September 14, 2020: Surprised, Active Fixed Income Investors Have Done Better Than Stock Investors For The Last 20 Years!

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Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Thursday October 1, 2020.

Please note: As of March 1, 2020, we officially phased out our old rebalance calendar for both SAA and TAA. They are now always rebalanced on the first trading day of a month.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Surprised, Active Fixed Income Investors Have Done Better Than Stock Investors For The Last 20 Years!

Well, stock investors were briefly scared last week and now it looks like markets are back again. Popular stock market indexes like S&P 500 are just fractionally down below their all time highs.

So it would be very surprising for many to see that active fixed income investments actually outdone stocks for the past twenty years.

Bond funds vs. stocks

Let’s first take a look at the following chart:

So LSBRX (Loomis Sayles Total Return Bond Fund) actually managed to outperform SPY since 2000! In fact, the other two bond funds, PTTAX (PIMCO Total Return) and VBMFX (Vanguard Total Bond Market Index) are not far behind SPY. Of course, these funds had much lower volatility than SPY.

The following table shows how the candidate bond funds used in our total return bond fund portfolios compared (we omitted funds that didn’t exist on 1/1/2000):

Total Return Bond Funds vs. SPY (1/1/2000 to 9/11/2020)

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	Since 2000 AR
LSBRX (Loomis Sayles Bond Retail)	-2.4%	-0.5%	0.9%	3.0%	4.2%	5.1%	6.6%
PTTAX (PIMCO Total Return A)	7.7%	8.0%	4.8%	4.4%	3.8%	5.0%	5.7%
TGMNX (TCW Total Return Bond N)	8.0%	7.9%	5.0%	3.9%	4.5%	5.6%	6.2%
MWTRX (Metropolitan West Total Return Bond M)	7.7%	8.5%	5.4%	4.3%	4.5%	5.5%	5.6%
PDBZX (Prudential Total Return Bond Z)	5.9%	7.2%	5.6%	5.3%	5.2%	5.8%	6.1%
VBMFX (Vanguard Total Bond Market Index Inv)	7.1%	7.8%	5.1%	4.3%	3.6%	4.3%	5%
SPY (SPDR S&P 500 ETF)	4.9%	13.5%	12.4%	13.4%	13.9%	9.0%	6.1%

Among the five total return bond funds that had history back to 1/1/2000, three of them outperformed SPY!

Although one can simply attribute the outperformance to the super bull bond market for the past 20 years, we note that VBMFX (Total Bond Market Index) didn’t outperform SPY here, so the extra returns had to come from other sources. We’ll discuss this in some more details shortly.

Total return bond fund portfolios

If we compare SPY with our total return bond fund portfolio, the difference would be even bigger:

Portfolio Performance Comparison (from 1/1/2001-9/11/2020)

Ticker/Portfolio Name	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR	15Yr AR	Since 2001 AR
Schwab Total Return Bond	6.9%	9.2%	5.9%	6.4%	6.5%	7.7%	8.6%
SPY (SPDR S&P 500 ETF)	4.9%	13.5%	12.4%	13.4%	13.9%	9.0%	7%
LSBRX (Loomis Sayles Bond Retail)	-2.4%	-0.5%	0.9%	3%	4.2%	5.1%	6.7%

See detailed comparison here >>

Comments:

Since our total return bond fund portfolios started on 1/1/2001, so we can only compare up to that point. But it’s almost certain that the outperformance will still hold if we could include year 2000.
The above chart shows that $1 invested in 2001 would become $5.06 in the Schwab portfolio, compared with $3.7 in investing in SPY.
Click on the above here and scroll down to look at more data, you can see that LSBRX had maximum drawdown (DD%) of 30.7% and Schwab portfolio had only 7.8%! SPY, on the other hand, had an even worse and steeper maximum drawdown: 55.2%. So the Schwab portfolio had much better returns while its maximum interim loss (maximum drawdown) is only 1/7 of SPY.

Will outperformance continue?

Many subscribers are concerned that with interest rates being all time low, how much more a bond fixed income portfolio can deliver? We agree that the current situation is indeed a very difficult one, especially for strategic buy-and-hold investors for a long term period (more than 10 years). However, relatively speaking, we believe the total return bond funds and our active portfolios (that select best bond fund monthly) will likely outperform a stock index like S&P 500 in the 10 or a bit longer time frame.

The following are our thought process:

In the event that there are some big stock market losses in the coming years (which are extremely likely), we believe credit markets (i.e. investment grade or high yield corporate bonds and foreign bonds) will suffer at some similar scales. This will present opportunities for total return bond fund managers to find better returns. What’s more important, in those undershoot situations, high yield bonds, corporate bonds in general and/or foreign bonds will experience steep loss and when they recover, our bond portfolios will be able to capture a good portion of returns from those lows.

Basically what we try to say here is that, even in the current (and continuing) ultra low interest rate environment, credit risk, one of the two main factors that determine bond prices (the other one is interest rate risk), can give a tactical strategy such as the one used in our total return bond portfolios an opportunity. In fact, if we look at what has happened since 2000, total bond market index funds (such as VBMFX) didn’t manage to outperform SPY in the above comparison, but the outperformance by LSBRX and TGMNX etc. indicated that these funds managed to squeeze out more returns from risky bonds’ big swings, as evidenced by the steep interim losses LSBRX experienced. So our tactical total return bond portfolios are similar to those tactical strategies in stocks: even bonds (and/or stocks) might not have much total returns 10 years later, their interim losses caused by credit risk (bankruptcy and defaults) or economy slowdown (for stocks) will help these tactical portfolios to gain better returns.

In the event that there are no interim steep losses for both risky credit bonds and stocks (an unlikely but still theoretical possible situation) in the following 10-12 years, total return bond portfolios will still produce higher interest payments than stocks, which, as we discussed in the previous newsletter, will likely return flat or negative in the 10-12 year time frame. Look at this in other way, iShares Investment Grade Corp Bond ETF LQD currently pays about 3.1% annually, higher than SPY’s dividend yield 1.7%. So in this case, we believe our active bond portfolios will still do better than just buying and holding stocks at the current nose bleeding valuation.

To summarize, the depressing low returns in the coming decade will likely favor an active fixed income investor than a strategic buy-and-hold stock investor. Of course, stock or balanced investors might do better if they adopt an active investment strategy such as Asset Allocation Composite (AAC) , For a conservative investor such as retirees, a total return bond portfolio with some allocation to tactical stock investments can help to boost returns without taking much more risk.

Market overview

After the correction, we do see some encouraging signs: investors are rotating out of hot growth stocks. Now the return gaps between S&P 500 and other indexes are narrowed, compared with those two weeks ago (refer to the similar chart in our pervious newsletter):

Subjectively, if the rotation continues and there isn’t any big disruptive event, we believe current speculative sentiment will continue for a while.

Again, we shouldn’t rely on our subjective opinion and should follow our strategies instead:

For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation now reached another high. For the moment, we believe it’s prudent to be cautious while riding on market uptrend. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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