Global Macro Trading Journal
- Thread starter Daal
- Start date
In Brazil this played out because of the inflation risk that savings accounts take. In the US, people have had access to bond funds with duration for a long-time (whereas in the Brazil, this is more of a new thing). There it can also be true that having a little bit in equities is better than 100% in these bonds funds. Sometimes (like now) the bond funds get clobbered but equities rise so you get protection there. Here are the US numbers from 1968 to 2016
These are the returns from the perspective of a Brazil investor (adjusted for FX movements and domestic inflation) but it doesnt matter because they are all changed by the same variables.
There was risk reduction by some metrics even though you took more risk
Point is, owning some equities is a good thing! The initial allocations (5/10%) are almost "free" from a risk perspective
These are the returns from the perspective of a Brazil investor (adjusted for FX movements and domestic inflation) but it doesnt matter because they are all changed by the same variables.
There was risk reduction by some metrics even though you took more risk
Point is, owning some equities is a good thing! The initial allocations (5/10%) are almost "free" from a risk perspective
The case where this is not true is when the investor takes on very low duration risk (by using savings accounts or very short-maturity bonds) and there is no spike in inflation (or when there is but then the central bank responds by hiking rates VERY aggressively). In that scenario, diversification from equities wont help from the risk perspective
I guess the widow who refuses to take on any equity risk (and specially if she stays in very low duration instruments), is taking ANOTHER risk. Which could be even greater. That is the "financial repression risk". Carmen Reinhardt shows that even developed economies like to engage in financial repression quite a bit. So that widow is being fooled by money illusion. She might see that she makes nominal gains every year but she is not taking into account inflation and when financial repression kicks in, she gets hurt. By putting 5-10% of her money into equities, she can decrease that risk a little
Thats pretty much what happened in the US since the financial crisis. People that made a living off fixed income with short-durations got clobbered. Every year their nominal and real returns came down. But the folks that had some duration (say 8-10 years, the widows with some risk appetite) at LEAST got a capital gain out of it. There was some compensantion there. The people that said "I'm rich already, I dont need to take any more risk, I just want to be safe for the rest of my life so I own Treasury Bills" got really hurt, they were taking risk without knowing. They should have had some duration (at least a little) and some equities instead of avoiding risk totally
Right now in Brazil its interesting because people can take on duration risk. A "Treasury Direct" program started in 2005 and people can buy inflation linked bonds for as far as 2050. This creates an interesting dynamic because its an asset that historically was not avaliable, most people could only own savings accounts (that would compound every 3 or 1 month) and some fixed income funds with low durations. In fact, the government couldn't even issue very long-term bonds denominated in the domestic currency, because no one would buy them.
In the US, duration is a good stock market hedge (usually). But in Brazil so far this has not been the case, when the crisis hit stocks and long-term bonds fell. At the same time Brazil still has hyperinflation risk, all it takes for that to happen is a crazy loon to get elected in the next 20 years and put another group of loons in the central bank (which is not legally independent). So long-term bond holders take on "stock market risk" (risk aversion risk) without the hyperinflation protection that stocks have.
At the same time, they benefit from the possibility that Brazil is going to be doing very well in the next decades as the central bank learned from the past and now, like in other developed economies, every business clycle, inflation will to go a new lower level. If that plays out inflation could be headed to 2-4% and interest rates will collapse. These bond holders will make huge money. But so will stock and real estate holders. But the last two are more protected against the risks
In the US, duration is a good stock market hedge (usually). But in Brazil so far this has not been the case, when the crisis hit stocks and long-term bonds fell. At the same time Brazil still has hyperinflation risk, all it takes for that to happen is a crazy loon to get elected in the next 20 years and put another group of loons in the central bank (which is not legally independent). So long-term bond holders take on "stock market risk" (risk aversion risk) without the hyperinflation protection that stocks have.
At the same time, they benefit from the possibility that Brazil is going to be doing very well in the next decades as the central bank learned from the past and now, like in other developed economies, every business clycle, inflation will to go a new lower level. If that plays out inflation could be headed to 2-4% and interest rates will collapse. These bond holders will make huge money. But so will stock and real estate holders. But the last two are more protected against the risks
One thing that my tests are showing, that is on the dissapointing side, is gold. Not that it doesnt help to decrease risk, it does. But its value is nothing compared to UST-bills/bonds and US stocks. Its obvious to me now but the tests have shown that as an emerging market hedge, the problem with gold that it is volatile. In my sample its Standard Deviation of returns is 33%, this compares to 18% and 21% of US bills and bonds (the high SD of bills is due to the FX fluctuations). The benefit of gold happens during those unexpectated bursts of hyperinflation/inflation but you get the SAME benefit by using US bonds and bills WITHOUT the day to day, week to week, month to month crazy volatility. At the same time US bonds help you to hedge part of your US stock portfolio and global risk aversion (which will help the EM stock portion). So you get ALOT more bang for the buck by buying US bonds in terms of Sharpe. The annual returns are quite similar, gold CAGR was 4.27% and bonds 3.67% but bonds are a lot steadier
This is all hindsight of course, its possible that US rates are headed a lot higher and you wont get shit in terms of hedge effect from US and bonds but at least in the data so far. US bills and bonds are THE hedge for an EM investor
This is all hindsight of course, its possible that US rates are headed a lot higher and you wont get shit in terms of hedge effect from US and bonds but at least in the data so far. US bills and bonds are THE hedge for an EM investor
I guess gold is more valuable to US investors. You guys cant run into US bonds if the USD is falling off a cliff globally, in that case, you need gold for protection. But for the rest of the world, gold's value is more limited. Gold is good for an EM guy when he cant get the money out of the country (or if its too expensive to do so). Then you buy gold and bury it in the backyard