The Rational Reminder Podcast Dave Plecha: The Long and Short of Investing in Bonds (EP.163)
Role Of Bonds Remains Risk Control
- Bonds still serve primarily as risk control and liability matching, not just return engines.
- Low risk-free rates lower expected returns across assets, but premiums (term, credit) remain meaningful.
Prioritize Real Rates And Hedge Currency
- Focus on real rates, not nominal rates, when saving for future consumption.
- Hedge currency when buying foreign bonds to equalize short-term rate differences.
Inflation Risk Tied To Duration
- Nominal bondholders bear unexpected inflation risk and demand a premium for it.
- Shorter duration reduces inflation exposure because bonds mature sooner and can be reinvested at new rates.
Even among rational investors with diversified portfolios, there seems to be less known about the inner workings of the bond portion of their investments. Here on the show today to help us get a better understanding of fixed income investments is none other than Dave Plecha, Global Head of Fixed Income at Dimensional Fund Advisors. Dave is one of the authorities on the subject of bonds and is amazing at articulating the concepts at play in this arena. This conversation goes in-depth, but is also a great starting point for investors to begin thinking about this part of a portfolio, and deepen an understanding of something that is so often misunderstood or misused. As you will hear, Dave has a real passion for this subject and has been presenting and speaking on precisely this work for the last twenty years. We cover a lot of ground with Dave, talking about why his approach might be confused with a certain type of market timing, the impacts of inflation, the current low interest rates and if these affect bond investments, an explanation of forward rates, and so much more that you will not want to miss. We even find time for a quick story about Dave's early days working with Eugene Fama, so make sure to stay tuned in for that.
Key Points From This Episode:
- Assessing the role of bonds in a portfolio, in relation to the current low interest rates. [0:02:30.3]
- Concerns over negative interest rates for bond investors. [0:05:30.1]
- Bonds and real returns; the impact of inflation on Canada's market. [0:09:30.7]
- Dave's perspective on the argument for long bonds as diversifying assets. [0:15:39.4]
- Comparing and contrasting the bond market with the stock market. [0:17:55.7]
- The trading of bonds and what differentiates it from trading stocks. [0:22:29.5]
- The volatility of last March and Dave's reflections on trading during that period. [0:27:17.8]
- Differentiating Dimensional's approach to bonds from the other big firms'. [0:29:21.7]
- The primary factors that influence expected returns in fixed income. [0:31:40.4]
- Understanding forward rates and the information they provide about expected returns. [0:37:26.7]
- Building better investing strategies using forwards rates. [0:40:43.5]
- Clarifying expected premiums for maturity in a variable maturity strategy. [0:44:06.7]
- Dave explains why market timing does not work with regard to fixed income. [0:46:30.4]
- Quantifying the differences in expected returns from the index and Dimensional. [0:51:01.7]
- A great argument from Dave for maintaining a diversified approach to all investments. [0:52:31.51]
- The connection between present observable credit spreads and future realized payments. [0:55:48.5]
- The game-changing development of Trace in the bond market. [0:59:40.2]
- Applying the Dimensional approach as a do-it-yourself investor. [1:05:57.7]
- A great story from Dave about his early days working with Eugene Fama. [1:10:25.2]
- How Dave defines success in his life and work these days. [1:11:30.1]