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Bonds
7upfree
Posted: 06 April 2018 14:42:51(UTC)
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My current pension is invested 100% equities. I am probably 20 years from retirement, all being well. My overall financial position (i.e. all assets) is probably something closer to 50% equity\50% cash. I stayed fully invested in 2008 and therefore think I have a fair appetite for risk.

I like the overall analysis of a 60/40 split in my pension. This is how it currently rests. It seems to reflect a conventional wisdom from Markowitz to Bogle and the like. However, I cannot think of any good reason to invest in bonds in the present climate. NS&I will give me 1.95% fixed, risk free with the option to withdraw on a 90 day penalty for interest. This is a rate of return which exceeds the UK 10 year gilt. It seems to me that buying bonds in the present climate is the equivalent of buying the Nikkei in 1989. That said, having looked at the Vanguard japanese bond market fund for the past 10 years, it has generated a return of just under 5% annually. Japanese 10 year government debt was returning just under 2% in 2008. I have no doubt at that stage I would have drawn the same conclusion as I do today (surely it can't go any lower) and missed on 5% compound returns from this safe asset class.

While I have "no edge", I am also mindful of the fact that investing at the extremes of valuation (particularly for lump sums) is very dangerous. UK 10 year debt is currently yielding 1.4%. So there is still some potential for movement downwards. Global bond funds (i.e. government and corporate debt) are offering not dissimilar returns.

How are other people dealing with bond investments in their asset mix? I don't really see anything other than NS&I as being a good proxy for bonds. The only risk of this is sterling devaluation, but the chances are I would look for a hedged bond fund in any event. My inclination is to be patient and leave it in NS&I.

6 users thanked 7upfree for this post.
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King Lodos
Posted: 06 April 2018 15:08:24(UTC)
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This is (next to the growth vs value question) the biggest unknown.

So as you say, it's basically a directional bet – if Japan winds up being the model for where we are in 20 years time (more QE, lower for much longer, etc) then bonds could have further to run .. I *think* we've decided negative rates don't really work – but what if we did find ourselves with negatively yielding bonds?

So I suppose you've got to say: what's holding bonds a bet on? More stimulus and lower rates .. In which case stock valuations probably go up to PE 100, and bonds don't really hedge anything – you'll catch all the upside with stocks.

But as a value investor? The last times bonds were this expensive was 1946, and they spent the next several decades returning nothing (real) .. Stocks offer better value: hold stocks.

I think where bonds may have some value (and Buffett holds most of his as short-dated bills) is in financial stress .. They were a very in-demand haven when banks looked risky .. If we could get the US yield (touching 2.8% on a 10yr) I'd certainly put a third of my portfolio in that – as an individual bond, not a fund .. The problem is the cost of hedging nulls most of that – it's really only US investors who have that option at the moment, as otherwise it's more of a currency bet, and dollar-pound doesn't look like a very safe bet
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7upfree
Posted: 06 April 2018 16:12:13(UTC)
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Thanks as ever. Like you I cannot see a situation where there is a meaningful sell of in equities without the same happening to bonds. Can you imagine the FTSE halving and yielding 8% with 10 year debt at 0.8%! Me neither. However, on the basis that bonds are supposed to stabalise rather than yield a huge return, 2% on NS&I will do for me.
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Mr Helpful
Posted: 06 April 2018 17:58:08(UTC)
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7upfree;60246 wrote:
My current pension is invested 100% equities. My overall financial position (i.e. all assets) is probably something closer to 50% equity\50% cash.
I like the overall analysis of a 60/40 split in my pension.
However, I cannot think of any good reason to invest in bonds in the present climate.
How are other people dealing with bond investments in their asset mix?

How are other people dealing with bond investments in their asset mix?
With great difficulty and frustration. The Bonds we do hold are all short-duration in line with the thinking of Tim Hale and Frank Armstrong. But to boost the yield and diversify, also hold other Asset Classes such as Commercial Property, Renewables, Infrastructure, and specialist Bond Funds alongside those ST-Bonds on the 'defensive' side.
Plus a healthy dollop of Cash.
Hopefully some Asset Classes will zag as others zig (MPT again?).

I like the overall analysis of a 60/40 split in my pension
This seems a contradiction if Bonds are so unloved?

The 60/40 or similar portfolios beloved by so many in the passive brigade; may have emerged and gained popularity during the Bond Bull Market of the last 36 years or so.
http://www.multpl.com/10-year-treasury-rate
The investor could not go wrong holding intermediate or even long-duration bonds.
If however we were to wind the clock back to say the 1970s, what would then be the consensus on a balanced portfolio?
Especially with inflation raging (not that serious inflation seems to be on the agenda presently).

Just thoughts; no easy answers.
5 users thanked Mr Helpful for this post.
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King Lodos
Posted: 06 April 2018 18:17:11(UTC)
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Then there's the possible value of inflation-linked bonds ..

But then, longer duration has the opposing force of duration risk, when rates rise with inflation (which I suppose is why Ruffer spend quite a bit hedging that with Options), and shorter duration yields close to 0.

I've had a tiny bit in Royal London Short Duration Inflation-Linked, but I think whatever small return it eeks at the moment gets nulled by currency hedging, fund and platform costs.


So the picture I get is that the market's really squeezed returns out of anything low risk, to about 0% real (before costs).

I think it's potentially a very different world from the world of 60:40 .. But then again, if I were in the US, having 40% in a ladder of bonds yielding 2.8% wouldn't be a bad option
Keith Cobby
Posted: 06 April 2018 18:34:50(UTC)
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It all depends on your investment objectives. Bonds are OK for a little jam today whereas with equities I am looking for a little jam today and a lot of jam tomorrow!
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7upfree on 06/04/2018(UTC), Guest on 07/04/2018(UTC)
7upfree
Posted: 06 April 2018 18:54:44(UTC)
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Mr Helpful;60263 wrote:
7upfree;60246 wrote:
My current pension is invested 100% equities. My overall financial position (i.e. all assets) is probably something closer to 50% equity\50% cash.
I like the overall analysis of a 60/40 split in my pension.
However, I cannot think of any good reason to invest in bonds in the present climate.
How are other people dealing with bond investments in their asset mix?

How are other people dealing with bond investments in their asset mix?
With great difficulty and frustration. The Bonds we do hold are all short-duration in line with the thinking of Tim Hale and Frank Armstrong. But to boost the yield and diversify, also hold other Asset Classes such as Commercial Property, Renewables, Infrastructure, and specialist Bond Funds alongside those ST-Bonds on the 'defensive' side.
Plus a healthy dollop of Cash.
Hopefully some Asset Classes will zag as others zig (MPT again?).

I like the overall analysis of a 60/40 split in my pension
This seems a contradiction if Bonds are so unloved?

The 60/40 or similar portfolios beloved by so many in the passive brigade; may have emerged and gained popularity during the Bond Bull Market of the last 36 years or so.
http://www.multpl.com/10-year-treasury-rate
The investor could not go wrong holding intermediate or even long-duration bonds.
If however we were to wind the clock back to say the 1970s, what would then be the consensus on a balanced portfolio?
Especially with inflation raging (not that serious inflation seems to be on the agenda presently).

Just thoughts; no easy answers.


Many thanks - your comments are helpful and interesting.The rationale for loving 60% equity (or indeed any different proportion of equity holding) is also formed with reference to the past. So not really any different from bonds. I always like the way Harry Markowitz explained his preference for a 50/50 portfolio! I think you are correct to look at different asset allocations, but most of them zig and zag in the same direction at the same time. I have dabbled with active asset allocation using passive funds (e.g. Blackrock Consensus) and wonder if that might be a way forward.
7upfree
Posted: 06 April 2018 18:58:11(UTC)
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King Lodos;60266 wrote:
Then there's the possible value of inflation-linked bonds ..

But then, longer duration has the opposing force of duration risk, when rates rise with inflation (which I suppose is why Ruffer spend quite a bit hedging that with Options), and shorter duration yields close to 0.

I've had a tiny bit in Royal London Short Duration Inflation-Linked, but I think whatever small return it eeks at the moment gets nulled by currency hedging, fund and platform costs.


So the picture I get is that the market's really squeezed returns out of anything low risk, to about 0% real (before costs).

I think it's potentially a very different world from the world of 60:40 .. But then again, if I were in the US, having 40% in a ladder of bonds yielding 2.8% wouldn't be a bad option


The value of index linked gilts is astonishing. They are largely being offered over very long periods of time with a tiny coupon. I really couldn't stomach buying them. I did wonder about high quality, short dated corporate debt but very few funds exist in this sector. Indeed, if you are prepared to take a 3% coupon based on the quality, why not just buy the stock!
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King Lodos on 06/04/2018(UTC)
Tony Peterson
Posted: 06 April 2018 19:05:44(UTC)
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Anything less than 100% equity and I would have only a fraction of the fun.

And I see the FTSE 100 beat every other index in the world last month. Cool.
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Keith Cobby on 07/04/2018(UTC)
7upfree
Posted: 07 April 2018 13:34:14(UTC)
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I had a quick look at a few Vanguard Funds last night re bond prices.
The UK Investment Grade Bond Fund has a coupon of 4.4%, a YTM of 2.8% and an average maturity of c.12 years. This implies a current price of 116.21 (100 being par). If interest rates doubled, this would imply a fall to 89.62, but you would have a YTM of 5.6% to compensate. However, the capital loss of 22% is pretty steep. Equally, if interest rates halved, the price would rise to 133.03 – a more modest capital appreciation of 14% with a lower yield of 1.4% to maturity. Having done the sums, I might be able to live with this. There’s a fair chunk of BBB rated investments, however.

Taking the UK Government Bond Index Fund, the numbers pan out as follows. The coupon is 3%, YTM 1.5%, and average maturity is c. 17 years. This gives an implied price of 122.43. Doubling interest rates will take the price back to 100 which would be a painful hit on gilts. Halving interest rates would bring a fairly modest rise to 135.85.

I picked UK funds because of the currency risk.

However, by comparison, the Vanguard Global Bond Fund (Active) has a coupon of 3.8% and a YTM of 3.1%. Average maturity is 9 years. Current price is 105.47. 100% increase in rates leaves you with a fall at 83.63 but a yield of 6.2%. Painful but reasonably compensated. 100% fall would give you an increase of 118.83 but a yield of 1.55%.

Maybe my bond fears are a little overplayed. Of course, a doubling of rates is hardly the worst outcome that could occur and the assumption is that inflation is rising but not out of control. Of course, if you have stable finances and a stable currency, there is little to fear….
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Alan Selwood
Posted: 07 April 2018 22:48:10(UTC)
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Tony Peterson;60272 wrote:
Anything less than 100% equity and I would have only a fraction of the fun.

And I see the FTSE 100 beat every other index in the world last month. Cool.


That's rare!

The 250 has a better track record for most years in the last 10 or so.
Alan Selwood
Posted: 07 April 2018 22:49:57(UTC)
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I'll stick with my I-L NSCS for now!

No gilts or corporate bonds attract me at present prices at this point in the cycle.
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Mike L on 08/04/2018(UTC), George Muir on 09/04/2018(UTC)
xcity
Posted: 07 April 2018 22:59:16(UTC)
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7upfree;60298 wrote:
The UK Investment Grade Bond Fund has a coupon of 4.4%, a YTM of 2.8% and an average maturity of c.12 years.
If interest rates doubled, ... you would have a YTM of 5.6% to compensate.

the Vanguard Global Bond Fund (Active) has a coupon of 3.8% and a YTM of 3.1%. 100% increase in rates leaves you with a fall at 83.63 but a yield of 6.2%. Painful but reasonably compensated.

The problem is that you wouldn't have 5.6% or 6.2% to compensate if you bought at current prices. What you would have is much higher interest rates on any cash you'd kept if you hadn't bought.
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7upfree on 08/04/2018(UTC)
King Lodos
Posted: 07 April 2018 23:40:50(UTC)
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I think the problem with investment grade is there's no real diversification benefit vs stocks: people won't run to corporate bonds when the next recession looms.

So then it's a simple matter of value .. and with yields of 2.8%, that's a PE ratio of 36 (for something with zero growth).

Then there's the added risk of things like ECB bond buying .. A lot of very weak businesses have been kept afloat by stimulus – so when that's withdrawn, there's presumably the risk of higher than normal defaults .. Pennies in front of a stream-roller, perhaps.
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sandid3
Posted: 08 April 2018 07:16:54(UTC)
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Surely the point at the moment is not so much bonds for the long run as bonds for the next six months. If investors think this is just a normal correction and the stock market will make a new all time high before the end of the year then it's a matter of what to do in the meantime. If the market goes down further before it comes back up again, will a bond fund give a positive return as opposed to zero return from cash?

These are the best UT/Oeic bond funds I could find in the High Yield, Corporate and Strategic sectors (versus Fundsmith for the last six months):



There still seems to be a positive correlation with equities as opposed to a negative one, which would have been useful.
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Slacker on 09/04/2018(UTC)
7upfree
Posted: 08 April 2018 10:22:13(UTC)
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xcity;60322 wrote:
7upfree;60298 wrote:
The UK Investment Grade Bond Fund has a coupon of 4.4%, a YTM of 2.8% and an average maturity of c.12 years.
If interest rates doubled, ... you would have a YTM of 5.6% to compensate.

the Vanguard Global Bond Fund (Active) has a coupon of 3.8% and a YTM of 3.1%. 100% increase in rates leaves you with a fall at 83.63 but a yield of 6.2%. Painful but reasonably compensated.

The problem is that you wouldn't have 5.6% or 6.2% to compensate if you bought at current prices. What you would have is much higher interest rates on any cash you'd kept if you hadn't bought.


Sorry - meant to say that you would be fairly compensated if you continued to buy. If it was a lump sum purchase, you are stuffed as you rightly observe. The other issue is the timing of the fall, I suppose.
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Tim D on 08/04/2018(UTC)
7upfree
Posted: 08 April 2018 10:27:00(UTC)
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King Lodos;60326 wrote:
I think the problem with investment grade is there's no real diversification benefit vs stocks: people won't run to corporate bonds when the next recession looms.

So then it's a simple matter of value .. and with yields of 2.8%, that's a PE ratio of 36 (for something with zero growth).

Then there's the added risk of things like ECB bond buying .. A lot of very weak businesses have been kept afloat by stimulus – so when that's withdrawn, there's presumably the risk of higher than normal defaults .. Pennies in front of a stream-roller, perhaps.


Agreed. My reservation is the quantity of BBB rated bonds in the portfolio. I have no doubt this in reality is a hop skip and a jump to junk in a deteriorating business environment. So a better bet might be a portfolio of AAA quality stocks.
Chris Dean
Posted: 08 April 2018 10:30:05(UTC)
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I've been reconsidering my bond allocation in a Personal Pension plan which I don't intend to access for at least 7-8 years, even then that should (hopefully) only be out of desire rather than necessity!

It is a low cost, passive, multi-asset fund 40% equity/60% bonds and the allocation can be changed within the plan at no cost. I don't fully understand bonds and my only other allocation to them is via Troy Trojan.

Bearing in mind the current negativity around bonds and the fact that I have sufficient income from an annuity & SIPP, ISA and approx 35% cash, perhaps I should be more adventurous with that pension fund and change to say, 80% equities/20% bonds?

Any thoughts would be appreciated.



King Lodos
Posted: 08 April 2018 23:23:36(UTC)
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7upfree;60345 wrote:
King Lodos;60326 wrote:
I think the problem with investment grade is there's no real diversification benefit vs stocks: people won't run to corporate bonds when the next recession looms.

So then it's a simple matter of value .. and with yields of 2.8%, that's a PE ratio of 36 (for something with zero growth).

Then there's the added risk of things like ECB bond buying .. A lot of very weak businesses have been kept afloat by stimulus – so when that's withdrawn, there's presumably the risk of higher than normal defaults .. Pennies in front of a stream-roller, perhaps.


Agreed. My reservation is the quantity of BBB rated bonds in the portfolio. I have no doubt this in reality is a hop skip and a jump to junk in a deteriorating business environment. So a better bet might be a portfolio of AAA quality stocks.


It's what I've been moving towards this year .. GAM Star Credit Opps has been a star bond fund for the past year or two, but I always said I'd cut holdings when funds like that started to wobble.

So I've been loading up more on Lindsell Train funds, Unilever and Diageo .. On PEs around 20, that's an earnings yield of 5% on some pretty decent quality companies.

Warren Buffett simply compares earnings yields on stocks vs comparable bonds, and whether this is the right advice at the moment, you can see Buffett is doing the same:

https://i.imgur.com/NolA54J.png
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Slacker on 09/04/2018(UTC)
King Lodos
Posted: 09 April 2018 00:19:47(UTC)
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Chris Dean;60346 wrote:
I've been reconsidering my bond allocation in a Personal Pension plan which I don't intend to access for at least 7-8 years, even then that should (hopefully) only be out of desire rather than necessity!

It is a low cost, passive, multi-asset fund 40% equity/60% bonds and the allocation can be changed within the plan at no cost. I don't fully understand bonds and my only other allocation to them is via Troy Trojan.

Bearing in mind the current negativity around bonds and the fact that I have sufficient income from an annuity & SIPP, ISA and approx 35% cash, perhaps I should be more adventurous with that pension fund and change to say, 80% equities/20% bonds?

Any thoughts would be appreciated.


It's an incredibly tricky thing to advise on .. as sandid3's post above shows: even if bonds are terrible value, if markets were to spend the next 7-8 years going down, stocks *may* still go down a lot more .. So raising your allocation to stocks now *may* be increasing your risk at a market top(?).

The big unknown seems to be whether we're in a normal market cycle, with a likely recession within a few years .. or whether we'll be back to stimulus and low rates, like Japan (where bonds and stocks could continue to push new highs) .. And I think we're 50:50 on that.

You can see Buffett (like me) is selling bonds .. But this isn't a market call – because he doesn't usually make them .. It's just value .. But he's also not aggressively moving into stocks, but rather upping cash .. I'd say: maintain a similar level of risk by moving some bonds into cash, and some into stocks .. And I know cash is less than ideal .. Troy Trojan's holding quite a lot of cash too

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