A false sense of complacency

The very part of your portfolio that you may think is the safest and most predictable of all of your investments could in fact be setting you up for a nasty surprise. I’m talking about bonds … and bond funds.

Today we’re going to take a look at how the ultra-low volatility of today’s interest-rate based investments can lull you into a false sense of complacency … and how TradeStops helps prevent this from happening.

Interest rates have been dropping for more than 30 years now. Just take a look at this chart of yields on the 30 year T-Bond.

As you can see from this chart of the 30 Year US Treasury Bond yield, rates have been dropping for decades. As rates have dropped, so has the underlying volatility.

But what happens when there’s a shock to the system? Like in 2008?

Zooming in on the most recent 12 years of the above chart, we can see how dramatic the 2008 crash really was on T-Bond yields.

Now let’s take a look at how the financial crisis impacted the volatility of some well-known and widely-owned bond funds.

The first fund we’ll consider is TLT, the popular ETF that tracks the price performance of US Treasury Bonds with maturities of 20 years and above. Normally you would expect such a fund to have very low volatility. Right?

Here is a chart of the TradeStops Volatility Quotient (VQ) on TLT for the past 12 years:

The VQ on TLT rose from below 6% prior to the financial crisis to over 18% before the dust finally started to settle. That’s an expansion in volatility of over 200%! Moreover, volatility stayed high for several years revisiting the 18% level again in 2012 … well after the end of the financial crisis.

All of this is to say that we shouldn’t get too complacent when it comes to the volatility of our bond funds.

Here’s another, even more conservative example. Take a look at CSJ, the ETF for 1-3 year maturities on investment grade bonds. The price dropped almost 11.5% during the financial crisis.

The VQ on CSJ today is less than 1% (see chart below) but during the financial crisis the VQ on CSJ reached heights of over 7%! That’s the equivalent of the VQ on a stock like Johnson & Johnson going from 10% to 70%.

One of the ways we help you avoid nasty surprises from bond fund volatility in TradeStops is to set a minimum VQ of 5% for all funds. Even though the true VQ on CSJ is under 1% today, if you run an analysis on CSJ in TradeStops today you’ll find that the current VQ is 5%:

Why do we set the VQ for funds like CSJ to a minimum of 5% even though they may have VQ’s that are lower than 5%? Precisely because we don’t want you to ever be unpleasantly surprised by a sharp spike in the volatility of something that you thought could never become that volatile.

Even savvy investors can become complacent in today’s low interest rate and low volatility environment. We’ve set the floor for VQ at 5% to help our members avoid just such complacency and to not end up with too large of a position size in ultra-low volatility funds.

Right now, we’re in just such a period of low volatility. This low volatility could continue for a while longer, but when it does change, and it will, TradeStops helps make sure that you don’t get caught off guard by a bond villain lurking in your portfolio.

Pun intended,