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Sunday, November 9, 2014

What is "Flight-to-Quality" ?

Source: Capital Pixel
Last week I wrote a post on the important role of bonds in a portfolio when the market gets scared--as in a 15% or greater sell-off.  The post showed that the four times the S&P 500 had negative returns over the past 20 years the Barclay's Bond Index produced positive returns.  When the S&P 500 returned -37% in 2008, the bond index returned greater than 5%.

Thus, bonds are a hedge or a type of insurance in the event of a significant sell-off in stocks.  This shift of assets into bonds is "flight-to-quality" and typically is concentrated in Treasury notes and bonds.  Again, it takes place when the market is scared.

A good way to put on this hedge is simply to use AGG or a similar Barclay's Aggregate Index exchange traded fund for the fixed income portion of assets.  Note three metrics:  .08% expense ratio, 5.3 duration, and 31.29% Treasury issues.  The duration of 5.3 tells you that, if yields rise 1% from 2.3% to 3.3% over the next 12 months, then AGG will fall in price by approximately 5.3%.  Add in 1.8% approximately from interest payments and total return would approximate -3.5%.  There's no free lunch here!

Those looking for a really good "flight-to-quality" hedge might consider TLO - the long Treasury etf. Note that it has a duration of 16.6 years so is a lot more volatile than AGG.  Also note that it was up over 23% in 2008!

Disclaimer:  This post is for educational purposes.  Investors need to do their own research or consult a professional before making investment decisions.  Exchange traded funds mentioned are held by me and by my clients.

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