Cherished Fortune by Andrew Allentuck & Benoit Poliquin

Author:Andrew Allentuck & Benoit Poliquin
Language: eng
Format: epub
Publisher: Dundurn
Published: 2018-12-14T16:00:00+00:00

HOW TO BUY BONDS

Now let’s talk about the nuts and bolts of buying bonds. First, the rationale. Bonds have returned a few percent less than stocks over very long periods. For the 210 ten years from 1802 to 2012, stocks had a real (that is, inflation-adjusted) return of 6.6 percent per year.2 In that 210 years, bonds’ return was 3.6 percent after inflation. So stocks returned, one can say, nearly twice as much as bonds. Yet for some periods, for example, 1983 to 2015, bonds had an extraordinary run, generating returns averaging 8 percent per year.3 In that period, stocks went through the flash crash of 1983, the dot-com meltdown, and the entire market implosion in 2008–2009, the latter driven in part by a form of bonds, mortgage backed securities with the characteristics of junk debt.

The 1983 to 2016 run of bonds was based on back-to-back processes. The U.S. Federal Reserve, directed by Paul Volcker, worked to break the back of double-digit inflation by forcing interest rates up, and then, with inflation under control, rates fell gradually and steadily to the year 2000. The Bank of Canada under Governor Gerald Bouey followed much the same course. In 2008 and 2009, central banks in the U.S., Canada, and Britain and the European Central Banks bought government and even some corporate bonds from banks to boost their cash positions and, as well, to drive down interest rates. It worked. Getting even 3 percent on a long government bond took a miracle or a genius. Rates remain in the low single digits. So why bother with bonds? Given that over average one-year periods, stocks outperform bonds 58.8 percent of the time, and for thirty years, do so 99.3 percent of the time, why would anyone invest in bonds?4

It’s not to make a living. Rather, bonds in a portfolio can be regarded as insurance. If stocks crumble, it is a fairly sure bet that bonds will rise. Given that bonds do pay some return in the form of both interest and, often, capital gains if they are purchased right, bonds can be regarded as portfolio insurance that pays some of its cost.

Now let’s look at the mechanics of bond buying. Once upon a time, there were Canada Savings Bonds. They paid relatively little — almost always less than what chartered banks and credit unions paid on savings — but they were obligations of the Government of Canada and as bulletproof as anything could be. If you lost a bond, the Bank of Canada would replace it — after a good deal of paperwork, including making a solemn promise in a written indemnity that if the lost bond turned up, you would not try to get paid for both. Public interest in CSBs waned with the paltry interest they paid. Toward the end of their life, as a way for the Government of Canada to raise money, regular CSBs paid 0.5 percent per year and the so-called premium CSBs paid 0.7 percent per year. That

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