Posts Tagged ‘Collars’

I read an article this morning on CNBC.com about the asset allocations people are making into longer- term bond funds.  I must admit, I was somewhat frightened after reading it.  The portfolio manager interviewed did not believe the bond investors’ motives were sound, but he claimed the massive inflows into bond funds basically came from two camps.

First, since money-market returns are basically zero, people are moving money into longer-term bond funds in order to improve yield.  The second reason was around the fact that risk managers are forcing more long-term allocations into “risk-free” asset classes.

The fact of the matter is that there are risks to long-dated Treasury bonds.  Now, because the U.S. government can print more money, it will be highly likely to meet its obligations on the bonds.  This is true. For example, if an investor buys a 30-year bond with a 3.75% coupon and yield to maturity, he or she will likely get the coupon and the principal over that time frame.  However, this depends on the investor committing the money for the next 30 years.  Right now, rates are at historic lows because prevailing views around the economy are that the recovery will be weak for the extended future.

If for some reason that changes 12 months from now and inflation expectations come back to the marketplace at an annual rate of 4%, an investor holding a 30-year bond with a yield of 3.75% will be receiving a “real” return (basically defined as the return less the inflation rate) of NEGATIVE 0.25%.  That is not good. (more…)