prices. At the same time, the economic growth is still expected to lag far into at least 2022, and is much dependent on the severity of a second wave.

Commodities are still underperforming, but there has been some recovery during the month. Oil, which is the largest component in more or less any commodities index, has not recovered the slump from March and is trading around $45/barrel (Brent). As reference, the price exceeded $65/barrel by February. Manufacturing metals have also lagged as manufacturing has halted, but may see a recovery when big industries are firing up again. At the same time, other commodities have surged. The price on lumber has gone through the roof after a complete miscalcuation by producers who decreased volumes expecting demand to fall. But demand for timber has remained high thanks to a home improvement boom, causing an unbalanced market with too little supply, and a rally in lumber prices to all-time high levels.

Having stretched high above $2,000/oz by beginning of August, the gold price has retreated below the $1,950/oz mark when investors began taking home some of the profits after the rally the past few months. While gold demand from manufacturing (for example for jewelry) has been low, the price increase has mainly been driven by gold bugs and speculators. When the buy side temporarily falls away at the high prices, a set back was expected. It remains to be seen whether this is just a temporary consolidation before further runs upwards, or if the peak is behind us. Much will depend on future inflation of the USD and the strength of the recovery of the economy.

Government bond prices dropped during August following a policy shift from the Fed. Fed’s Jay Powell has communicated a policy shift for the Fed, allowing higher inflation at times. The 2% inflation target will from now on be an average target, meaning that inflation above 2% will be tolerated. Investors have interpreted this move as that rates will be kept ultra-low for longer. This has pushed down the price on bonds, as a higher inflation premium is now discounted for. Higher inflation will erode the real return of low-yielding assets, which triggered a sell-off in 30 year Treasury Bonds.

Prices of inflation-linked bonds, however, were not particularly affected by Fed’s policy shift.


Looking more closely at my portfolio, since my July 2020 update the overall portfolio is more or less similar, but with some shifts between assets. Government bonds have decreased, as has gold, but commodities and stocks have rebounded during the month.

The splits are thus similar, and very close to my aimed allocation. I am still overweight in gold, but I am happy with that exposure as an inflation hedge. Government bonds are slightly underweight, but that has not been harmful, at least considering the negative news from the Fed’s policy shift.

From the below graph, it becomes more visible how bonds have fallen, but that the fall has been largely offset by increases in other asset classes. My total wealth has thus remained intact.

From a year to date perspective, I now start to see convergence between assets after the dramatic moves by March. Stocks and commodities have began recovering, while bonds have fallen back toward pre-crisis levels. The investment into stocks and commodities in April seems to have been a wise move.

Lastly, here’s a view of the ETFs in my portfolio, and the performance of each during the last month, in table form. No new money has been added, nor any other trades conducted.

ETFClassISIN2020-07-312020-08-31Change
iShares Global Inflation Linked Govt Bond UCITS ETFTIPSIE00B3B8PX14€607.76€599.96-0.56%
iShares USD Treasury Bond 20+yr UCITS ETFGovt Bond LongIE00BSKRJZ44€1,325.94€1,249.68-1.10%
Invesco Bloomberg Commodity UCITS ETFCommoditiesIE00BD6FTQ80€320.76€336.484.90%
Xtrackers Physical Gold ETCGoldGB00B5840F36€488.91€481.39-1.54%
Vanguard FTSE All-World UCITS ETFEquityIE00B3RBWM25€1,222.88€1,291.045.57%
Total€3,966.25€3,958.55-0.19%


With this update, I would like to thank you for your attention. Remember to keep an eye out on the post on real estate investing that I will be publishing in the next week. It is a lengthy post that I am really happy with, as it covers many aspects of not just real estate, but also how to think when adding other asset classes to your balanced portfolio.

I have also set up a Patreon site, to cover hosting costs, which reach a couple hundred euros annually. If you find any content here at all useful and feel that you can treat me for the equivalent of a double-espresso, read more about what this means on the Support page here on the website. I have a hosting bill of around EUR 140 falling due in November, so any support is extremely helpful, as the monetization of this blog is very limited.

See you again in about a month, and I hope to hear your thoughts on credit ratings in the comment section below.

Until next time, and stay safe,
Nicholas


Book tip: The Everything Bubble: The Endgame For Central Bank Policy by Graham Summers

The Everything Bubble chronicles the creation and evolution of the US financial system, starting with the founding of the US Federal Reserve in 1913 and leading up to the present era of serial bubbles: the Tech Bubble of the ‘90s, the Housing Bubble of the early ‘00s and the current bubble in US sovereign bonds, which are also called Treasuries.

Because these bonds serve as the foundation of our current financial system, when they are in a bubble, it means that all risk assets (truly EVERYTHING), are in a bubble, hence our title, The Everything Bubble. In this sense, the Everything Bubble represents the proverbial end game for central bank policy: the final speculative frenzy induced by Federal Reserve overreach.

The Everything Bubble book is the result of over a decade of research and analysis of the financial markets and economy by noted investment analyst, Graham Summers, MBA. As such, this book is intended for anyone who wants to understand how the US financial system truly operates as well as those interested in the Federal Reserve’s future policy responses when the Everything Bubble bursts.

To that end, The Everything Bubbleis divided into two sections: How We Got Here and What’s to Come. Combined, these sections represent a blueprint for all things finance and money-related in the United States.

For anyone interested in the All Seasons Portfolio and Risk Parity investing, I find this a great read as you enhance your understanding for both the vulnerabilities of the economies (ref. discussion above on credit ratings) and government bonds. Or check out other great books on the topic on the Book recommendation page.

Check it out today on Amazon (affiliate link):

Buy it on Amazon.com

This Post Has 12 Comments

  1. Hi Nicholas,
    thanks for your new article.
    I share your concern about government bonds.
    I would like to make two comments.
    The first is that government bonds in an all seasons / risk parity portfolio have the function of balancing stocks and providing stability. Therefore, it is necessary to invest in the bonds of your country, to avoid the exchange risk, or if the bonds of your country do not have a high rating in the bonds of the country or countries that have direct influence on the economy of the country in which you live and therefore on your currency. For example, for those living in Europe, and particularly in the euro zone, Germany has a greater influence than the United States.
    The same can be said for inflation-linked bonds.
    The second observation is that an unleveraged risk parity portfolio needs long-term obligations. Only long-term bonds have sufficient volatitility to balance the volatility of stocks.
    iShares Global AAA-AA Govt Bond UCITS ETF has a duration, i.e. volatility, much lower than Xtrackers II Eurozone Government Bond 25+.
    The solution could be a mix of bonds:
    – iShares USD Treasury Bond 20 + yr EUR Hedged UCITS ETF;
    – iShares eb.rexx Government Germany 10.5 + yr UCITS ETF;
    – SPDR Barclays 15+ Year Gilt UCITS ETF;
    – Xtrackers Eurozone Government Bond 25+ UCITS ETF.
    The downside is that the number of ETFs to hold in the portfolio increases.
    Finally, I recommend this book to readers of your blog who are passionate about risk parity: Risk Parity Fundamentals by Edward E. Qian.
    See you soon.

    1. Hi Paolo,
      Thank you very much for the great comment, and apologies for the slow response time – I had a full day of travel yesterday from Italy back to Stockholm. Just managed to find some time in Frankfurt to finalize and publish the article.
      Beginning with your second observation, I agree with you. The IS0Z (iShares AAA-AA global bonds) has a current average duration of just 8.5 years, which is much too short in my opinion. The problem is that there is no ETF available that gives a proper exposure to global bonds in one package, i.e. a combination of long-term bonds (15+ year duration) and global issuers. I have too little capital available on my own for it to make sense to have four ETFs to cover one asset class, but with a larger portfolio, I would actually prefer that control. But I am years away from being in that situation anyway, but working for it. But the ETFs you suggest are great alternatives for such purpose.
      My point for including the IS0Z was to achieve a great diversity when considering geographical exposure. I currently have all my bonds exposed to the U.S. (I’ll comment on this later), and am looking for alternatives to be prepared if the U.S. will run into trouble. I am also considering the Xtrackers Eurozone Government Bonds 25+ ETF, and may begin with this and maybe top up with another (e.g. Swedish long bonds). If 4 ETFs is too much, then 2 is more manageable, at least for the long-term govies part of the portfolio that should have around 40% of one’s funds.
      If anyone knows about a good ETF with global reach and long duration, I am eager to learn about it.
      As for your first observation, this is a question I have been struggling with for long time (and I believe you and I have discussed it already), but I am torn between two main points regarding whether to have American or European bonds. On the one hand, as you correctly point out, for a European investor, investing in one’s home market significantly reduces the risk in one’s portfolio, and you can maintain relative wealth when compared to neighbors and others participants of the same economy as you. On the other hand, and the main argument for investing in bonds issued by the U.S. Treasury, is that the US Dollar is the current world reserve currency, and U.S. bonds are considered a safe haven during rocky times. This is evidenced by the difference in performance between the IS04 (iShares $ Treasury Bonds 20yr+ ETF) and the Xtrackers Eurozone Govt Bonds 25+ ETF during Q2/2020. The IS04 outperformed eurozone bonds thanks to the USD reserve currency status, and the strength of the reputation of U.S. Bonds. But this relationship is only true for global crises. I am mindful of that a crisis contained to the U.S. would leave you exposed to unwanted risk as a European investor. There is a EUR Hedged version of the IS04 though, which may decrease the currency risk, but not the market risk.
      Have you found any good resources on this topic of geographic exposure? You sound to be convinced of eurozone exposure, and I am hoping to learn what convinced you. And I will definitely pick up the book by Qian; thank you so much for recommending it.

      Sincerely,
      Nicholas

  2. Nice update Nicholas! And food for thought..

    Following your portfolio updates a few months now; interesting and good reads!

    I have build a similar all seasons portfolio with monthly deposits to rebalance.
    To reduce country risk, currency exposure and spread mid- and long term bonds, my picks on bond ETF’s (55% of total portfolio):

    – iShares $ Treasury Bond 20+yr UCITS ETF EUR Hedged -DTLE(20%)
    – Xtrackers II Global Government Bond UCITS ETF EUR Hedged – DBZB(20%)
    – Vanguard EUR GVBD – VETY (10%),
    – iShares € Govt Bond 15-30yr UCITS ETF EUR (Dist) – IBGL(5%),

    This combination holds roughly around 40% on +20y bonds. US exposure still a bit (too) large in my opinion, f.i. DBZB is +-35% US bonds, so thinking about another spread in the near future.

    When building my portfolio, I did not check too much on the credit ratings. This might be something to also reconsider and take into account, especially thinking long term and after reading your post!

    Would be interested to hear about your opinion compared to your allocation!

    Best regards,
    Michiel

    1. Hi Michiel,
      Thank you so much for the kind words, and I am happy to hear that you like what I do!
      I understand you have 55% of your portfolio allocated to government bonds – do you have any inflation-linked bonds or TIPS? Otherwise the portfolio may not be balanced, as it will be biased to perform worse if inflation would be higher than expected. I have 15% of my portfolio in inflation-linked bonds and the remaining 40% in ‘regular’ long-term government bonds. (as a comparison, the RPAR ETF holds about 12.7% in TIPS when underweight in that asset class).
      With four different ETFs, is it easy to maintain the correct split? I have noticed that with more ETFs and with a lower amount of capital, it is extremely hard to hit the right share, as units may be priced oddly. For example, is it easy to maintain the 5% target of the IBGL? For this reason, I have decided to hold only 1 ETF per asset class until I have more capital to invest. See also the comments to this article by and to Paolo as well for reference, as that discussion relates to the same topic.
      About the ETFs as such, there seems to be some overlap between the VETY and IBGL? Both are eurozone govt bond ETFs, but I would prefer IBGL of the two, as it has a longer average duration of the bonds (17 years compared to 8.4 of VETY).
      As for DTLE, this is the ETF I hold as well (but I have the non-hedged version). I believe the EUR hedging is wise, and have been considering this as well, especially after the wild EUR/USD exchange rate fluctuation in July.
      The DBZB provides good global exposure, which has been my case for the IS0Z (iShares AAA-AA global bonds ETF). But the issue with both of these is the short average duration of approximately 8 years. This was also discussed in the separate comments. Perhaps a good long-term government bond share of a portfolio would be a mix between only IBGL and DTLE, with more capital allocated to IBGL? Then the geographical risk is spread more, and long duration is kept, but on the other hand, one would lose the access to countries in other parts of the world. I maintain my position that there is no perfect global long-term government bonds UCITS ETF available, unfortunately.
      I think that credit ratings should only be treated like a parenthesis when investing, but a factor which may contribute to price movements. If a country would be downgraded, this is caused by a stressed national economy and will impact also the stock markets in that country. In such environments, investors will any way move funds from stocks to governments bonds, so bonds may still be a much better alternative than stocks. And as mentioned, it is difficult to predict which country will be hit hardest (as the rating is relative to comparable economies) so diversification may be key.
      Hope to hear from you soon again,
      Nicholas

  3. Hi Nicholas,
    I totally agree with you, the Xtrackers Eurozone Govt Bonds 25+ ETF is well diversified.
    In addition to the others, it contains government bonds of France and Germany, two politically and economically very important countries.
    To think that in the future France and Germany may fail or no longer exist is very difficult!
    There is also a physically replicated Lyxor Euro Government Bond 25+ (MTH), without securities lending.
    Very important circumstance in the event of extreme scenarios.
    For me who live in the euro zone it was very easy to choose a euro government bond ETF.
    For those living outside the euro zone, the problem is a little more complicated.
    The topic is treated very well in the book The Permanent Portfolio, Harry Browne’s Long-Term Investment Strategy by Craig Rowland, J. M. Lawson.
    This book cannot be missing in the library of those who share the philosophy of a portfolio all seasons/risk parity.
    Greetings to you and your readers.
    Paolo

    1. Hi Paolo,
      Even though I o not reside in the Eurozone, the Swedish economy is very much influenced by the Eurozone (for example, Germany is the greatest partner in terms of Swedish import). Thus, Eurozone investing is not irrelevant for me, but I would have preferred a longer term govt bonds ETF with broader geographical exposure with other strong economies for even better diversification (even though the Xtrackers ETF mentioned [DBXG] is rather well diversified already).
      I have begun thinking that as a middle-way, and a way to benefit from both the USD’s status as the world reserve currency, and to invest in one’s home market with a diversified portfolio of Eurozone government bonds, I am considering a mix between the DBGX (or MTH) and EUR hedged version of iShares $ Treasury Bonds 20+yr ETF with a 3:1 ratio on allocation with overweight to Europe. That is to say, two ETFs for the long-term bonds exposure, and with 30% of the portfolio to Eurozone bonds and 10% to American but with a currency hedge. I haven’t analysed the volatility of such split scientifically yet, but personally prefer to retain certain allocation to the U.S. while shifting my focus to the home market. As a side note, depending on whether China will be able to start competing with the U.S. and the USD over the coming decade for the world reserve currency status, also Chinese long-term government bonds may be of interest to add to the mix. But such ETFs are not available at all (I’ve seen one ETF with Chinese bonds but with rather short duration).
      And as you say, it is difficult to imagine a world where both France and Germany has collapsed, and by throwing in the U.S. to such failure scenario, if all three of these great economies would fail at the same time, I fear we have much greater issues to worry about.
      Does this make any sense?
      Many thanks also for this second book recommendation, I’ll definitely order it shortly! I appreciate all your reading tips and your great comments and discussions.
      Alla prossima,
      Nicholas

  4. Hi Nicholas,
    Thanks for the insight and advice; I appreciate it!
    55% spread over short- and long term government bonds was my first ‘best’ guess after reading about different strategies. Choosing VETY and IBGL was to find a better balance; geographical and short- mid- and long term bonds. I put TIPS aside after a look at downsides/limitations; fluctuation with volatile interest rates, no protection for deflation, and gold/cash/commodities(?) as inflation hedge. And I presumed most ‘regular’ bonds are covered with expected inflation. After reading your strategy I only looked on the US TIPS which where imho of no use in my portfolio. I now realize this might be insufficient. Adding global TIPS and perhaps reduce to IBGL and DTLE might be the answer for a better balanced portfolio!
    Maintaining the correct split is good to manage as me and my partner put in 1000-2000 euro per month from the start. In a later stage when we stop putting in our savings/budget, adjustment will be harder I guess; another reason to reduce ETF’s.
    Interesting and thanks again for your response. Keep up the good work!
    Michiel

    1. Hi Michiel,
      Thanks for the kind words and support!
      I have learned that short-term bonds have no place in a portfolio where you try to achieve risk parity, unless it is a substitute for cash in the short term. I used to include some mid-term bonds, but recently concluded that they did not help my portfolio’s performance, as they are not volatile enough to offset a fall in stocks in environments of lower than expected economic growth. I wrote a brief blog post on this lesson about a month ago in “Ditching Intermediate-term bonds“. Hope it helps!
      Most inflation-linked bonds actually have a zero floor, meaning that if inflation would be negative, the inflation-linked bond will not be negatively adjusted. I think it is only inflation-linked bonds issued by the U.K. (and some emerging market sovereigns) that lack this zero floor. Of the ones listed by you, gold and commodities are great inflation hedges (while cash is not).
      “Regular” bonds on the other hand, are harmed by increased inflation, as the expected inflation must be accounted for and be included in the yield. This, with higher inflation, yields must increase, which will make the value of the bond to fall.
      Also I am leaning more toward shifting my focus from the U.S. The inflation-linked bonds ETF that I have in my portfolio is the IUS5 (or IGIL on certain exchanges; the iShares Global Inflation Linked Govt Bond UCITS ETF), which gives a decent global exposure. I think it is good to include TIPS in addition to long-term bonds, as it will give you a good balance!
      You are in a really good place being able to fork in such substantial amounts each months! I’m just in the situation of buying my first apartment, so there has been little additions to this portfolio the past months I’m afraid, but I will restart making at least small deposits again as soon as possible. But would you really stop adding money one day, instead of perhaps just decreasing the amount when you have gotten the ball rolling? However, one does not need to rebalance that often; quarterly, or even annually, should suffice if you would not want to spend much time on your portfolio.
      What was it that got you hooked on this kind of balanced investing by the way? Always interesting to hear how others think about investing 🙂
      Looking forward to hear from you,
      Nicholas

  5. Hi Nicholas,

    I also checked your other blog and decided to follow your advice and changed into IBGL and DTLE. I have also rebalanced and added 15% TIPS (IUS5). The “all seasons portfolio” is in place; let’s see what the results will bring!
    Imho shifting from U.S. to global exposure is always better to diversify. Only time will tell; I am interested to learn about your decision making process.
    I also started an experiment with a 60/40 VWRL/IBGL portfolio in a one time investment and plan for yearly rebalancing/increase in funds. I wonder what longer term results will bring. And in this process I hope to learn how to better manage larger funds in a long term ETF portfolio. To be able to put in a decent amount every month is the result of some simple ‘FIRE’ rules… don’t lose money, increase savings rate, compounding interest and increase income every year. My reason for more balanced and diversified investing; working self-employed gives me the opportunity to build up my pension funds in several baskets. Of which the ETF portfolios are a two. Depending on the results after a few years; I will decide where to increase funds. Rebalancing will of course stay part of the portfolio; but probably just once a twice a year.
    Have a good one!
    Michiel

    1. Hi Michiel,
      Sorry for the slow response, it has been a rather busy week at work.
      I’m glad to hear that you are trying out the all seasons portfolio! Wish you great luck! How are the other parts of your portfolio split – i.e. stocks, commodities, and gold? And any other assets?
      I’d be interested to hear how your 60/40 portfolio will stack up against the All Seasons Portfolio. It should be a great learning opportunity.
      I’ve done some back-testing through 1H2020 with various geographical exposure, to compare the All Seasons Portfolio against a 60/40 portfolio, and in every case, the 60/40 is about 2 percentage points behind the ASP. Going forward, I believe the performance will depend much on inflation, as both stocks and bonds are biased to do well in environments of low inflation, which is what we may see at least for the nearest future.
      Additionally, a 60/40 portfolio has about 95% correlation with stocks. This is because stocks are much more volatile than bonds, and as stocks are the heavier component, stocks will have much greater impact on the total return than bonds. This is explained very well in the book Balanced Asset Allocation by Alex Shahidi, which is a book I strongly recommend.
      It seems you are in a good place for trying several strategies and improving along the way. That’s great, and I hope you keep me informed about how it goes – I’d love to follow your progress.
      Talk to you soon,
      Nicholas

  6. Hi Nicholas,
    My current ‘all seasons’ portfolio:
    – VWRL 15%
    – IWDA 15%
    – EXXY 7,5%
    – PHAU 7,5%
    – IBGL 25%
    – DTLE 15%
    – IUS5 15%
    Reasons for VWRL and IWDA is reduction in emerging markets (IWDA has none); perhaps I will change this too in the (near) future; depending on economic developments. As I hold an account at DEGIRO, not all my preferred ETF’s where available. Lower transaction costs where more important to me at this stage. I will let you know about the performance of the portfolios!
    Michiel

    1. Hi Michiel,
      Looks solid!
      I use Degiro as well, and in most cases, they seem quite helpful in adding ETFs to the platform if you send a request to their customer service.
      Low costs are always important.
      -Nicholas

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