Trading Thoughts - Two Bonds are Better Than One - FGMNX and FNMIX

I showed in previous posts how FGMNX is a bond fund that gives your portfolio domestic exposure with monthly dividends, linear returns, and very minimal risk during market drawdowns.  FNMIX gives you the power of increased returns of foreign (emerging market) exposure with less volatility than a stock equivalent, while also providing consistent monthly dividends.  Combining the performance of both of these funds could be a simple strategy to include bond exposure in your investment portfolio to provide some diversification while maintaining reasonable returns versus risk.

For this analysis I am assuming that you will allocate a certain percentage of your portfolio to bonds, for example 20%.  With that assumption, you would allocate 10% of your portfolio/contributions to FGMNX and 10% to FNMIX to compose the 20% exposure in your account.  Obviously, each person's asset allocation will very with age and risk tolerance.  The point of this analysis is to compare the performance of the combined average strategy to the individual performances previously reported as well as to the overall performance of a buy-and-hold strategy on the S&P500.

Let's take a peek at the numbers and the past performance of combining the returns of FGMNX and FNMIX (I will call it the AVG strat).   The AVG strat has an average annual return of 6.95% over the past 18 years.  It pays a monthly dividend and the max drawdown over the past 18 years was -23%.    The equity curve is fairly linear with a few sizable drawdowns during overall market retracements.  Below is a chart of the equity curve for AVG strat compared to the equity curve of SPY, a surrogate for the performance of the S&P500.  The AVG strat performs well compared to the performance of SPY which had an average annual return of 6.04% with a max drawdown of -55%.  Both curves are dividend adjusted.

Like its individual components, the AVG strat has done a good job of providing consistent returns comparable with the market, yet with less risk as indicated by the smaller drawdowns.  There have certainly been times during bull markets when the SPY has outperformed the AVG strat by a considerable margin (internet bubble, real estate bubble, financial crisis rebound).  Where the AVG strat really shines is during bear markets where it has often produced good returns compared to SPY.  This is typical of bond performance.  Below is a chart of the equity curve drawdowns for the AVG strat and SPY that highlight the improved risk performance of the combined bond strategy.

Let's see what you can expect from the fund's historical performance.  The one year rolling returns have averaged a return of 9.7%.  What this tells me is that had I chose to invest in the AVG strat anytime in the past 18 years and held it for one year, I would have averaged about 9.7% returns on that one year investment.  Also, 89% of the 4250 rolling one year returns were above 0%, so the odds are good that you will make money on your investment over the course of one year.  Below is a chart that shows the one year rolling returns for AVG strat (green) with the average of all the rolling one year returns shown in blue.

The rolling one year max drawdowns shows that there have been three substantial (around -20%) drawdowns.  The average rolling max drawdown was -2.1%.  This tells me I can expect a drawdown of at least -2.1% when I hold this investment for an entire year.  Also, 90% of the rolling one year max drawdowns were -5.1% or better, which is much better than the SPY (90% are -22.1% or better).  Below is a chart that shows the one year rolling max drawdowns for AVG strat (red) with the average of all these drawdowns in blue.

It is always important to remember that things can change in the future.  Regardless, this average bond strategy has done an exceptional job of providing consistent returns through some rough times.  The SPY has had a total return of about 288% over the past 18 years because it has been range-bound for most of that time.  If you were an exceptional market timer, you could have made much more during this period.  For a simpler approach, the average bond strategy has a total return of 337% over the past 18 years with smaller comparative drawdowns (-23% AVG strat compared to -55% SPY).  You would have made almost 7% a year using the buy-and-hold average bond strategy, which is a very good return considering bonds are supposed to be a conservative investment.