The Golden Age In Duration

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During his recent interview with Tobias, Dylan Grice, co-founder of Calderwood Capital Research, and author of the Popular Delusion Reports, discussed the golden age of duration. Here’s an excerpt from the interview:

Tobias Carlisle:
Last question and then I’ll let you go, but it’s sort of a bigger one. It was actually one of my first questions but it’s taken us this long to get there. You talked about a golden age in duration, a bull market in duration and you think that it might be coming to an end and then you’ve got some predictions for that. So what was the golden age in duration and what are the implications if that goes away?

Dylan Grice:
So we have a very inclusion economy in the 1970s and that was global phenomenon, that was a widespread phenomenon, and what happened as we know is the ’80s, ’90s… and overlapping years, the inflation continues to surprise on the downside. Continues to surprise on the downside. What that is, is it ultimately drove bonds to much higher levels… prices to much higher… Obviously, the longer the duration and the government bond the better the return. One of the kind of interesting things to me that I’ve discovered that I wasn’t fully aware of, and during this period if you go back and you use… data for returns, and this isn’t… You would need to be able to work to make sure that this is actually the right message onwards… would have the data. But if you go to the… premium, if you like, so the excess return of equity is over bond. It’s something from the 1870s to the present day, it’s something like 4.3 or something, 4.4%. That’s when your excess return for holding equity’s over bond. Right?

Tobias Carlisle:
Right.

Dylan Grice:
Since the 1980s that risk premium has actually been about 3.6. So the equity premium has actually been quite low during this period. The excess return of equity has actually been quite modest during this period. The real action has been in the bond market. The return to bonds have just been absolutely… and of course that carries everything with it. Right? Because equity is a duration asset. Right?

Tobias Carlisle:
Right.

Dylan Grice:
… infinite duration, but then there’s duration assets. The bond yields go up, your MTV comes down. So when bonds go up, then capitulations will fall.  So this kind of MTV uplift that you got into equity from bonds was certainly, certainly very… but the real bull market in equity since the ’80s to my mind was actually a bull market in bonds and they are bull market in duration, and what you’ve seen over the last 40 years, ’80s, ’90s, north east and 10s, you’ve seen this bull market in all duration assets. Whether it’s public equities, whether it’s private equities, venture equity, government bonds, corporate bonds, all of these things have just been… You’ve just been in a phenomenal, phenomenal period of returns then these assets classes and it’s all driven by government bonds. You don’t need to predict a massive inflation problem to see that the likelihood that… It’s very difficult to see how that happens again. How do you get the same sale when bond yields go up from 20 to 2 over 40 years. How do you get that kind of structure or tailwind for duration assets? The honest answer is that you don’t.

Dylan Grice:
So when you don’t get any tailwind, best case scenario you get no tailwind. Worse cases scenario is that turns into a … because you use do see a tick up in inflation, you do see a tick up in bond yield, and everything goes into reverse. But the basic idea was that as pension funds run… allocate more to private equity, and to venture, I think is over. That game is over. That whole thing is over. So I think the whole duration bull market is over. Equity, bonds, corporate bonds, private equity. It’s just dead. There are not going to be any returns. For the next 40 years what’s going to work is things that didn’t really work so well in the last 40 years.

Tobias Carlisle:
What’s that commodities?

Dylan Grice:
That’s going to be our new fund.

Tobias Carlisle:
That’s great. I was going to see if I can pin you down for a prediction. I’ll get you back on in 10 years time and we can analyze that one.

Dylan Grice:
I do feel that… Again, I keep saying it. I…. You don’t have to be… It’s not all about… It’s not all about… It’s not all about equity risks. There are other risk premiums that you could take now. If you’ve got 40 billion and down, okay, then that’s a difficult one. That’s a very difficult problem to solve. I’m not sure that there’s that much that you can do, but if you can be small and nimble I just think there’s… This is why we sit on the business. It’s just incredible. It’s incredibly… to be an investor at the moment, I think.

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