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Dethronement of myths: why bonds are more profitable than actions

Tuesday, 06 January 2015 11:31

Investment remains not science, but art: experience, information and sense of the market still win against "laws"

Within 20 years World investors passed a way from primitive mythology of the financial markets before perfect possession of the theory of investment. However the theory works not always.

The American market from 1990s to nowadays can be an example. For this period the market passed two growth cycles and falling of rates and the prices of exchange goods, two large-scale and one local crisis — so visited the most different circumstances. It is the most liquid and big in the world, respectively, laws of investment best of all have to be carried out on it.

Let’s begin with the most obvious and simple: in the theory actions bring in higher incomes, than bonds.

But if to count up any year from 1992 to 2009, the index of the stocks S&P 500 for today still loses to indexes of bonds — and corporate with A rating and higher, and highly profitable — and to bonds of developing countries. S&P showed the best results only during 1995-1999 — four years from twenty. For this period at S&P 500, for example, with the MLBofA US high yield bonds index the divergence was in 27%.

Theoretically bonds of developing countries have to be more profitable, than bonds of the similar companies from the developed countries. But results of MLBofA US high yield are similar to results of JP Morgan EMBI (and even slightly more steadily and above). Probably, the markets don't do distinction between developed and developing countries, paying attention only to ratings of issuers. It is a serious argument against those who urged to invest many years in BRICS, motivating such strategy with smaller profitability of US high yields and endowing essential bigger diversification, liquidity and opportunity not to pay the commission, buying ETF.

In the theory if the investor every time chooses the class of assets which showed the best result for last period, so-called regression to an average will result low profitability of such portfolio. Practice (in our case) doesn't correspond to the theory: the portfolio made of S&P 500, JP Morgan EMBI and MLBofA US high yield by the principle "60% of that index which was the best last year, 30% — the second and 10% — the worst", gives average annual profitability of 9,4% against 6,89% at EMBI, 7,54% at high yield and 6,1% at S&P 500. Moreover, if to take portfolios more aggressive (with ratios 70/25/5, 80/15/5 up to 100/0/0) — all of them show significantly the best result, than portfolios with one class of assets, and than portfolios with the fixed diversification.

It would seem, more reliable portfolios bought on margin shouldn't be more effective than more risky without margin: the market estimates assets "honestly", at identical risk different portfolios on the long period of time should to have a close profitability; buying on margin, we pay for it, reducing the income and increasing risk — thus, we do a portfolio on margin "worse". However practice "lets down": bond portfolio with A rating and higher (index MLBofA A + US corporate bonds) with margin 1:2, 1:3 and higher surely advances all presented portfolios with one class of assets, showing high correlation only with the portfolio of "dynamic allocation" look through in the previous paragraph.

On the basis of these examples it is possible to make only one conclusion: as well as before emergence of coherent theory, investment remains not science, but art: experience, information, sense of the market still win against "laws of investment".

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