Factor Investing in Fixed Income (EP.138)

Episode Summary

Executive Summary: The episode blends podcast/community updates with two major educational segments: why term and credit risks in fixed income may be time-varying and potentially forecastable, and how PWL is improving financial-planning assumptions by modeling time-varying expected returns rather than static historical averages. It also covers Bitcoin hype, bad crypto advice, and listener Q&A.

Main Topics: Podcast and community updates: Hosts share merch fixes, listener reviews, Goodreads/Peloton engagement, and announce a poll about offering CE credits for podcast quizzes to Canadian licensed professionals. Book recommendation: wealth and family dynamics: Discussion of Jennifer Risher's memoir 'We Need to Talk' about sudden wealth, social pressure, and the emotional/relational complications of extreme affluence. Bitcoin ETFs and crypto commentary: Covers Canada’s launch of the first North American Bitcoin ETFs, inflows, Bitcoin’s surge, energy use, and the hosts’ skepticism about Bitcoin maximalism and retirement advice built on recent returns. Fixed income factor investing: term premium: Explains why bond term risk can have a time-varying expected return premium tied to the yield curve, with forward rates and historical research suggesting the yield curve shape forecasts term premia. Fixed income factor investing: credit premium: Argues credit spreads largely reflect changing credit risk premiums rather than default rates, and that variable credit exposure can improve returns when spreads are wide. Financial planning with time-varying expected returns: Describes PWL's evolving return model that uses valuation-based expected returns and drift over time to better reflect mean reversion, sequence risk, and long-horizon retirement outcomes. Talking Sense and bad advice of the week: Includes lighthearted job and lifestyle questions plus a critique of an article urging retirees to 'incorporate Bitcoin' because of its recent performance, which the hosts call irresponsible.

Key Arguments: Fixed income contains real risk premia beyond just low yields: term and credit are distinct return sources, and their compensation varies over time. Because bond cash flows are more predictable than stock cash flows, yield curves and credit spreads can be more informative about future expected returns than equity valuation signals are in the short run. Fama and later studies show forward rates and the yield curve contain information about expected term premia, so a flatter curve generally implies less compensation for term risk. Credit spreads are not primarily driven by changes in default rates; most variation appears to come from changing credit risk premia, supporting tactical credit exposure. A cap-weighted bond index can mechanically increase exposure to less-compensated credit or duration when spreads narrow or the curve flattens, potentially lowering expected returns. Financial planning should not assume a fixed 10% equity return; expected returns are time-varying, and valuation-based models better capture sequence-of-returns risk and long-horizon planning. Monte Carlo models that ignore serial correlation can be misleading; allowing expected returns to drift with valuations may improve realism and retirement planning outputs. Bitcoin’s rapid rise and cult-like advocacy should not be confused with sound retirement planning; recent stellar returns are not a sufficient reason to take concentrated crypto risk. The advice to boost retirement savings by moving heavily into crypto three to five years before retirement is presented as especially reckless. The hosts argue that reasonable bond allocations can still make sense even with low nominal yields, especially if investors can harvest term and credit premia more intelligently.

Data Points: Podcast episode: 138 - Episode number mentioned at the start of the show Community size: ~2,200 members - Rational Reminder community membership mentioned during updates Peloton group size: 30+ members - Rational Reminder hashtag group on Peloton Goodreads connections: 20+ people - New followers linking up with Ben on Goodreads over two weeks Bitcoin ETF day-one inflows: $165 million - Purpose Bitcoin ETF reported first-day assets raised Bitcoin ETF day-two assets: $200+ million - Reported second-day assets for the Bitcoin ETF launch Bitcoin price milestone: $50,000 per coin - Referenced as a recent market milestone during the discussion Bitcoin market cap: Over $1 trillion - Mentioned as Bitcoin’s total market capitalization Energy usage ranking: Between Norway and Argentina - Cambridge study cited to compare Bitcoin mining energy use as if it were a country Five-year Bitcoin returns in bad-advice article: 121% annually - Return figure used in the article recommending crypto for retirement savings Bitcoin drawdown in article context: 70% drop - The article noted Bitcoin fell sharply from 2018 to 2019 Term premium simulation excess return: 12 basis points - Dimensional variable maturity strategy versus static benchmark Credit premium simulation excess return: 17 basis points - Dimensional variable credit strategy versus static benchmark Combined term+credit simulation excess return: 30 basis points - Variable maturity plus variable credit strategy over 1974-2015 Combined strategy standard deviation: Lower than benchmark - Reported result from Dimensional’s simulated bond strategy Credit-spread explanation of default rates: Little explanatory power - 2010 paper finding spreads do not track default rates well Variation in U.S. investment-grade credit spreads: Over 90% explained by expected credit premia - 2014 variance decomposition study cited in the episode Portfolio planning bond expected return: 0.57% real - PWL assumption for bond expected returns used in financial planning

Pivotal Quotes: "We wanted to do the popular demand, get an update on your battle bots." — Cameron Passmore: Opening banter and community update at the start of the episode "The most important assumption that you make in financial decisions is expected returns." — Benjamin Felix: Intro to the financial planning segment on why return assumptions matter "If you couldn't have your first choice job, what other types of jobs would you consider?" — Cameron Passmore: A lighter 'Talking Sense' question near the end of the episode

Implications: Listeners should treat bond allocation and retirement planning as dynamic problems, not static averages. Time-varying term/credit premia and valuation-based equity expectations may justify more nuanced portfolio construction and more realistic withdrawal assumptions.