During the on-going long term bond bull market since 1981 there have been six approximately 12-18 month long bear corrections. The corrections are :1983-84, -25.2%; 1987, -24%; 1993-94, -25%; 1999-2000, -22%; 2009, -20%; and in the current correction of 2012-13, -15.4% to the lowest daily close on August 21, 2013. The monthly 30 year T bond chart shows these six major corrections and many smaller ones since 1981.
Bond sentiment has grown quite bearish lately with many comments and articles announcing the beginning of a great secular bond bear market. Much of this is based upon fear (or joy) that the US FED will "taper" their bond buying or even tighten short term rates and bonds will therefore have no where to go but down. Granted that I have written my belief that bond rates have been lower that they "should have been" since about 2003. This belief was based upon the Kondratieff wave history since the 19th century with interest rates normally bottoming when crude goods/commodity prices and wages and incomes bottomed. Crude goods/commodities bottomed this time between 1998 and 2003, but rates did not. The reason may simply be due to the fact that the US dollar dropped 41% against its major trading partners' currencies from 2001-2008 in the absence of stronger economic growth which would normally have sent interest rates up as well. All of this transpired while China and other new growth nations outperformed economically. Thus crude goods prices rose on this demand and a major US dollar bearish move. The Kondratieff wave is a world wide phenomenon, not just a US or developed world happening as in earlier centuries.
Several analysts have pointed out that the Tbond decline and rate rise since mid 2012 has occurred at the same time that the expected inflation rate, as determined from the ten year T note rate minus the ten year TIPs rate, fell from 2.6% to 2.0% several months ago. This is unprecedented and can only be explained as excessive negative bond sentiment in the absence of an acceleration of inflation.
My view is that the $USB 30 year chart would need to fall to 120 or lower from its current level of nearly 131 to prove that the very long term bull market has ended. It could happen, but I am betting there is another bond rally out of this oversold excess. People who have moved out of bonds and into stocks in recent months may have sold the low in the former only to buy the high in the latter.
I just read the prospectus summary and learned that was was wrong about TFSMX's market neutrality approach. They apparently do NOT hedge their longs with short index positions but with short individual stock:
"Market Neutral Definition: The Fund employs a “market neutral”
strategy, which is defined by TFS Capital LLC (the “Adviser”) as a
strategy designed to generate returns that have a low correlation to the U.S. equity market. Consequently, the Adviser will actively manage the Fund’s holdings in an effort to maintain a low correlation to the movements of the U.S. equity market. The Fund does not seek to adhere to any other definition of market neutrality including, but not limited to, dollar neutrality, beta neutrality, capitalization neutrality or sector neutrality.
Techniques for Maintaining Market Neutrality: The Fund seeks
to minimize overall U.S. equity market risk by taking both long and
short positions in U.S. common stocks. The Fund will generally own
a diversified portfolio of common stocks and will maintain a short
position in a different diversified portfolio of common stocks. The
Fund will primarily invest in common stocks and, to a lesser degree, in
registered investment companies."
The past may not repeat, but sometimes past results are instructive for planning. Mid 2007 saw a peak in many financial and real assets. Many markets have now returned to 2007 highs or exceeded them, so it's useful to see how some funds performed over this extremely volatile period.
During this period stock indices plummeted and recovered as did non-Treasury bonds. Commodities and gold fell, rose greatly and fell again. Real estate crashed and rallied some. Overall it was a disinflationary period start to finish with an inflationary scare in 2011.
With the exception of Vanguard S & P 500 Index fund VFIAX, I have owned all of these funds. I still own the others except for TFS Market Neutral TFSMX and Vanguard Wellesley Income VWIAX. All of these funds were open (accepting new accounts) in 2007 and had several classes with different minimums and annual expense ratios.
My goal in retirement has been to avoid excessive downside volatility. I had no idea the 2007-2009 bear market would be so severe, but the funds I held outperformed broad stock market index funds like VFIAX which was down almost 50% on a month end basis by February 28, 2009. http://screencast.com/t/ZHWbzcb9
FPA Crescent Fund FPACX, a midcap balanced fund which increases cash holdings proactively when they see trouble, was down 25%. Loomis Sayles Bond Fund (investment grade) LSBDX, MainStay Marketfield MFLDX (see below), and Vanguard Wellesley VWIAX (40% dividend stocks/60% investment grade bonds) were down 19%, 18%, and 16% respectively. Pimco All Asset All Authority PAUIX (inflation hedge fund) and TFS Market Neutral TFSMX (short broad indices, long selected mid caps) were down 9% and 6% at end February 2009.
None of these escaped damage, but the average was down "only" 15.5% compared to 49+% for VFIAX. If one averages in one's cash and even Pimco Total Return Bond fund PTTRX which was up 11.3% at end February 2009, total portfolio value was almost exactly even for the period from mid 2007 to March 2009. Of course one could not have known in 2007 how well relatively new funds like MFLDX or TFSMX or even PAUIX would perform in a major financial crisis or that one would occur. The point of a portfolio like this it is that it had relatively low volatility in a very volatile period, in crash mode, in disinflation, and in inflation periods.
The next time this happens we will quite likely not still be in a long term bond bull market, and that could make a very big difference in these specific funds' performances. Time spreads in futures, options and other derivatives are very dependent on near and short term interest rates, as are bonds of course, and that makes hedging of all kinds more expensive. All of these funds shown here are "hedging" funds in one way or another. All of them also are discretionary as opposed to being index-mimetic.
MFLDX is a stock hedge fund in the classic sense, but even VWIAX and FPACX hedge their longs with bonds and/or cash. FPA is the home of the famous near cash fund FPNIX, and their cash is managed by FPNIX and the cash ratio to total assets varies with their stock market views.
TFSMX differs from MFLDX in basically being short the whole market in as much size as they are long their specific picks, whereas MFLDX shorts what they see as worthless stocks against their favorite longs. They both have to be very good to have good returns. But TFSMX doesn't have to be quite as good as it is easier to short the whole market. But their overall risk is also less than MFLDX's risk. And looking at Hussman Strategic Growth Fund HSGFX we find a fund that has lost money since 2007 by doing poorly what TFSMX does well.
Unfortunately, neither MFLDX nor TFSMX is accessible to most of us at this time. MFLDX is still managed by its founders, but is now marketed by MainStay for the past few years. Original investors (lucky me) were allowed to remain and to add to positions, but new accounts are for $5,000,000 minimums. There are some other open classes of the fund which have higher annual fees and other expenses. TFSMX has closed several times to get a firm grasp on handling large inflows, and has now been closed to new accounts since 2011.
We can look, for free, for closed-end funds which do many of these same functions at CefConnect.com and for alternative funds at Morningstar.com on a trial subscription. Closed-end funds tend to be more volatile than open end mutual funds.
As already mentioned, in a bond bear market LSBDX, PTTRX, and VWIAX would not likely do as well as the others. But if we admit that we don't know what cards the future holds for markets, we might still wish to have some creative bond funds.