Real Return Bonds

[marty123]

I'm trying very hard to resist the urge to tinker.

1. What is the purpose of RRBs in your asset allocation plan?
2. Does that still apply?
3. If yes, then hold, else got to 1.

I don't know what carnet's answer is, but I've been giving all of this some thoughts over the past several weeks:

1. Where the purpose is to protect a retiree's nest egg and future real cashflow, then the answer is probably to not tinker, because the goal continues to be achieved. Essentially, if a retiree determined that the 2.4% real return of 500,000 2008 dollars was an integral part of their long-term withdrawal plan, then there has been no change. The book value and market value are significantly different, but the main objective of the RRB remains without impact (giving a consistant real cashflow).

2. Where the purpose is to use RRB as a way to diversify a growth (pre-retirement) portfolio, then one ends up in a difficult position, sitting on a recent and significant capital gain, but knowing that real long-term appreciation of that portion of the portfolio cannot possibly achieve long-term portfolio objectives. Because the goal of a pre-retirement investor is to grow the nest-egg, it's harder to ignore the recent gain. The bottom line is portfolio size and managed growth, not a secure income. It boils down to being in a situation where we have to look at the rate of growth on book value rather than the rate of growth on market value. If we were Vancouver landlords holding onto a 10-year old property that still provides a decent return on book value instead of cashing out, we'd be labelled as crazy.

Over the next 2 decades, I'm aiming for a modest 3.0-3.5% real return on my portfolio. Having 40% of it returning 1.65% makes this modest goal difficult to achieve. It presents both a liability for the future, and an opportunity for the present. I'm essentially market-timing on a portion of these RRBs right now.

P.S.: I don't want to seem like I'm asking for someone to take a decision for me, I'm thinking out loud. At a minimum, I'll have to rebalance in the a short while.

[Shakespeare]

1. Where the purpose is to protect a retiree's nest egg and future real cashflow, then the answer is probably to not tinker, because the goal continues to be achieved. Essentially, if a retiree determined that the 2.4% real return of 500,000 2008 dollars was an integral part of their long-term withdrawal plan, then there has been no change. The book value and market value are significantly different, but the main objective of the RRB remains without impact (giving a consistant real cashflow).

If the goal is to use the capital to purchase an annuity, then the capital is preserved in real terms as long as the real return is positive (assuming dividend reinvestment). (Not reinvesting distributions will slowly deplete capital.)

[rhenderson]

XSB may well be a hedge against deflation but I fail to understand how it would be a hedge against rate hikes.

If rates suddenly spiked wouldn't the value of the bonds held in XSB be lower ?

If your holding period is longer than the duration, the initial effect of rate changes cancels out. XSB has a short duration so interest rate hikes will give a positive return after about 3 years.

XBB has a much longer duration - about 6 years - and is more vulnerable to rate hikes.

Agreed, if one's timeframe is 3 years then XSB would be similar to a 3 yr cashable GIC yielding 4%.

[carnet]

1. What is the purpose of RRBs in your asset allocation plan?
2. Does that still apply?
3. If yes, then hold, else adjust your RRB holdings accordingly.

Good questions.

A big move in inflation would be bad. The damage it would likely cause to everything I own that is not a RRB wouldn't be good. Reducing the impact of a big inflation move is the reason I bought them.

Unexpected inflation protection is nice to own. The protection was nice to have when I bought them and it is nice to have now.

Thinking about this a bit more seriously that my original post...I think it's unlikely that there is going to be a big move in inflation. In fact, I think the opposite case of Japan-lite is more likely. But the possibility of a big move in inflation is still there and it would still hurt. For that reason, I'll keep them. Thanks.

[jonathan]

TCC tokens are going up 15%

[Peculiar_Investor]

TCC tokens are going up 15%

Now if they only paid a dividend I did read that the TTC is restricting bulk purchases, Five TTC tokens per customer, as fare hike looms

To which asset class do they belong?

[Bylo Selhi]

To which asset class do they belong?

A quick back of the envelope analysis: A TTC token cost 25¢ in 1973(*) According to the BoC Inflation Calculator that's $1.19 in current dollars or 4.43% annual inflation over 36 years. Assuming a 2% real yield, i.e. 6.43% nominal, then a TTC token should be $2.35 today. Assuming a 3% real yield it should be $3.30. So I suppose TTC tokens are a reasonable substitute for RRBs, especially for those who lack enough money to buy RRBs.

(*) Prior to that the TTC had two fare zones. They were enough of a pain to deal with when I had to go north of Eglinton back in the day so I'm not going to try to factor them in

[Solo]

My bond (non-high-yield, non-cash) allocation is about 50:50 2021 RRB:XSB.

As a novice DIY investor at the beginning of retirement, I'm still trying to wrap my head around the pros and cons of setting up a bond ladder versus purchasing bond ETFs. So, I would be very interested to learn the logic behind choosing XSB for the short-term bonds but not XRB for the RRBs.

[Bylo Selhi]

the logic behind choosing XSB for the short-term bonds but not XRB for the RRBs.

XSB holds 186 bonds, about 2/3 AAA and the rest AA, A and BBB. That latter 1/3 includes provincial as well as corporate issues which should generate higher yields and provide diversification (if you think GoC isn't sufficiently creditworthy.) In theory that should offset the 25bp MER and relieve you of the burden of rolling ST bonds as they mature.

XRB holds only 12 bonds, mostly long term. About 85% is in federal RRBs and the rest in provincials. Despite the limited opportunity for diversification, higher yields and the need to roll RRBs very often, the MER is higher at 35bp. That said, XRB is still useful as a vehicle for stashing RRB interest payments until there's enough to buy more RRBs.

[Doug]

http://www.financialpost.com/video/inde ... xdVHPZzczG

Above is a link to a FP interview with David Ranson. For inflation hedging, he makes the argument that commodities are better than inflation indexed bonds. His argument is that governments determine the inflation index, and that there is underestimation of the inflation index. I'm not sure how mainstream he is; his second interview mentions holding a significant portion of one's portfolio in gold bullion as an inflation hedge.

[ghariton]

Sigh. I'm not getting into that "underestimating unflation" crap any more....

I personally believe that the CPI overestimates inflation by about 0.5% a year, a nice dividend to holding RRBs

Interesting new book,Animal Spirits, by George Akerlof and Robert Shiller. Its subject is a behavioural approach to macroeconomics (now that we've seen that the current mainstream approach doesn't work).

Their main point is that economic actors are not rational, as assumed by current macroeconomics, but are driven by "animal spirits". They don't quite say it, but it's clear that "animal spirits" are a synonym for irrationality -- or at least non-compliance with economists' notion of rationality.

They give five examples of "irrational" behaviour. One is money illusion: The vast majority of people do not understand inflation and its effects. As an example, the authors cite a study showing that, from 1976-2000, only 19% of Canadian union contracts were indexed, fully or partially, for inflation.

They also point to the overwhelming preference of investors for nominal bonds, instead of indexed bonds (pages 48-49).

So they seem to be suggesting that investing in nominal, rather than indexed, bonds is a product of money illusion, which in turn is "irrational".

Interesting.

Now if only the yield on those damn RRBs could go up a bit -- just in time for Tuesday.

George

[newguy]

So they seem to be suggesting that investing in nominal, rather than indexed, bonds is a product of money illusion, which in turn is "irrational".

But what if the regular bond investors are rational and are earning a spread they believe will compensate them for inflation? I always thought rrb investors were the market timers, now I'm wondering if maybe it's vice versa. The rrb investor is betting that inflation will be higher than the tips spread and the nominal investor is betting it will be less. But if you think FI is for a steady indexed income, then rrb's are more rational because then you don't care about the spread.

newguy

[ghariton]

But if you think FI is for a steady indexed income, then rrb's are more rational because then you don't care about the spread.

Exactly.

The holder of nominal bonds is absorbing the risk of unexpected inflation, and presumably being compensated through through extra yield. The TIPS or RRB holder is insulating himself from inflation, expected or unexpected, and giving up a bit of yield to do so.

IMHO speculating with RRBs -- or even frequent trading of them -- is a bad idea. The spreads are too big and the short-term price movements too unpredictable. They are best used to lay the basis for a fixed income component of your retirement.

George

[newguy]

They are best used to lay the basis for a fixed income component of your retirement.

But it's hard accepting a 2% swr when you're hoping for 10%

newguy

[ghariton]

But it's hard accepting a 2% swr when you're hoping for 10%

Indeed.

I strongly believe in the risk-reward relationship. Increased safety means lower expected returns. Higher expected returns requires one to take on more risk.

Now, as it happens, after having gotten burned very, very badly in 2000, my primary objective is safety. (I didn't realize what risk was until it bit me on the ass.) So I;m heavily into RRBs, the safest investment I can find.

But that positioning is obviously not appropriate for many, perhaps most, posters. They need a higher return than I, and are prepared to take more risk than I am. I wish them good luck.

George

[Shakespeare]

The 2021 yields only 1.36% today according to http://www.pfin.ca/canadianfixedincome/ ... turns.aspx . I think the interest I just got will stay in MMFs/short-term bonds.

[marty123]

They are best used to lay the basis for a fixed income component of your retirement.

But it's hard accepting a 2% swr when you're hoping for 10%

newguy

Be careful not to make SWR = Real return. That's only true if you want to die with an inflation-protected nest-egg. In a 2% inflation environment, a 1.5% real return can give a 4% SWR for 33 years or 5% for 28 years. There will be no capital left at death, but we're not talking about 2% SWR (nor 10% ). The risk comes when it's time to roll it over.

[newguy]

Be careful not to make SWR = Real return.

I realized that, but I have 50+ years to go, even more for my gf. I just took a guess. I have to read up on the math becuase until now I've been ignoring them. Someone call me when the real yields hit 3%

newguy

[Bylo Selhi]

I have 50+ years to go... Someone call me when the real yields hit 3%

That could be a 50+ year wait

So many people are now aware of RRBs and there's so much concern about returning inflation that demand is driving yields down to previously "unimaginable" levels, e.g. today's ~1⅜% real. Contrast with the mid-1990s when RRBs were almost unknown and inflation had been wrestled to the ground. Then you could get 5% real. Or even a year or two ago when rates where ~2½%.

[Doug]

Richard Ferri posted an interesting article on the downside of inflation indexed bonds:

http://www.forbes.com/2009/12/04/ferri- ... -tips.html

There is a string related to the article on the Bogleheads forum:

http://www.bogleheads.org/forum/viewtop ... 1260015110

[Shakespeare]

Having done reasonably well on my PH&N Inflation Indexed Bond holding - about +3% in 3 months - I have entered a switch tomorrow to PH&N ST B&M.

[Nowhereman]

The time is coming for RRB's, I will start watching mid to late 2010, all that Bama Bucks is coming home to roost.
I am not adding to JNK but will be at 0% by mid year.

[SoninlawofGus]

I'm about 95% sure the answer is "no" to this, but I'll ask it anyway: is there a way to buy RRBs (or any Canada bonds other than CSBs or provincial savings bonds) outside of brokerage accounts? I think the answer is "no" because the government packages the bonds for sale. TIPS can be bought directly, though the last time I checked, the Treasury Direct site would only accept orders from US citizens.

[MaxFax]

Look at the index mutual funds offered by TD e-series. They have a system going for really small $$ investors that is a quasi-broker. They have a portfolio of index mutual funds that can be bought through them. Very probably an RRBond index fund is in their lineup.

But really, is opening a broker's account so very daunting? It is really not a big deal.

[newguy]

Look at the index mutual funds offered by TD e-series. They have a system going for really small $$ investors that is a quasi-broker. They have a portfolio of index mutual funds that can be bought through them. Very probably an RRBond index fund is in their lineup.

Nope, just i-series at 1.42% mer.

newguy