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Portfolio Update – February 2021 – Dire Outlook for Bonds?

Contents of this month’s post include:

I am glad to have you back for another monthly update of my All Seasons Portfolio.

February 2021 has been a rather eventful month, as we have seen a change in inflation expectations, causing bond yields to rise across the board. As long-term government bonds is a key component of an All Seasons Portfolio, and any risk parity portfolio for that matter, we will have a closer look at the jitters in this post before looking closer into my portfolio.

But first, from beginning of March, I have started to offer some tools and resources for Google Spreadsheets that will help managing a your own portfolio. I will continue to build up the inventory over time, but already now, you can find a simple Portfolio Tracker, which allows you to keep track of a portfolio of up to 10 assets, and get useful information for your portfolio, such as portfolio volatility and correlation, Value at Risk measures, and instructions for rebalancing. It also includes a helpful economic dashboard with lots of useful data of the portfolio and the economy.

Check out the Shop page for more details on great tools and resources.

Dire Outlook for Bonds?

In the last week of February, the bond market came under scrutiny in a culmination of a rapid hike in yields and a failed US 7Y Treasury Bond auction on Thursday February 26th. You may have noticed this from the quite bad performance of any bond ETF (a key component of an All Seasons Portfolio) over the past month; in fact not a single ETF in the credit space has seen a positive performance in February.

A complete dry-up of risk appetite in fixed-income space briefly pushed the 10Y treasury bond yield above 1.60% in an intra-day posting. This was the crown of a month-long trend throughout February with rising treasury yields. The 10Y yield closed the month at 1.41%, being up 55% YTD.

Data from Google Finance

As the US economy is the largest and most significant in the world, and its currency is the most important reserve currency, the credit crunch has sent ripples across the global fixed-income markets.

Yields in most major economies have followed the American upwards, putting downward pressure on bond values, as, quite logically, the price of a bond moves in the opposite direction of yields (for example, a bond with an interest rate 5% becomes increasingly attractive if newly issued bonds only yield 3%, pushing up its price).

becomGraph courtesy of Financial Times

Where are yields going from here? Of this, there are widely disparate views. In his annual letter released on 1 March 2021, Warren Buffett warned the shareholders of Berkshire Hathaway that the credit market will see dark days ahead and that it is no place to be for a sensible investor.

On the other hand, economists (given a voice by David Rosenberg to CNBC) believe the bond market to be oversold and will begin falling back toward the 1.00% mark for the UST 10Y bond. In the beginning of March, we have seen a bit of a retracing of the rise in yields, but yet not as dramatic as Rosenberg predicts. The bottom line is still that a lot of uncertainty remains, so it is difficult to take a position for a hard bet on yields for the coming 3 months.

What caused the yields to spike?

The rally in yields also spilled over to equity markets where Nasdaq saw its worst day on 26 February since September 2020. But let us review the causality: it was not the risk off sentiment in the fixed income space that alone caused stocks to dip, but rather, another external factor had occurred that affects bonds and stocks alike.

Taking a step back and thinking about bonds’ biases, we are reminded that bonds do well in times of lower than expected economic growth and lower than expected inflation (and even deflation).

Thus, bonds form a vital part of a risk parity portfolio to protect your wealth against low growth and low inflation environments.

On the other hand, if economic growth would pick up at a higher pace, that would hurt bonds as growth assets would be more preferred and the yields rise, as interest earned from bonds should cover both inflation and economic growth rate for compensating investors of the risk.

The arch enemy of bonds is, however, inflation. This is due to bonds’ interest rate risk. What happens in inflationary environments is that central banks will try to cool of the environment to bring inflation back to normal levels. It does so by increasing interest rates and thus slowing down the pace at which money flows through the economy to new investments. When interest rates rise, so do bond yields, meaning that bond prices fall.

Interest rate hikes affect bonds of different maturities differently. Short-term bonds are less affected, as the shorter time until repayment means less interest rate risk for investors (they will anyway get repaid soon). Long-term bonds, on the other hand, react more to changes in interest rates as there extended time to maturity means that there are a larger number of interest due dates for the held bond that will pay less than any newly issued bonds with higher interest rate.

Moreover, at times of higher inflation, the interest received from bonds may be lower than the inflation rate, which means that the real return of bonds is likely to be negative. Higher inflation therefore is a double-blow to bonds, as the prices of bonds fall and the interest received has lower purchase power.

In the book The Permanent Portfolio by Craig Rowland and J.M. Lawson, bonds’ biases are explained beautifully and in a way that is easy to understand, in the context of a well-diversified and simple portfolio (albeit built with 25% stocks, 25% bonds, 25% gold and 25% cash). More details about this book will follow at the bottom of this article.

But did the Fed, or any other major central bank for that matter, during February signal its intent to raise rates in the near future? That did not happen. Rather, Fed is currently acting quite dovish and ready to hold the economy under its arms with ready for further QE as needed. On Thursday 4 March, Powell announced that the central bank is expecting to remain patient in withdrawing support for the recovery, and that they may not intervene immediately if measured inflation actually picks up. The bond sell-off thus continued also on this side of the February end-of-month.

So if the Fed has not announced any increases in interest rates, why did the bond market react as it did? It is due to inflation expectations having risen lately, i.e. due to the increase in quantitative easing, stimulus packages and rapid increase in money supply, the market is expecting higher inflation in the future.

Inflation expectations is commonly measured in the difference in yield between the nominal bond yield and the inflation-protected bond yield. As the only difference between these two bond types is the inflation premium om nominal bonds. As a reminder, TIPS face value is adjusted for the CPI inflation rate, meaning that the paid interest is less than for a nominal bonds. The difference in yields for these types of bonds is therefore what the market expects the inflation to be in the future, and this is also called the “breakeven inflation rate”.

The below graph shows the change in the breakeven inflation rate over the last six months. As evident, it has been rising steadily, and in January 2021, the market has begun to expect inflation well above 2%, now even nearing 2.5%.

5Y Inflation Expectations since 1 January 2020 –

So, as the market expects higher inflation, both due to increase in money supply and a growth in commodity prices (another inflation driver), the market also foresees that if inflation rises to uncomfortable levels, the Fed will (at least should) react and increase rates to counter the increasing inflation to not allow it to go out of control. Because this is the expectations today, the market begins pricing in the interest rate hike already now, pushing yields up and bond prices down.

So what should you do with your bonds now?

Raising yield have had a wide impact on ETFs across the fixed-income space. Below is a graph of 27 bond UCITS ETFs and their performance of the past 30 days (click images to enlarge). If you do not recognize all their names, the categories are summarized to the right (removing hedged versions, hence the smaller amount of lines).

As is evident, the hike in yields has hade a quite harsh effect on all types of bonds, both in the government bonds and corporate bonds segments.

Because corporate bonds are more tied with equity risk, and therefore not relevant for the bonds portion of the All Seasons Portfolio, we have below focused on bonds issued by governments.

The worst performer has been Long-Term US Treasury Bonds with terms longer than 20 years (thick blue line; a key portion of my own portfolio), even though prices have recovered in the beginning of March.

The only bonds ETF not having negative performance over the past 30 days is short-term bonds, (or cash in other words), but all other categories have performed badly, to varying degree. But as the yields have risen due to inflation expectations, you see from the chart above that inflation-liked bonds have not been as severely hit.

Does this mean you should abandon bonds in your portfolio?

Absolutely not! This is a good time to remind us why we include bonds in a risk parity portfolio, such as the All Seasons Portfolio, and what its “job” is. As discussed above, bonds are included in the portfolio to hedge against deflation and falling economic growth.

Moreover, the point with a risk parity portfolio is to be prepared for whatever scenario plays out in the economy and financial markets. It is a fundamental truth that predictions is an unnecessary hobby, and the only thing we can really do is to prepare for any possible outcome. Especially this year, amidst of a pandemic paired with experimental and unprecedented central bank and government medling, it is useless to think one will be meaningfully correct in any guesses of what will happen in the even the next quarter.

Do you remember the sentiment before the 2008 crisis? I don’t (I was a bit too young back then), but in the spring of 2008, investors were also worried about rising yields and rising inflation. Note therefore in the graph below, how yields were ticking upward from March through June on the left hand side of the graph.

Also then, it was perceived that yields are as low as they can possible go (and they were low from a historical perspective), but then in the fall, the sub-prime mortgage crisis hit, and yields made a huge dive.

What if you would have been an investor scaling down your bond holdings and increasing risk assets in the spring of 2008 in anticipation for higher yields? You would have made a huge loss toward the end of the year. And can you say, with confidence, that it is any different this time around?

We do not know what we can expect around the corner. Think about all the uncertainty that remains, and how fragile the state of the economy is. Stock values are held up by helicopter money and levels of stimulus never seen before, but at the same time, unemployment remains an issue, and we are not yet certain the vaccination rollout will really work. Mostly, the stock market and the economy is now only pushing forward on hope, rather than substance.

Therefore, even if I personally right now believe more in the inflation case rather than stagflation case, the latter remains a possibility. For us to come out of the pandemic in 2021, many things need to go right and the planets must align. If any of those fail, we are at risk of seeing the balloon loosing its air.

As long as unemployment remains an issue, the Fed might not even raise rates as much, regardless if inflation goes substantially above its target of 1.5-2.5%. Fixing the unemployment requires the coronavirus outbreak to be fought back, and for as long as that battle is not won, we remain at great risk.

The bottom line of this rather lengthy text is therefore, even though yields have been rising, and might rise for a little longer, there is nothing saying that they may not fall again. As has been proven by many economies, zero nominal rates is not by all means a floor (just last week, the Swedish central bank – the first to come out of negative rates – announced that one potential tool in the near future is not only negative rates, but VERY negative rates).

Read more in the portfolio update segment below how I am treating my bond holdings these days.

Bonds are included in the All Seasons Portfolio for a reason, and if you are worried about the rising yields, you should zoom out and see the portfolio view rather than looking too close at the individual assets. In a well diversified portfolio, not all assets will perform well at all times, but not all assets will perform bad at the same time either. Remember that a negative environment for one asset (bonds in this case) will be offset by it being a positive environment for others (gold and commodities in the inflation example above).

Hence, remember to stay strong and confident of the risk parity strategy that you have implemented, and not to waiver now when it might be needed the most. As famously said by Howard Marks: You cannot predict, but you can prepare.

It is thus important that you have a portfolio which actually balances the risk exposure to different environments. If you have not already built your own All Seasons Portfolio to really diversify your portfolio and balance your risk, I strongly suggest that you begin preparing for whatever market environment that may come as soon as possible, to better manage the risk and volatility in your portfolio, while still not forfeiting return. If you need inspiration, check out my post on How to get started with the All Seasons Portfolio strategy or check out some example portfolios.

How are you treating the bonds in your portfolio in this environment when yields are likely to only rise? Let me know by voting below, and join the discussion in the comment section at the bottom of this post.

This poll is no longer accepting votes

Have you kept your bond allocation despite the resent selloff (excluding inflation-linked bonds and corporate bonds)?
14 votes

February 2021 Portfolio Update

Since the January update, my activity in my portfolio have been few and straight forward.

Firstly, I have added a bit of funds to the portfolio, which I have allocated to the inflation-linked bonds portion of the portfolio as I have been rather under-exposed to this asset class in recent times of deflation fears. Now that inflation expectations are increasing, I have now gotten back to within the aimed allocation (12.9% held vs. aimed 12%), as you will see from the charts further below.

The second action has been to diversify my long-term bonds allocation, in the light of the above discussion on bonds. If you go back to the chart over performance of different bond classes, global bonds have performed significantly better than LT US Treasury Bonds which were the most affected of all. I still have the same allocation as previously to bonds as such, but rather than having all my exposure to US Treasury Bonds, I have sold half of the bon holdings (the non-hedged ETF IS04) and instead bought IGLE – a EUR hedged global LT Bonds ETF. Hence, now all my bond holdings are EUR hedged, whereof half are allocated to the US (DTLE) and half are global bonds (IGLE).

As you will see further below, my nominal bond holdings are currently 18% lower than my aimed allocation for this asset class (31.2% instead of 38%). With the current trend in mind with increasing yields, I will not sell any bonds, simply wait with rebalancing the portfolio until yields are stabilizing. We will see if this comes already in 2021, but by the looks of how fast the yield increase has begun, we could be in rebalancing territory toward Q3. A good benchmark for rebalancing is when an asset class deviates around 30-40% from its original allocation, meaning that when bonds have shrunk to make up only 22.8% of my portfolio, it should be bumped up.

Other than that, no exciting news to share on my trading activities. No further adjustments are planned within the near future.

Last month, I also polled whether you guys and girls had invested in the Gamestop mania. It seems I have had a rather good picture of the target audience of this risk parity strategy blog, as 90% of you responded that you had not made any trades in GME. The rest had managed to trade and make a profit – good for you!

Now, with the added funds, my portfolio is back to being rather close to my aimed allocation.

For a while, my allocation to Long-Term Bonds has been lower than aimed, in favour of commodities in anticipation for higher inflation. This has meant that I have been less affected by the recent sell-off, and my portfolio performance has more stable than anticipated.

Commodities have been a strong asset so far in 2021 (up 16%), and I have as of today no plans in reversing this Dynamic Risk Allocation yet, in anticipation of further stimulus packages being passed. As we are just on the doorstep for secular inflation, this could turn out to be a good trade. Most importantly, the increase in commodity prices has not been isolated to any sector (energy, industrial metals, or agricultural goods), but rather, prices increases have been broad – everything from oil to copper to corn is on its way up since November 2020, driven by stronger growth outlook with the vaccination rollout and underinvestment for the past decade in minerals sector when commodities have been out of favor.

In the last episode of Macro Voices podcast (episode no. 261), you get a good presentation of the commodity market and how to take advantage of this. Pick, for example, the broader ETFs that track Bloomberg Commodity Index or the Rogers International Commodity Index instead of GSCI, as the latter is very heavily exposed to energies (around 50%), while BCOM and RICI are more diversified also to softs and metals. Check out my blog post from September 2020 for more information on the best commodity indexes to track.

As for my portfolio performance, it has been rather stable and positive for the past rolling three month period. A lot of this, but not all, is attributable to my holding in Bitcoin, considering it only makes up about 3-5% of my portfolio for the shown period. Other significant contributors to the positive performance have been stocks and commodities, albeit the former has lagged in February (compare with S&P 500 in the graph).

For the past 12 months, return of my model portfolio (calculated on my current holdings) shows a return only 1 percentage point below stocks, but with 2.5 times less volatility. This means the risk-adjusted return (measure as Sharpe Ratio) has been double that of stocks, even though my portfolio includes many highly volatile assets (stocks, commodities, Bitcoin, and VIX).

While total portfolio performance in February was quite stable (as shown below), most asset classes have seen negative returns, but the portfolio is kept above 0% return thanks to Bitcoin and commodities. Note that these two asset classes currently make up only 14% of my portfolio, but still managed to offset losses in other assets.

A similar story can be told for 3M performance when splitting it down to asset classes (ETFs). Note that the below graph is logarithmic to fit the Bitcoin after its crazy rally.

If you are looking to invest in Bitcoin or other cryptocurrencies directly instead of exchange-traded certificates, consider using Coinbase – the most trusted cryptocurrency exchange with more than 43 million registered users, where you can securely trade more than 30 different cryptocurrencies directly in your own wallet.

Bonds are the only significant outlier in negative territory, and as I have had a lower allocation to bonds than I aim for the long term, the overall performance of the portfolio has improved.

Gold is still underperforming, which at a glance may seem counterintuitive considering the inflation expectations. It actually makes sense, and gold will continue to wait for its breakout on the upside for as long as yields are rising, as rising real yields is the enemy of gold on the back of the rise of breakeven rates. When the increase in real yields plateaus, we are likely to see gold bouncing up from its current consolidation phase.

Lastly, as usual, here is the table of my ETFs and the changes laid out in table form.

ETFNameAsset Class2021-01-312021-02-28Change
IUS5iShares Gl Infl Lnk Govt Bd UCITS ETF USD AccTIPS€453.30€589.0029.94% (Bought for cash constribution)
IS04iShares $ Treasury Bd 20+yr UCITS ETF USD DistLong-Term Government Bonds€694.34€0.00-100.00% (sold out)
DTLEiShares $ Treasury Bd 20+yr UCITS ETF EUR Hgd DistLong-Term Government Bonds€863.94€786.94-8.91%
IGLEiShares Global Govt Bond UCITS ETF EUR Hedged DistLong-Term Government Bonds€0.00€637.26#DIV/0! (New buy)
M9SAMarket Access Rogers Int Com Index UCITS ETFCommodities€372.60€409.8610.00%
VGWLVanguard FTSE All-World UCITS ETF USD DisStocks€1,302.00€1,355.704.12%
VOOLLyxor S&P 500 VIX Futures Enhcd Roll UCITS ETF C-EVIX€131.28€142.978.90%
Added cash€150.00

Thank you yet again for following this blog, and if you haven’t done so already, make sure to subscribe to the newsletter via the form in the page footer, and to drop any comments you may have on the content with the comment section or via email to I appreciate all discussions and I believe it adds a lot of value to talk about ideas on investing and strategies.

Remember also to check out the Shop page which I will be filling up with useful tools and resources for managing an All Seasons Portfolio. If you have any suggestions for any particular spreadsheet or tool that you are after, let me know in the comments below and I will see what I can do to have it included.

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 an espresso, read more about what this means on the Support page here on the website. My annual hosting bill for running the website is around EUR 140, so any support is extremely helpful, as the monetization of this blog is very limited.

We’ll catch up soon for the March update!
Nicholas Ahonen

Book tip: The Permanent Portfolio by Craig Rowland and J.M. Lawson

The Permanent Portfolio provides an up close look at an investment strategy that can handle today’s uncertain financial environment

Market uncertainty cannot be eliminated. So rather than attempt to do away with it, why not embrace it? That is what this book is designed to do. The Permanent Portfolio takes you through Harry Browne’s Permanent Portfolio approach―which can weather a wide range of economic conditions from inflation and deflation to recession―and reveals how it can help investors protect and grow their money.

Written by Craig Rowland and Mike Lawson, this reliable resource demonstrates everything from a straightforward four-asset Exchange Traded Fund (ETF) version of the strategy all the way up to a sophisticated approach using Swiss bank storage of selected assets for geographic and political diversification. In all cases, the authors provide step-by-step guidance based upon personal experience.

  • This timeless strategy is supported by more than three decades of empirical evidence
  • The authors skillfully explain how to incorporate the ideas of the Permanent Portfolio into your financial endeavors in order to maintain, protect, and grow your money
  • Includes select updates of Harry Browne’s Permanent Portfolio approach, which reflect our changing times

While the Permanent Portfolio is not a Risk Parity portfolio, as it balances between asset classes based on capital rather than their relative risk, this is still an excellent book to pick up to learn the fundamentals of the asset classes’ behaviours and biases in different market conditions, and why it is so important to diversify not only within asset classes (like in different stocks), but between asset classes.

This is a book that I have picked up myself, and I find that it is a great resource for beginning to learn about risk parity investing. All information is presented in a way that is very easy to understand and take in, and it provides several practical tips on how to set up your portfolio.

The Permanent Portfolio is, in other words, an essential guide for investors who are serious about building a better portfolio.

Or check out other great books on the topic on the Book recommendation page.

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This Post Has 4 Comments

  1. Louis

    Hi Nicholas, great post!

    I fully agree with you concerning bonds and the role they play in a risk parity portfolio.
    In the past, US Long Term Bonds had bad years (in USD):
    1980: -5%
    1994: -7%
    1999: -8,66%
    2009: -12%
    2013: -13%

    Excepted in 1994, during those years equity had a very good performance. Hence, the global portfolio performance has been positive on those years.
    Maybe 2021 will result in a negative performance year for my portfolio. A risk parity portfolio can have negative years. And we must accept this, even if that year equity have a good performance.

    I think (of course, I could be wrong) that this interest rates increase is just temporarily, and will finally start decreasing.
    This is not the first time inflation increase is expected (2009, 2013, etc), and then… nothing. While central banks continues to keep rates near zero (and they will, otherwise Governments will be bankrupt), no reason to panic.

    I voted option 1.
    Not sure it’s a good idea to move to another gov. ETF now. If rates will start decreasing (as I expect), the US Long Term Bonds ETF will probably have the best performance and so could recover.
    I also had a look at those “global gov. bonds”, but I preferred to not move, at least for the moment. I added iShares Global AAA-AA Govt Bond UCITS ETF in my watching list.

    Have a nice week and thanks for sharing your thoughts!


    1. Nicholas

      Hi Louis, thank you very much for your kind words!
      This is a great comment from you with a lot of wise insights.
      As you correctly point out, the purpose of risk parity is not for building and scaling a portfolio with the purpose of only being exposed to asset classes that are most likely to do well in the near future. We include different asset of the sole reason that the future is uncertain, and we do not know what will happen in the markets next month, next weekend, and barely even tomorrow.
      Sure, it may look like bonds have a hard time ahead in the near future, but we do not know the extent of that hardship nor for how long it will last. By scaling down bond exposure, you would be making the same mistakes as many stock investors trying to time the market.
      As a point of reference, now that the US bond yields climbed up to 1.60% for the 10Y, the 10Y Yield is now higher than it was before the Covid crash in March last year (it was 1.50% in January 2020). You could therefore say that now again, there is room for it to fall sharply if something unexpected would occur with the recovery.
      And if yields will keep rising, well, as you also state, other asset classes are likely to make up for the losses in bonds and add a bit more profits (when raking in the risk premium).
      No portfolio is perfect in that sense that it gives you a profit every single year nor every single month. But at least with a risk parity portfolio, the profits are more certain than an all-stocks portfolio for example, and the lower volatility will make it easier to sleep at night.
      I understand your reluctance to including global bonds and I can see your perspective (I am not strongly opposed to this view as such). Regardless, I chose to diversify my bond holdings as the US is experimenting heavily with stimulus checks, and I do not want to have all of my bonds exposed to an economy taking these measure. That said, many economies are in the same race to the bottom devaluing their currencies with fiscal and monetary stimulus, and with the increased uncertainty from these activities, I prefer being diversified.
      As a last thought, I’ll share an article about a survey done by Deutsche Bank on how young Americans (24-35 year old) plan to spend their USD 1,400 stimulus checks. Half will invest most of their stimulus checks on the stock market. That is quite staggering, and could cause an inflow of up to USD 170bn to stocks within short. We should be heading toward turbulent times ahead in other words, and I wonder if this not the final push upward before the bubble bursts? Will be interesting to follow.
      Have a great weekend ahead!

  2. Kris

    Great article. Pls let me know when the portfolio tracker becomes available.

    1. Nicholas

      Thank you Kris!
      A simplified version is available, and I am working on final touches to the portfolio tracker which allows to keep track on buying and selling. Hopefully this will be in good shape to publish in the very near future. I’ll keep ou informed.

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