Global Bond Market as of March 31, 2015

“The chart below shows the difference between estimated Global bond demand and supply. This mismatch aids in returns for fixed income, as more investors look to invest (creating more demand) with less supply to satisfy these needs. The left chart breaks down the sources of demand, showing that monetary easing has created a large portion of this demand as developed market central banks continue to purchase bonds to stimulate their economies.

The next slide highlights the growth in the fixed income markets and provides some data points to highlight some of the diversification benefits of different markets. Read more »

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Harvard Management Company: Creating Optimal Mix of Portfolio

Formed in 1974, Harvard Management Company (HMC) manages Harvard University’s endowment and related financial assets. Here is the excerpt from HMC website and Annual Endowment Report 2014.

“Over the long term, HMC has produced excellent investment returns for the Harvard University portfolio. The annualized return on the endowment over the last 20 years has been 12.3% per year and the endowment was valued at $36.4 billion at June 30, 2014. In fiscal year 2014, distributions from the endowment contributed almost a third of the University’s operating budget. The following charts show historical investment returns and the total value of the endowment.

Historical Investment Return

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Diversification and the Average Investor

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The Effects of a U.S. Rate Hike on the Yield Curve

by Gerald Hwang of Matthews Asia

“The fear of a rate hike is powered by the tacit assumption that rates along the entire yield curve will rise in tandem. Only such a parallel upward shift would raise discount rates on all cash flows from risky assets (e.g. equities and corporate bonds). Consequently, the present value of those assets would decline, if cash flows stay the same. Importantly, the Federal Reserve holds sway over only short-term rates through its setting of the federal funds rate. This policy rate may be affected more by Federal Open Market Committee assessments of economic growth than by inflation.

Moreover, this short rate is a weak lever on longer rates. Rates at longer maturities embed the compounded effect of expected future real rates, expected inflation and a term risk premium that captures the volatility of these factors. Market anticipation of higher future inflation, or the possibility of inflation surprises, will be expressed as higher long-term interest rates. The Fed’s credibility anchors these market expectations, and the loss of that credibility is perhaps the biggest risk to long-term rates.

In rate hike cycles over the past 20 years, Fed credibility may have been enhanced by the very act of raising rates in the first place. One indication is in the flattening of the U.S. yield curve. In each cycle, short rates rose more than long rates. Interestingly, in two of the past four hike cycles, the longer part of the curve (10-year to 30-year) declined in yield. A parallel shift in the yield curve is as rare as receiving the equity market’s long-term average annual return in any single year. Most likely, a future federal funds rate hike will not translate into higher rates all along the curve.

As seen in Figure 1, only the 1994 rate hike cycle saw an upward shift in the entire yield curve, yet yields at longer maturities rose less than those at the front end.

 

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The current size of the Global Stock Market

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Global Equity Valuations as of March 31, 2015

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S&P 500: Sector Data as of March 31, 2015

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Interesting facts about High-Yield bonds return and volatility

By Gershon M. Distenfeld, CFA

“High-yield bonds may look like other bonds, but they don’t necessarily act like them. High yield is not closely correlated with interest rates, and in fact, the asset has done well historically during periods of Fed tightening. Over time, the high-yield market exhibits a reasonable correlation to equities, as both are strongly linked to the business results and fundamentals of the companies they represent. But here’s something some investors may not realize: over the past three decades, high-yield bonds have delivered equity-like returns with much lower volatility“.

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Valuation levels aren’t a predictor of market corrections

“Many investors fear that higher valuations suggest that a bear market is imminent. But history suggests that bear markets more often result from factors external to the stock market, such as recessions, wars and credit bubbles. There have been ten pullbacks of approximately 20% or greater since the 1920s.

Instead of trying to time the next market correction, investors should stay diversified to protect one’s portfolio against unforeseen market shocks”.

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