A reader left a question asking for my opinion about zero coupon bonds and whether now is a good time to buy 30 year zeroes.
I am generally favorably disposed to how they work but they are a nuisance in taxable accounts. You can click here if you are unfamiliar with what these are.
Zeroes are a great tool at the right time and a horrible tool at the wrong time, especially 30 year. Zeroes are extremely volatile when rates start moving. It would be very easy to buy in at the wrong time and be down 20% before you know it.
Long term rates are very low right now. There is more room for them on the upside than there is on the downside. I think this is especially true given that the curve is inverted such that long rates are very low by historical standards and short term rates are kind of middling by historical standards.
If 30 year zeroes ever had an implied yield of 10% again (from this point on I will just say yield and not implied yield) I would consider loading the boat for a lot of clients. Here is the idea. Zeroes yielding 10% maturing in 30 years might cost $0.15 for a dollar face value (making that number up, this is just an example). One thought for a $100,000 portfolio is to buy $100,000 face value for, in my made up example, $15,000. Then invest the remaining $85,000 in a normal manner in the stock market. Another thought is to invest some larger portion of the portfolio in the same zeroes; we are talking 10% after all, and the rest in equities.
The bigger macro is that stocks average about 10% per year. If that can be had risk free (not volatility free) in a treasury product...well, hello.
So the question becomes at what yield for a zero does this compel you? I'm not sure at what level I find it compelling but 4.5% for 30 years or 4.75% for 20 years ain't it.
The way cycles work there are good times and bad times for certain products. When it is the wrong time for a product the best thing is to just wait. I think this is the wrong time for zeroes.
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3 comments:
Roger, I have read that zero-coupons are particularly effective in a deflationary environment. This makes sense to me. I own a small slice of BTTRX in my account right now. I have abstained from adding to it until there is more data supporting a deflationary outcome in the US. Also, I have done some basic chart overlays comparing BTTRX and TLT which show the two to be rather closely correlated. In the future I'm more likely to use TLT as a proxy.
Does BTTRX own zeroes? I don't know the fund.
I would be surprised if TLT could be a proxy for zero coupon bonds during most parts of the bond market cycle. Zeroes tend to whip around more than regular bonds when rates start moving.
Zero's can be useful in hedging a commodities positions as well, oil and gold in particular, since on average one tends to zig when the other zags. A large position is usually unwarranted though and in the current environment I wouldn't be a buyer of zero's frankly; FWIW
PS: BTTRX is the last in the old Benham Target Funds lineup (Twentieth Century Funds, now American Century, bought Benham out some years ago and has not instituted a new target series AFAIK). It contains only zeros with a maturity date of 2020 (at which time the fund will be liquidated at par). As with all the American Century Target funds it contains nothing but treasury zeros of a given single-year maturity and imputed interest is handled each year via an inverse split of fund shares. TLT is correlated with the the longer duration target funds -- BTTTX and BTTRX -- but the effect is somewhat weaker as one would expect. I tend to buy and hold zero's directly but have used the Target funds to make allocation adjustments or hedge various positions from time to time.
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