When we exit our long-equities strategy, what do we do? 

We have found that the best thing we can do when the stock market becomes problematic is to step aside.  Over time we will be in equities approximately 70 percent of the time, but that remaining 30 percent can be treacherous.  And the best place for us to move is to the treasury market. 

In years past we would have simply had a passive investment in treasuries, but we have since learned how to rank and rotate among the various maturities.  Additionally the inclusion of TIPS (Treasury Inflation Protected Securities) provides good coverage against inflation, normally the plague of debt markets.  TIPs avoid the need to allocate some money to gold, which is always very volatile and difficult to predict.

What can one expect?  Over the period of 2002 to the present which encompasses different economic cycles, a passive investment in treasuries would yield between 3.67 and 4.11 percent compounded annually, depending on whether one did not or did include TIPS.  And to get those returns one would be exposed to a maximum drawdown of one’s equity of 7.73 percent.  If we were to rank the various maturities and rotate among them, our returns would be 5.53 percent with a 6.92 percent drawdown, a nice improvement.  But that is if we were in bonds the entire time, which is not the case.

If you only looked at the time when we were out of equities (and therefore in bonds), a passive bond portfolio would yield 9.48 percent (compounded annually) with a 6.64 percent drawdown.  Our bond rotation would yield 16.37 percent with a 6.79 percent drawdown.  This demonstrates that we are certainly correct in moving to treasuries in general, and that our rotations of their maturities provide value.

When we rotate debt we typically make one transaction per week and in doing so we move completely from one maturity to another.  That is, we do not ladder our holdings because the basic risks in treasuries are similar for all maturities.  Historically the bulk of the time we were in the 10-year (37%) and 2-year (29%).  We were in TIPS 13% of the time and 3-month Bills 12%.  Interestingly we were hardly ever in the longbond (6%), the most volatile of the lot.  The 5-year picked up the small remainder.  All of these can be nicely owned by Exchange Traded Funds (ETFs):  TLT, IEF, IEI, SHY, TIP, and a money market fund. 

Our rotated bond returns while in treasuries, compared with Treasury index returns while we are in treasuries