Bond ETF Investing Warrants Caution

by: Lowell Herr

Bonds are normally part of a portfolio, particularly as one approaches retirement. The need for income and reduced portfolio uncertainty are more important for retirees than required for twenty- and thirty-year-olds. Given the importance to include bonds in a portfolio, what is the current outlook for bond and Treasury ETFs in this market?

To answer the question I selected eleven bond or Treasury ETFs that span both the domestic and international markets. I inserted two REIT ETFs for reasons I'll explain later. Short-term and intermediate-term bonds are also included in this analysis I title, "Bond Delta Factor." What the following table does is examine the historical performance of each ETF as well as the projected future growth rate over the next six to twelve months. The difference between the future and historical percentages forms the values in the Delta column.

The "Delta Factor" column uses information from the Historical, Future, and Delta columns to make a probability projection of how well each ETF will perform with respect to a reference ETF. The "Delta Factor" is no more than a probability factor for how well one might expect the ETF to perform going forward.

Looking down over the "Delta Factor" column, the projected outlook for these bond and Treasury ETFs looks rather grim. Keep in mind that these are only projections. Anytime one plays with extrapolating data, bad results have a way of coming true.

The reason for including two REITS, one domestic and one international, is to provide alternatives to bond or Treasury ETFs when it comes to generating income. Granted, REITs are generally more volatile than bonds, but the additional risk may be worth it considering the potential for future gains.

One reason for looking at bonds, as analyzed above, it tied to the ITA Risk Reduction model, a modification of the Faber-Richardson trend following model articulated in their book, The Ivy Portfolio. When moving from equities into cash, where does one put the cash?

With money market yields next to nil, bonds or Treasury ETFs are one alternative. While the above "Delta Factor" analysis pushes one away from bonds as long-term investments, they are potential cash holding tanks for shorter term investments if one is employing a risk reduction model advocated by Faber and Richardson.

For more information on the "Delta Factor," check out this site.

Disclosure: I am long TLT, TIP, BND, BIV, IEF, JNK, HYG, EMB, RWX, VNQ, PCY.