The asymmetry of the bond market

November 17, 2023

The President of the United States gave a speech about fiduciaries and annuities, and it was pretty good! Fiduciaries = good, annuities = bad. Well he actually qualified his statement on annuities, probably because lots of people in that industry donate to his campaigns, but it was still a big warning coming from the president.

"Fiduciary" is an odd-sounding term that has gotten traction in the public lexicon. This is a major problem to our competitors, as for decades they have been able to wash their conflicted advice away with sweet-sounding words. Now what is happening is people are walking in and saying "Are you a fiduciary?" And they say "By the way I meant to ask you how your grandkids are doing?" And the client says, "They're absolutely wonderful, but I said 'Are you a fiduciary?'" At which point it is definitely time to distract the client and start talking about lithium shortages in electric battery production.

Here is the new little trick emerging from financial firms, and you should be aware of it. Make one account a fiduciary account, and the others continue with the usual profitable shenanigans of being paid product commissions. So if you ask a firm the question, make sure you ask "Are you a fiduciary on all accounts, all the time." Learn more here.

Note that being a fiduciary is good, and it rises above the ethical swamp no one should be in anyway, but it doesn't necessarily make someone a good investor.

Remember, the industry doesn't get fixed until people move their assets away from those firms. It's certainly not going to fix itself. It's up to you how you want your future to be.

Now to the bond market. There is so much interest in the bond market these days! I think this is a reaction to increased interest in the Federal Reserve. Chairman Jerome Powell does not light the room on fire, and probably shouldn't, but at least it appears to Americans that the Federal Reserve functions. And so it's kind of fun and comforting to think part of Washington works, and so people watch it more.

Remember that the bond positions in your portfolios are there to offset the equity market. They are the rebar to concrete, the yin to the yang. Ultimately, when something goes very bad in the stock market, they are your life raft.

The interest rates we are at now are close to the long-term normal. They are not "high" as the media reports almost daily. Here is James Grant, the founder of Grant's Interest Rate Observer:

“Five percent is more or less the average of investment-grade rates since the time of Alexander Hamilton. The problem is the structures that 10 years of ultra-easy money brought about. People blame it on the normalization of rates. The previous bout of abnormal rates is the problem.”

In our view it's good to get back to normal. Paying interest to borrow money is a fundamental tenet of capitalism, and it's good to get back to it. It helps avoid asset bubbles and asset allocation errors (like junk companies that shouldn't exist).

We don't know what direction interest rates will go from here, but most bonds have asymmetric forward-looking returns now, particularly in longer durations. For example, if interest rates rose 1% from here, in a long-duration Treasury bond fund such as TLT you would lose 10.8% over the next year. But if rates go down 1% from here, in the same fund you would gain 22.3%. This is a function of what is called "convexity" in bonds, and while that term is not as well-known as "fiduciary," convexity currently means that your gain or loss on the same interest rate movement, but in different directions, is asymmetric. We did a little graph of TLT so you can see more data points visually. Click to see it here.

Dan Cunningham

^{1. Bond data above as of 10/27/23.}