Here are the best things I read this week, their main takeaways, and the most important chart from each piece:
Why Investors Keep Coming Back to Argentina by Colby Smith
- According to a recent paper, the government bonds of serial defaulters have delivered higher returns than safer countries. The researchers examined 220,000 individual foreign-currency bonds from 91 countries since the Battle of Waterloo in 1815.
- The return advantage of serial defaulters like Argentina, Brazil, and Greece over U.S. Treasuries and U.K. Gilts has been consistent since the mid-1800s.
- It takes around 5 years for investors to recover their money after a default.
- The researchers found that most prolonged defaults occurred prior to World War 2. Only Argentina in 2001 and Ecuador in 2008 produced comparable losses for bond investors.
Are ETFs Really Crushing Mutual Funds? by Ryan Kirlin
- Mutual funds have experienced outflows in three of the last five years, but overall their asset base isn’t rapidly shrinking. 2018’s total mutual fund outflows of $102 billion were small relative to their $13.6 trillion total.
- Until last year, rising asset prices helped mutual funds recover from steady outflows. Mutual fund AUM went from $14.7 trillion to $13.6 trillion in 2018, while ETF AUM dropped much less on a relative basis from $3.41 to $3.38 trillion.
Buyer Beware: The Reality of Tax-Loss Harvesting Benefits by Maneesh Shanbhag
- The benefits of tax loss harvesting are frequently touted to be >2% per year. This doesn’t pan out in the data.
- The value of tax deferral grows as returns increase. With high stock valuations and low bond yields, the potential benefit of tax loss harvesting over the next decade is likely lower than usual.
- Investors would regret tax loss harvesting if tax rates increased in the future, since their deferred gains would be taxed at a higher rate.
- Tax loss harvesting involves four trades: selling the losing position, buying a similar security, selling the similar security, then re-buying the original position. Transaction costs can add up.
- Buying and holding for more than one year is the simplest way to increase tax efficiency since it doesn’t incur capital gains or trading costs. Maneesh Shanbhag calculates the best-case benefit of tax loss harvesting to be 0.28% per year, before costs.
- The author picked the optimal month to harvest losses in the S&P 500 for each decade since 1928. The only two decades where tax loss harvesting delivered meaningful return improvements were 1928-1937 and 2008-2017. No big losses to harvest = no big benefit from tax loss harvesting.
- There’s a strong relationship between emerging market assets and the U.S. dollar. One reason why EM stocks struggle in the face of U.S. dollar strength is because EM countries tend to have a lot of U.S. dollar denominated debt. They borrow in USD because they can borrow more money and at cheaper rates.
- This isn’t a free lunch – it causes EM economies to be pro-cyclical. Economic booms in emerging markets typically cause the currency to strengthen and inflation to fall, which allows the central bank to lower rates. Principal payments on foreign currency debt shrink as the local currency appreciates. The government budget balance also tends to improve, often moving to a surplus and bringing the current account with it. Strength begets strength.
- EM economic busts typically see weakness in growth causing the currency to fall, which causes inflation to rise. The central bank tightens policy despite a slowdown. The government surplus turns to a deficit, and the need for imported capital turns the current account deficit negative. Rising short-term rates and falling currencies cause foreign currency denominated debt payments to increase. Weakness begets weakness.
The Errors That I Don’t See by Nick Maggiulli
- Small document errors don’t seem like a big deal. But the small errors make someone realize there are likely bigger errors that can’t be seen.
- Always check your work.