Opinion: Market timing is easier with stocks and gold than bonds, but fund managers try it anyway, and usually fail

If you think US interest rates will continue to rise, the best bond investment strategy may be to buy and hold.

That doesn’t make sense on the surface, since bonds lose value as interest rates rise. But few bond fund managers can beat a simple buy-and-hold approach. This is true even during periods when the overwhelming consensus among bond experts is that interest rates will rise.

Take last year, for example. The 10-year Treasury yield TNX,
+0.86%

TMUBMUSD10Y,
2.374%
at the beginning of 2021 it stood at 0.92%, and there was a general certainty that interest rates had no choice but to rise. Indeed, the 10-year Treasury yield ended 2021 at 1.51%. However, a large proportion of actively managed bond mutual funds in 2021 still did not perform as well as a straight buy-and-hold strategy.

This is surprising because beating a bond benchmark should be relatively easy when rates are rising. All a fund manager needs to do, within the range of durations they can invest in, is keep their duration as short as possible.

Consider funds in the short-term US government bond category, which encompasses funds whose average duration is between one and three years. An actively managed fund in this category could have outperformed its benchmark simply by holding its average duration at or near the one-year end of that range. However, according to S&P Global SPIVA Scoreboards73.68% of actively managed funds in this category underperformed their benchmark in 2021.

The proportion following a buy and hold strategy is not that low in all calendar years. But over longer periods of time, the amount of actively managed funds that get left behind in a buy-and-hold approach becomes almost overwhelmingly high.

This is illustrated in the chart above, which reports the proportion of various categories of actively managed US government bond funds that lagged their benchmarks through the end of last year. In the 10-year horizon, the percentages range from 76% to 99%.

Momentum for short-term bonds

The struggle bond funds endured last year should give pause to those who believe bond market timing is relatively easy, especially during periods of rising rates. More evidence comes from Hulbert Financial Digest’s (HFD) tracking of bond market timers, which has found that very few of them beat a long-term buy-and-hold investor.

For the purposes of this tracking, the HFD assumed that each of the 88 separate bond strategies could choose between only two investments: a bond market index fund and a money market fund. As a result of this tracking methodology, the only source of difference in your returns would be your managers’ decisions about when and how much to shift allocations between market and cash. Only five of these 88 strategies (5.7%) outperformed buy and hold during the periods for which the HFD has performance data.

Volatility: A Market Timer’s Best Friend

There is another reason why you should doubt claims that bond market timing should be relatively easy: the bond market is not very volatile, and successful market timing depends on market volatility.

Consider the relative volatilities of the stock, gold, and bond markets. Judging by the standard deviation of monthly returns over the last four decades, the bond market is 66% less volatile than the stock market and 68% less volatile than the gold market. So, to that extent, the stock market will be even less likely to succeed in the bond market than in the equity or gold arenas.

The bottom line? Unless you have a good reason to believe you can beat the overwhelming odds in front of you, just pick your target bonus allocation and stick with it through thick and thin.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at mark@hulbertratings.com

Also read: The Yield Curve Is Accelerating Towards Investing: Here’s What Investors Need To Know

Plus: Prepare for a recession this summer, a bearish housing market and a drop in stock prices, warns strategist David Rosenberg

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