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As you can see in the above table

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, despite the relatively paltry buy and hold returns offered by long-term fixed income securities around the globe, investors have been exceedingly well compensated over the past one, three and five years with returns many multiples above the annual coupon of the bo nds. Said differently, to a bond investor it has not felt like they were investing for 1-3% returns when they have achieved greater than 10% returns over the medium term. Ironically, the equity markets are wrestling with the concept that strong recent perform ance may be borrowing from future returns as multiples have increased, and yet nobody is talking about the fact that the 31% one year gain in the 30-year bond h as reduced the total profit potenti al for the remaining 29 years by 40% (the 30-year compound total return was 146% one year ago and the 29 year forward compound tot al return is now 88%). That’s paying it forward. Let’s consider what it would take to perpetuate double digit returns in the 30-year bond from here. In order to earn 10% in the subsequent 12 months from a 2.2% starting point, investors would need to make 7.8% from capital appreciation on top of the yield. With an approximate duration of 20 years in the 30-year bon d, this implies 39bps of tightening would be necessary, placing the 30-year at approximately 1.8%. Extending this track record three years forward would imply a landing spot for the 30-year at 1% and, in the middle of 2020, the yield would be 0%, with 24 years remaining on the bond. As an absolute return manager, it’s hard for us to get excited a bout making absolutely nothing for 24 years. That is Flatland, a line across the page . While in the last 30 days U.S. Treasuries have backed up to 2.75%, essentially flat on the year after a 12% 32-day gain and an approximate (12%) 30-day decline, this phenomenon is even more pronounced in Germany, where 30- year government bonds yield 0.76% (t he 10-year is 26bps). A buy and hold investor will make 25.5%, total, cumulatively, chain-weighted, over a 30 year period, and if they make 10% a year for two years, they will make 0% for the remaining 28 years. Of course, we could have made these arguments one, three, and five years ago, and on average bond bulls have been right to the tune of 10% per a nnum. We have maintained a short position in governm ent bonds for the past seve ral years as a hedge against equity multiple compression, and while the bond hedge has been cheaper than an equity hedge, it has been premature and therefore wrong. However, what we do know for certain is that at maturity, holders will only get their money back, and the extraordinary returns enjoyed by bond investors will absolutely end with certainty over the coming decade/decades.

The Fixed Income Trader Did It!

Because of the dynamics we described above, we logically conclude that holders of sovereign fixed income around the world fall into one of three camps: a)

Central Banks, who will get a “return” on their investment in other ways by promoting economic growth and investment; b)

Forced holders, who by charter, regulation or simply inertia hold these securities because they don’t have an absolute return mandate but rather have forced conditions upon them (dedicated sovereign debt products, financial institutions with inflexible, i nertial or backward looking investment policies or those with regulatory constraints that incent holding sovereign debt due to the perception of safety); and c)

Fixed income traders, who simply believe that yields are going lower before higher, and that they will be in and out before long-term rates rise and bond prices fall. Alternatively, these traders could be momentum traders who will use price action to deter mine when the run is over. In either case, they are s hort-term players in a long-term instrument. We left out the fourth category – an absolute return manager who seeks 76bps of annual income in Germany or 2.2% annual income in the U.S. Perhaps our ambitions are greater than the average investor, but we know of no pension fund, health care trust or college savings account that can defease its liabilities and satisfy its obligations making 1-2% per annum in perpetuity.

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