Changing Asset Allocations

When I heard the news earlier this week of a possible referendum in Greece about the EU bailout and austerity plan, I entered a new limit order to sell our VEU shares (all world stock index except U.S.) if the share price dropped by 6%. It did and all of our shares were automatically sold. As I said earlier, I have had it with the volatility and general lack of benefit from owning this foreign stock ETF.

This decision wasn’t made merely on recent events. I reviewed all of the facts and found these negatives to also be persuasive:

  • Over the past 12 months, VEU is down 12.65%
  • Over past 5 years, VEU is down 16.28%.
  • There is no anti-correlation benefit, e.g., the price movements of VEU and VTI (U.S. stock market index) shares are tracking very closely, with VEU sadly showing both lower highs and lower lows.

In other words, what is there to like about holding VEU? Where is it headed over the next few years, with Europe in continual “who will be the first to default” turmoil?

Is the “you must have foreign equity exposure” rule of thumb really just another retirement planning “rule of dumb”?

I am 60 years old. I’m not waiting indefinitely for some light at the end of the foreign stock market tunnel.

After the the limit order triggered, I started researching and thinking about what to do with the resulting cash.  I gave some consideration to buying one of the new specialized “retirement income funds” from PIMCO.  I ultimately decided against it but I will revisit this again soon.

I also tried to buy some individual TIPS bonds on the secondary market but the prices were not attractive.

Instead, I bought a TIPS  ETF from PIMCO:  LTPZ  This particular TIPS fund focuses on the longer maturity bonds, with an average maturity of almost 20 years. This adds some additional interest rate risk but according to the Fed, interest rates aren’t going anywhere anytime soon.

What appealed to me about LTPZ is its steady performance that is not correlated to movements of U.S. stock indexes.  The fund is up 21.2% YTD, 12.7% over the past year, and has a 15.4 % annualized return since inception.  The distribution yield is 3.30%  while the expense ratio is only 0.20%.

We are now even more heavily weighted in inflation protected investments.  Part of me thinks this is a bad idea but the actual numbers say something else.  Core inflation is on the rise, which will make TIPS more valuable.   I just need to keep a close eye on interest rate trends as compared to inflation trends.  I will also put in a limit order on this holding to protect our position against a dramatic events.

So far so good this week as LTPZ is up 0.66% just since we bought it.


  1. Bill says

    The whole point of diversification is to have assets that are uncorrelated. For some unknown reason, since the meltdown in 2008 nearly everything has been correlated – stocks (domestic and international), bonds, commodities – all seem to go up and down together. “The market can stay irrational longer than I can stay solvent.” (attributed to Keynes, but I think incorrectly).

    I’ve always avoided mutual funds (or ETFs) that invest in TIPS, since they behave significantly differently than the bonds themselves. While the NAV of a typical bond fund depends on interest rates (rates go up, NAV goes down, and vice versa); the NAV of a TIPS fund depends on two things – interest rates and predicted inflation rate. It makes the NAV far more volatile than I’d like. Right now, the yield of a 10-year T-note is 2.04%, and the predicted inflation rate is 2.12%; so the “real” yield of the 10-year TIPS is negative (which I’m blaming on the Fed’s Operation Twist). The TIPS purchased at auction in January of 2011, with a coupon of 1.125%, are now up over 15% — and this absurd market value is reflected in the NAV of the TIPS ETF. Its even more extreme for the 30-year TIPS; the auction in February 2011 set the coupon at 2.125%, and their current market value is up about 40%. When the “real” rate goes back to the more normal 1%-2% (when the Fed stops suppressing the yield on longer term notes and bonds), the NAV of TIPS ETFs will lose that premium. Holding the bonds themselves to maturity insulates us from these gyrations. I realize this is essentially the same argument Bill Gross made about USTreasuries at the end of QE2, and he lost big on that bet, but this time I think the analysis is right. Auctions this month and next are both reopenings, so you pay that same absurd price as in the aftermarket. I’d wait until January for the next issue of new bonds.

    One other aspect of TIPS bond values relates to deflation. If we enter a deflationary spiral, the value of TIPS ETFs will drop with the CPI, but the individual TIPS bonds will still pay off at par at maturity. I still consider this chance 50-50.

    And, the question of the day, why is the 10 year maturity of TIPS called a bond, while the 10 year maturity of other US Treasury obligations are called notes?

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