Putting the pieces together...

TWO INCOME CHARTS

The first is a chart of four closed-end non-US bond funds: Alliance Bernstein Global High Income (AWF), Templeton Global Income (GIM), Aberdeen Asia-Pacific Income, and Templeton Emerging Markets Income (TEI). AWF As result of a merger several years ago, AWF is partly non-US and partly US bonds, primarily corporate high yield. The chart is from the first day of trading (per FT). GIM is primarily sovereign bonds of both advanced and emerging market countries. FAX is in Australian state bonds and Korean sovereigns as well as corporate bonds of Asia and international agencies. TEI is 2/3 in emerging market sovereigns and 1/3 emerging market corporates. I own all of these funds. PTTRX and LSBDX are included for comparison's sake. I also own these funds.

http://screencast.com/t/UEkrwZ3K6I

The second chart shows three income mutual funds, PTTRX, LSBDX, and Pimco Income Fund (PIMIX) which I own, and three to which I am gradually migrating to defend against rising interest rates. I am doing this because are rates are so very low but also because of increasing evidence that the FED is beginning to unwind some of QE1 and QE2. They are restarting reverse repo auctions, and have hinted about selling some "toxic assets" and not continuing QE2 beyond June 30. Many have cautioned this for equities in the second half of 2011, but longer Treasurys would likely be hit harder and effect a ripple in the corporate bond world.

Since this idea is still conjectural, I am not rushing a change but will do so more or less on a regular weekly schedule over the next few months. More on this another time.

http://screencast.com/t/9R6z6ffB

I have mentioned Fidelity Floating Rate High Income Fund (FFRHX) and its PIMCO cousin (PFIIX). I do not plan to overweigh these as they have some risks (credit risk as well as pre-payment or refinancing risk).

I have mentioned the PIMCO Short Term Fund (PTSHX) with an effective bond duration of about 9-10 months. This pays only about 1% but that's a lot higher than a money market fund. Another destination for migration is the PIMCO Unconstrained Bond Fund (PFIUX). Unconstrained in this context means discretionary or not tied to a mandated benchmark. PFIUX is alowed to vary its average bond duration from +8.00 to -3.00. What's a -3.00 duration? Basically at that point they would be short enough longer duration bonds to make the whole portfolio modestly net short. Theoretically, in my own view, this would mean if rates went up 1%, the fund could go up 3%. So in a sense PFIUX is a variable rate fund. It is currently paying about 3% with a duration of 1.25. If you check duration on this fund, be sure to note when then data were collected, as it can change over a short period of time as the managers see fit. I think this is a sleeper fund. One of our long time commenters here has owned it for a while, and I will soon own it.

(Note that the PIMCO, Loomis Sayles, and Fidelity funds in these two charts are available in several classes with different minimum investment requirements and annual charges.)

MAKING A BOND PORTFOLIO

In retirement I am a consumer of investment returns and/or capital. So I need to have thought and *keep* thinking about my investments the way a pension fund does. They have a pretty good idea what they are going to have pay out each month over the next 20-30 years. We have to do the same.

With a large IRA or 401K account the IRS does it for us. They tell us each year how much we must take out and pay taxes on. It's based on a life expectancy table, and it goes up each year. Hugh Chou has a calculator http://www.hughchou.org/calc/irawith.cgi I can fill in with IRA totals. I put 0 (zero) for monthly contribution, estimated inflation, dollar estimated contribution increase, and minimum withdrawal to get the actual IRS required minimum withdrawal (RMD). This is an eye opener. You can experiment with earnings estimates, but personally I want to be very conservative and assume not more than 5% annual returns for now. One can vary return assumptions and one can force a distribution greater than the minimum. Try multiplying what you'd like to get each month by 12 and putting that in the last row to see what that does to length of years of payout.

While Chou's calculator is designed for IRAs and 401Ks, you can use it for all your investment funds to see what's realistic to expect from the investment totals you actually have.

OK, so you know what 5% per year will do at each year of age for safe but progressively larger annual withdrawals. How do you get 5% per year on average at this time? Not easily. Go to http://www.gmo.com and click on individual or private investor and sign up for access to their free comment and position papers. Do NOT worry they will try to sell you something, even if you have over $10,000,000 to invest. They don't want you as a client! They are being kind and generous to let us look at some of their work. Once you get your approval email back--it took me three minutes--go to the research area and click on the picture of James Montier. Some of you may remember several posts here on Montier three or four years back when he was with Dresdner Kleinwort and later with Societe Generale. Being a conservative value investor, he's a natural at GMO. Near the top of his most recent report at GMO look for Exhibit 2: GMO 7-Year Asset Class Return Forecasts as of January 31, 2011. Study that exhibit and see why 5% per year adjusted for 2.5% inflation may be hard to get according to GMO, one of the best. Then go back and plug 2.5% inflation into Hugh Chou's calculator and experiment with increasing the annual return % up or down 1-3%.

GMO's 7 year forecasts are similar to those of John Hussman in his weekly blog posts at http://www.hussmanfunds.com . Hussman is value-orientated like GMO and presents a lot of his calculations and assumptions.

Another research report at GMO I find very useful for understanding how to structure my own "pension fund" bond portfolio is Bill Nemerever's August 2010 report New World Bond Management: A Practical Framework for Decision Making. This is how pros do it, and I learned a lot about what bonds can and can't do, how, and why. Especially look at the Exhibits 4 and 5 in Nemerever's report showing how 75% bonds reduced the losses of 25% stocks in the worst quarter years for stocks since 1980. Keep in mind, however, that bonds have been in a bull market since 1981. But reducing capital losses is so important for a personal "pension fund" that it's essential to understand what bonds *can* do and did under difficult conditions for stocks. Re-read my own post of yesterday on what I am taking away from all of this.

Very much as an aside to the GMO reports is the fact that they do not directly address how to protect the portfolio from inflation except to say there are derrivatives to do this. Personally I think gold is such a "derivative, as you know. Currently I have 29% in precious metals holdings about equally divided between metals and metals stocks, the latter half of which are traded into and out of from time to time. That's a higher percentage than most advise, and it is just my own idea and NOT a recommendation. Husman's HSTRX does the same trading in gold stocks but within a range of about 2-15%.

I've covered a lot here. If you have time you might want to check Hugh Chou's calculator, play with it, and see the future realities for the investment totals you now have. If you aren't retired you can also see what you would need to put in every year to get back what you want. Let me know your own thoughts on this or your own ideas.

What Next?

The issue here for me is where are equities going? As you know I don't carry a big generic (index type) equity position in my retirement. I learned by doing that corporate bonds, investment grade or high yield, usually do as well or better than equities. And I like the yields.

http://screencast.com/t/JhKrVXGYg

Corporates have been outstanding for the past two years, but I have a lot of them through VWINX/VWIAX, LSBDX, PIMIX, VWEAX, VFSUX, and even some of PTTRX. In 2008 I was lucky or skilful enough to dodge the bullet when corporates crashed with equities...and with everything else.

The recent "sentiment failure" at the early March buy signal is a negative.  So is the possibility that the FED really will begin in June to unwind  all their efforts of the past 2 1/2 years. Bill Gross has a way of making the complex understandable to non-pro investors, and this new piece at PIMCO's site lays it out: http://tinyurl.com/47gzkrg

Basically the ten year Treasury rate is 1.5% lower than it "should" be in a market economy. If the FED heads back towards market economics, who will buy enough Treasurys to prevent rates from going up substantially?  And wouldn't that put a strain on equities (and corporate bonds) if no buyers show up or demand higher rates, as they would? Then too, the equity markets have retraced a good bit of the 2007-2009 declines. I have been neither a raging bull nor a raging bear on stocks, but rather an opportunist.

I'll hate to have to sell all the great bond funds above or even a lot of them. They can't be hedged except with equity options (or short equity indexes) or VXX, and they are really too large a part of the portfolio to hedge them all. LSBDX and VWEAX have some penalties associated with liquidation. But they are modest penalties given the loss possibilites in an equity rout. Corporates have fed me well. A bond bear market involving corporates would be a hardship. With short term rates so abysmally low, where would widows and pensioners go for income? I've written some about variable rate funds recently, but it's not a large universe, and many issuers could call them in. There are closed-end bond funds of all types including emerging markets debt and variable rate bank loans, and there are master limited partnerships and oil trusts that pay large dividends. But they also trade somewhat like equities, as we saw all too clearly in 2008.

I've started a pretty good position in PIMCO's short term fund PTSHX. It only pays a little more than 1% annualized with a duration risk of less than a year, but that's substantially higher than the money market fund (3 months) paying 0.07%!  But, alas, it's a also a lot less than the 5-7%  in LSBDX and VWEAX. A period of relatively high yield with fairly modest risk could be drawing to a close. If so one has to decide whether to accept capital losses or income yield losses. There's no free lunch in a true bond bear market. I saw what happened to my grandfathers in the 1960's and 70's. I'd rather spend some capital than lose it in a bond bear market.

These are just my thoughts these days and not recommendations for anyone else. I forgot to mention inflation-indexed bonds (TIPs). They are still bonds and will go down in a bear market and perhaps get partially adjusted six months later for official US Government CPI. I vote no on TIPs under those conditions. 

I don't have to do everything at once, and I don't have to do anything at all. But I am planning my retreat if it becomes necessary. My first step would be to get rid of the few true equity funds I have including some bought just recently. Then PIMIX, LSBDX, and VWEAX would have to go completely or in part. I'd add to PFIIX and FFRHX (variable rate funds) and probably PTSHX (short term). I've already added to precious metals for, hopefully, additional capital gains.

It's all part of the "game of life". I'd prefer to live with that perfect set and forget portfolio, but I haven't found one that will work forever for a retired person living on savings and investments. I do have an annuity, and I do have Social Security, but I wouldn't want to have to live on them alone with accelerating inflation. Nor should you even if you are NOT retired now. It's a serious quest, and no one is going to guarantee it for anyone of us, now or ever. I'm grateful that I have come to enjoy the quest that feeds me and my family and gives us many of the better things.

 

 

March 20, 2011 UPDATE

Well I was clearly wrong about the equity buy signal in early March. Fortunately I didn't buy much, only two deeply discounted closed-end funds, Source (SOR) and Tricontinental (TY). Of course, as Bill Gross realizes and has put into print recently, a lot of other assets more or less track equities: corporate bonds for one, but also closed-ends of all sorts, master limited partnerships, pass-through trusts, etc. Unfortunately I sold the VXX too soon. But given my diversification and fairly short duration exposure, I only lost 2% from my high on March 7 to my low to date on March 16, and I gained back a good bit of that on March 17 and 18.

I have two news tickers going at all times, but I try desperately to avoid changing investments on the basis of news. Sometimes news causes short term market moves, and these can be useful for entering new positions or exiting old ones. I've been interested in investing in Japan for some time and already had a small position in Mathews Asian Growth and Income Fund (MACSX) for about a year and the Aberdeen Asian Income Fund (FAX) since February, the former in taxable accounts, the latter in tax-deferreds. During the Japan plunge last week I bought an initial small position in Morgan Stanley's Asia Pacific Fund (AFP) which is ~45% in Japanese stocks, and I bought Daiwa's Japanese Equity Fund (JEQ), both for the taxable accounts. Depending on how things go I may also buy the Japanese small cap fund, JOF. My feeling is that Japan has wrung out a lot of fat since 1990 and is fairly well priced.

Several books I've read the past few weeks reinforced my "feeling" about Japan. Michael Murphy's "Survive the Great Inflation" did so indirectly, and David Skarica's "The Great Supercycle" directly recommends Japan for the same reasons I am drawn there. Mainly, when one looks around the world there is little that is underpriced. I am not a big fan of equities in general, so I am not going wild on this. It may not even turn out well, but I'm going to give it a chance for a little while. Japan clearly has its work cut out for it, but perhaps that is what will jolt Japan out of two decades of denial and lethargy. They are a great and a rich country, and, as we are in spring baseball season, which they love as much as we do, it's time to "step up to the plate".

I also took advantge of the silver stumble to buy some AGQ which is leveraged to the silver price.  I remain convinced that the inflationary trend is still in effect. In support of another aspect of that belief, I established positions a while back in variable interest rate funds: PFIIX, FFRHX, PFN, EVV and bit  of AEB. The first two might close to new investors at some point so I wanted to have a toehold in them. I have plenty of PTTRX, PIMIX, LSBDX, VWEAX, VFSUX and VFIJX which could easily be be transited to the variables if and when conditions warrant.

Watch and wait is my current mantra. So far I am up only 1.12% on the year (5.29% annualized) which hasn't kept up with the US dollar melt down, despite my gold and the precious metals stocks. Of the 50 largest US mutual finds, posted each day in the local newspaper, only 20 have returns to date over 2% this year PTTRX is up 1.2%.  I always have a slow start to the year. 

MARCH 3 UPDATE

Based on the failure of 2CS to get above 80 on the recent pullbacks, and using the Dow volume studies of Don Wolanchuk, I got bullish last evening on equities for the first time in a while. I sold the rest of the VXX this morning for a modest loss, and I bought two discounted closed end equity funds, SOR and TY, which have long records and interesting portfolios.

Another positive factor was the short mention of Ray Dalio's ideas on MarketWatch yesterday. I saw the tape of the CNBC interview with Dalio early today: http://www.cnbc.com/id/15840232?video=3000008442&play=1

Incidentally, recently someone mentioned high yield corporate bonds being in a "sweet spot" in the equity cycle, a phrase Dalio used today for real equities.

My indicators yesterday suggested a sharp rise and then another pullback in a week or two. That is based on a similar setup in April/May 2010.

MARCH 1 UPDATE

I've stuck with and fine tuned the inflation portfolio gradually. As Treasurys have risen and yields fallen modestly over the past few weeks I've positioned more into adjustable rate funds (ARFs) and maintained positions in high yield funds and gold and energy stocks.

High yield gives you a cushion so that if they start to fall in price with rising rates or falling stock markets, you have a few weeks to decide to get out or not before you could lose capital equal to a year's interest payments. My three favorite yield funds are LSBDX, PIMIX, and VWEAX all of which are very professional and fairly conservative for that normally riskier class. These are not the highest of the high yield funds, quite the contrary, and that is why I like them.

Gold and energy are naturals over the long run as they have been already for a decade. Brent and WTI crude oil made new post 2008 highs this past week and gold and silver made new all time highs today. It's hard to buy them at these levels, but also hard to buy them when they fall. If you don't own them already long since, the only way to buy would be gradually over time at set intervals: dollar cost averaging.

FFRHX, PFIIX, and PTSHX are my main ARF entries for rising rates, with much smaller pieces of PFL or PFN and EVV for a bit of a "kick". AEB is a single company A rated perpetual AR bond packaged as a NYSE stock. I've mentioned them all recently below. These funds don't pay much interest now, but that's the reason  for buying them before rates rise. I think of them as modestly more volatile  substitutes for money market funds while waiting for rates to rise. Money market funds (MMF) pay essentially nothing now while these funds pay 1-3%. But not only will the payout rate rise but the price of these funds will rise as well if and when rates rise. But it's OK simply to sit in MMFs and wait for rates to rise. I prefer to earn 1-3% instead. Every percent earned adds to annual returns

I'll discuss gold and golds and commodities more soon.

As always, keep in mind that this is just my financial diary or thinking and not recommendations for others.

Also with Loomis Sayles. Pimco, and Vanguard funds there are fund classes with very small initial deposits required, and they cost little more than the "institutional" class. The latter are offered through various fund platforms, like Vanguard, for $25,000 minimums instead of $1-5 million! So good management is available for reasonable annual fees.

QuantumOnLine.com is my favorite place for basic information on yield instruments. It's free, and they won't bother you with emails ever (so far in 5 years) if you register, but if you use it much consider a donation.