Thursday, May 13, 2010

New(ish) research highlights ways to outperform in the bond market

Certainly, the best and the brightest do not find this surprising, but for those of us non-experts in the bond markets, Rob Arnott of Research Associates has put out some very interesting research.

From the WSJ:

"Why on earth would you want to construct a portfolio where the more in-debt a bond issuer is, the more [of their bonds] you want to own?" Mr. Arnott asked me. The question was rhetorical: It didn't make sense to me either.
Mr. Arnott and his colleagues Jason Hsu, Feifei Li and Shane Shepherd have looked at data over the past 13 years and found what they think are better strategies.
For example, he says, when investing in bonds issued by governments, don't lend the most to the countries that borrow the most. Instead, lend the most to the countries that rank highest on four key measures: population, land mass (as a proxy for their natural resources), GDP and energy consumption (as a proxy for economic advancement).
Among sovereign bonds issued by developed countries, for example, Mr. Arnott found that a portfolio allocated according to these measures would have earned you an extra 0.9 percentage points a year, on average. In the safe, stable world of sovereign bonds, that's a big edge. "It basically makes the difference between [earning] 5% a year and 6% a year," he says.
The full piece (download here) is a very interesting read, especially in an environment where every bit of yield (not to mention preservation of principal) will be hard-fought in the bond market.  Important for all of us...

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