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The Future of Fixed Income and Capital Preservation

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Can Fixed Income Continue to Provide Both Income and Capital Preservation?

Fixed income invest­ments his­tor­i­cal­ly served a dual role in a port­fo­lio, to pro­vide both fixed income and cap­i­tal preser­va­tion.

Can that dual role be main­tained as fixed income invest­ments face both near term and long term chal­lenges?

An allo­ca­tion to fixed income has tra­di­tion­al­ly been present in all but the most aggres­sive of port­fo­lios. Con­ser­v­a­tive port­fo­lios are often 100% fixed income. Cer­tain­ly, many port­fo­lios have ben­e­fit­ed from their allo­ca­tion to bonds over the last 35 years. But the wise investor should look for­wards, not back­wards.

When con­sid­er­ing con­di­tions today and for the fore­see­able future, the abil­i­ty for bonds and fixed income invest­ments to deliv­er against the dual role they typ­i­cal­ly serve in a port­fo­lio is in ques­tion. Yields are at his­toric lows and demand for bonds have remained quite high ever since the cred­it cri­sis of 2007-08 for a vari­ety of rea­sons:

  • Investors’ fears of equi­ty mar­kets;
  • non-U.S. cen­tral banks main­tain­ing a healthy cush­ion of cur­rent account reserves;
  • open mar­ket oper­a­tions by the Fed­er­al Reserve Bank (i.e., “quan­ti­ta­tive eas­ing”);
  • and a very accom­moda­tive mon­e­tary pol­i­cy.

As every stu­dent of finance knows, the yield on bonds is inverse­ly relat­ed to its price. As demand for bonds has soared, the yield has plum­met­ed. So let’s look at the chal­lenges for bond invest­ments today and going for­ward.

The Income Challenge

First let’s con­sid­er the chal­lenge to the income pro­duc­ing role of bond allo­ca­tions in a port­fo­lio. The yield curve shown below high­lights this sit­u­a­tion. An investor pur­chas­ing U.S. Trea­suries on June 18th, 2015 is sig­nal­ing a will­ing­ness to be com­pen­sat­ed at an annu­al rate of 2.35% over the next ten years, and 3.14% over the next thir­ty. Yields this low are unlike­ly to even cov­er the rate of infla­tion, leav­ing Trea­sury investors today with a neg­a­tive real return.

US Treasury - Yield Curve as of 6.18.2015 - Swan Global Investments- Capital Preservation

Source: Data from

The Capital Preservation Challenge

What about the oth­er role fixed income plays in a port­fo­lio, that of cap­i­tal preser­va­tion?  Cer­tain­ly over the last three decades bonds have filled this role admirably, offer­ing not only cap­i­tal preser­va­tion but cap­i­tal appre­ci­a­tion. Over the last 35 years (Jan 80 – Dec 14) the invest­ment grade bonds of the Bar­clays U.S. Aggre­gate Index have aver­aged an annu­al rate of 8.16%.

Chart of 30yr+ Bull Market in Bonds - Swan Global Investments - Is there Capital Preservation Ahead?

Source: Zephyr StyleAD­VI­SOR,

The graph above illus­trates why. As infla­tion was tamed and inter­est rates descend­ed from an eye-pop­ping 15.8% in 1981, the val­ue of high-yield­ing invest­ment-grade bonds increased dra­mat­i­cal­ly. Today, with yields at 2.35% there is lit­tle upside remain­ing. In fact, many would argue there is much more down­side to bonds than upside.

With such a long, steady fixed-income bull mar­ket, it is easy to for­get bonds can lose mon­ey, espe­cial­ly when inter­est rates change. Dura­tion mea­sures the sen­si­tiv­i­ty of a bond’s price to changes in inter­est rates. With a cur­rent dura­tion of 4.85 (Morn­ingstar cat­e­go­ry aver­age: Invest­ment Grade Bonds, 6/18/2015), the typ­i­cal bond fund is very sus­cep­ti­ble to cap­i­tal loss­es should inter­est rates rise from their cur­rent low of 2.35% to the his­tor­i­cal aver­age over the last 30 years of 5.44%.

Those rely­ing on bonds for down­side pro­tec­tion, or pro­tec­tion for their often irre­place­able cap­i­tal, might be in for a rude shock.

Such draw­downs are by no means unprece­dent­ed.  A study by Dim­son, Marsh, and Staunton exam­ined the draw­down in real terms of US and UK bonds and equi­ties over an 80 year peri­od.  Post-war bond investors expe­ri­enced a much greater loss of wealth than equi­ty investors.

Chart of drawdown in UK equities 1930-2010- Swan Global Investments

Chart of drawdown in Us equities 1930-2010- Swan Global Investments

OK… Now What?

  • What can an investor do if fixed income can no longer fill the role of cap­i­tal preser­va­tion in a port­fo­lio?
  • If an investor is pro­tect­ing a 60% posi­tion in equi­ties with a 40% allo­ca­tion to bonds, what would hap­pen if equi­ties and bonds hap­pen to fall in val­ue simul­ta­ne­ous­ly?

By pro­tect­ing its equi­ty hold­ings with long-term put options, Swan’s Defined Risk Strat­e­gy (DRS) seeks cap­i­tal preser­va­tion via hedg­ing rather than rely­ing on bonds that can under­go very long peri­ods of loss­es and draw­downs. Diver­si­fi­ca­tion strate­gies only work if the his­tor­i­cal rela­tion­ships between invest­ments con­tin­ue in the future; the DRS was designed to address mar­ket risk direct­ly. We believe a hedged equi­ty approach may be a bet­ter down­side pro­tec­tion option giv­en cur­rent mar­ket con­di­tions.


About the Author:

Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsMarc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.




Impor­tant Dis­clo­sures: Swan offers and man­ages the pro­pri­etary Defined Risk Strat­e­gy (“DRS”) for its clients includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Swan’s DRS per­for­mance results here­in are of the DRS Select Com­pos­ite which includes all non-qual­i­fied accounts. Addi­tion­al infor­ma­tion regard­ing Swan’s com­pos­ite poli­cies and pro­ce­dures for cal­cu­lat­ing and report­ing per­for­mance returns is avail­able upon request. All Swan per­for­mance results have been com­piled sole­ly by Swan Glob­al Invest­ments and are unau­dit­ed. Oth­er per­for­mance return fig­ures indi­cat­ed in this mate­r­i­al are derived from what Swan believes to be reli­able sources (i.e., S&P 500 index, oth­er index­es and bench­marks), but Swan does not guar­an­tee its reli­a­bil­i­ty. This analy­sis is not a guar­an­tee or indi­ca­tion of future per­for­mance. Invest­ments in for­eign secu­ri­ties involve addi­tion­al risks includ­ing cur­ren­cy risk. Ref­er­ences to the S&P 500 and oth­er indices and bench­marks are for infor­ma­tion­al and gen­er­al com­par­a­tive pur­pos­es only. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar invest­ments, ETFs and options in which Swan invests or writes may prove to be incor­rect and may not pro­duce the desired results. Swan Glob­al Invest­ments, LLC, Swan Cap­i­tal Man­age­ment, LLC, Swan Glob­al Man­age­ment, LLC and Swan Wealth Man­age­ment, LLC are affil­i­at­ed enti­ties.   Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 or

By | 2017-11-15T13:22:57+00:00 July 1st, 2015|Blog|Comments Off on The Future of Fixed Income and Capital Preservation