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For most of the previous cycle, and much of the post-COVID-19 recovery since the lows of March, 2020, there has been a large distaste among investors for maintaining Treasury bond exposure in the asset mix.

The argument typically points out the low level of yields, or how stretched valuations are (not that it’s stopped equity investors), or how much more money they can make in the stock market. Just close your eyes and buy the dips.

Is investing really that simple? And are concentrated, non-diversifying strategies really the most efficient way to build returns? The answer is no.

Not everything in investing is a get-rich-quick scheme, and there are significant benefits to holding Treasuries that are often overlooked. They are still a great hedge when things go awry – and things always go awry.

Many people will look at a 1.2 per cent 10-year Treasury yield, and then look at what the stock market has done and decide that the former is simply not a good investment option. The fact is that successful investors do not just focus on potential returns, but also the need to protect capital and manage their downside risk.

The simplest way to evaluate a portfolio on this basis is to look at risk-adjusted returns, which is what the Sharpe ratio accomplishes. How much alpha is a portfolio generating per unit of volatility? The higher the number, the better the result on this front.

We wanted to demonstrate how adding Treasuries to the asset mix can improve the risk-adjusted return, thus showing how bonds can be a ballast in the portfolio. To do so, we looked at annualized excess returns (over and above the risk-free rate, which we defined as short-term Treasuries) from the past five, 10, 20 and 30 years of a simple mix of: 100 per cent stocks; 90 per cent stocks/10 per cent Treasuries; 80 per cent stocks/20 per cent Treasuries; along with 70/30, 60/40 and 50/50 mixes – and divided each by their respective volatilities over the same time frame to arrive at the Sharpe ratio. Take a look at the accompanying table for the results.

Portfolio (Equity/Treasuries)Excess Returns
(annualized)
5 Yr.
Excess Returns
(annualized)
10 Yr.
Excess Returns
(annualized)
20 Yr.
Excess Returns
(annualized)
30 Yr.
Sharpe Ratio
5 Yr.
Sharpe Ratio
10 Yr.
Sharpe Ratio
20 Yr.
Sharpe Ratio
30 Yr.
100% / 0%16.2%14.7%7.3%7.9%1.081.080.490.55
90% / 10%14.8%13.5%7.0%7.5%1.111.120.530.58
80% / 20%13.3%12.3%6.6%7.1%1.131.160.570.62
70% / 30%11.8%11.0%6.2%6.6%1.171.210.620.66
60% / 40%10.3%9.8%5.8%6.1%1.201.280.690.71
50% / 50%8.8%8.5%5.3%5.6%1.251.360.770.78

Source: Bloomberg, Rosenberg Research

Note: Risk-free rate calculated using S&P U.S. Treasury bill 3-6 month total return index; equity returns derived using the S&P 500 total return index; bond returns measured using Bloomberg Barclays U.S. Treasury total return index

As shown, once Treasuries are added in meaningful size (40 per cent plus), the Sharpe ratios begin to increase dramatically across all the time frames we looked at (as in, the return per unit of risk goes up with this incremental bond exposure).

For example, over the past five years an all-stock portfolio had a Sharpe ratio of 1.08 – while not a bad reading in isolation, a traditional 60/40 portfolio over the same time frame had a higher Sharpe of 1.2 and a 50/50 mix was an even greater 1.25. Bonds as a ballast is a good thing.

It is the same pattern even when we look further back. An all-stock portfolio over the past 30 years would score worse on a risk-adjusted basis, with a Sharpe ratio of 0.55, compared with the 0.71 reading of a 60/40 portfolio and a 0.78 of one split evenly between equities and Treasuries.

While a portfolio heavily weighted toward stocks will obviously have a better return, it actually performs worse in its Sharpe ratio compared with when more Treasuries are added to the mix.

This is the basic trade-off investors need to make – balancing risk versus reward depending on their personal financial situation and investment horizon. But a simple analysis such as this demonstrates that, despite the popular narrative, bonds are not dead and do have an appropriate place in the portfolio from a risk perspective.

David Rosenberg is founder of Rosenberg Research, and author of the daily economic report, Breakfast with Dave. Marius Jongstra is an economist and strategist with the firm.

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