Wow! I just realized this week that it has been four and half years since I first wrote about trend following for bonds. Time for an update I think. The inspiration and reminder that it had been a long time since I had written about TAA for Bonds was this great post by Corey at Newfound Research on tactical credit. I’ll briefly summarize Corey’s post and then compare the tactical credit strategy presented in his post with the updated results for the TAA Bond 3 strategy I wrote about. As a reminder you can find the TAA Bond 3 strategy on AllocateSmartly and in my Economic Pulse Newsletter. Lets jump right in.
In the post on Tactical credit, Corey shows that a simple TAA bond strategy has pretty good performance characteristics. Here’s my summary of his results. Read the whole post. It is well worth your time.
- We explore tactical credit strategies that switch between high yield bonds and core fixed income exposures.
- We find that short-term momentum signals generate statistically significant annualized excess returns.
- We find that a significant proportion of returns are generated as price returns occurring during periods when credit spreads are above their median value and are expanding.
- Excluding the 2000-2003 and 2008-2009 sub-periods reduces gross-of-cost strategy returns from 2.9% to 1.5%, bringing into question how effective post-of-cost implementation can be if we do not necessarily expect another crisis period to unfold.
So, basically, TAA for bonds, i.e tactical credit, works pretty well as long as we expect another crisis period in the future. And even without a crisis period assumption excess returns are positive but we really need to pay attention to costs.
The next thing I wanted to do was implement Corey’s tactical credit strategy for myself and compare it to TAA Bond 3 over the same period. For the tactical credit strategy, I use HYG and BND to represent the two bond asset classes, 3 month relative momentum to choose 1 of the two ETFs to invest in, and a one month holding period. As a reminder, the TAA Bond 3 strategy uses 9 bond ETFs, 6 month relative momentum to chose the top 3 ETF to invest in, and a one month holding period. The backtest period was 1999 through May 2019. Performance results for the two tactical credit strategies, along with the benchmark (BND), are shown below. All backtests were performed on Portfolio123.
As the table shows, both tactical strategies outperform the bond benchmark with TAA Bond 3 leading the way over this time period and with drawdowns similar to the benchmark. TAA bonds 3 due to the use of more ETFs and more holdings has a higher number of trades and turnover than Tactical Credit which is only using 2 bond ETFs. Now, let’s take a look at the latest bull market period, from the end of 2008 until now to see how the strategies have performed outside of the most recent time of crisis. Results from the end of 2008 until now are shown below.
In this period, a non crisis period, and an equity bull market, the tactical credit strategies also outperformed the bond benchmark. Even by more than the whole 1999 to June 2019 time period. This time tactical credit led the way by having a higher allocation to high yield bonds than TAA Bond 3. The allocations to higher yielding bonds works well in non crisis periods.
That’s about. Tactical credit or TAA for Bonds continues to work well against a bond benchmark. The approach works both in crisis and non-crisis periods.