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  • FIRST POST
    • northbob
    • By northbob 21st Sep 16, 12:51 PM
    • 16Posts
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    northbob
    UK gilts or US treasuries?
    • #1
    • 21st Sep 16, 12:51 PM
    UK gilts or US treasuries? 21st Sep 16 at 12:51 PM
    I hold index trackers for global equities, Vanguard Lifestyle 100 60%, and 10% each in global small cap, high dividend yield, and emerging markets. OK until now but I want reduce equity exposure to around 60% with the rest in bonds, a small amount of cash and/or gold not too much.

    I know bonds are unlikely return as much as equities but in an equity downturn bonds should fall less and can be sold to rebalance buying more equities at the lower price. I explain this in case anyone wonders why I would want to hold bonds.

    For lowest risk I think only top quality Government bonds not corporate.

    Is there a good reason to buy only UK gilts, or is it worth also holding US treasuries? If US treasuries is it necessary to hold the GBP fund or is it OK to hold the USD version as my long term living costs will not be in GBP anyway and I already hold all my equity holdings in GBP funds so I already have GBP currency exposure (which am happy with and I want to continue holding my investments in the UK).

    So UK gilts or US treasuries, or both, or if US treasuries in my situation should I still get the GBP version? I favour half in short 1-3 years and half in medium 5-8 years for stability and lower risk.

    Thank you for reading.
Page 1
    • jimjames
    • By jimjames 21st Sep 16, 1:04 PM
    • 10,445 Posts
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    jimjames
    • #2
    • 21st Sep 16, 1:04 PM
    • #2
    • 21st Sep 16, 1:04 PM
    With current rates would it not be better to just hold cash?
    Remember the saying: if it looks too good to be true it almost certainly is.
    • northbob
    • By northbob 21st Sep 16, 1:18 PM
    • 16 Posts
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    northbob
    • #3
    • 21st Sep 16, 1:18 PM
    • #3
    • 21st Sep 16, 1:18 PM
    I like I said I don't want to hold too much cash. I will hold some in bank savings but i want to stay within compensation limits and have some in NSI. But I dont want to hold 40% of my investments in cash.
    • bowlhead99
    • By bowlhead99 21st Sep 16, 1:29 PM
    • 4,652 Posts
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    bowlhead99
    • #4
    • 21st Sep 16, 1:29 PM
    • #4
    • 21st Sep 16, 1:29 PM
    I know bonds are unlikely return as much as equities but in an equity downturn bonds should fall less and can be sold to rebalance buying more equities at the lower price. I explain this in case anyone wonders why I would want to hold bonds.

    For lowest risk I think only top quality Government bonds not corporate.
    Originally posted by northbob
    Well, the return on the short dated 1-3 year bonds are nominal, pretty close to an interest-free bank account. Easily beaten with high street bank accounts assuming you are not trying to do it inside a pension wrapper where such bank accounts aren't available. Obviously if it's 40% of your entire wealth, it might be too mich to get the top bank account rates designed to entice small customers, but you can still get half a percent or more.

    The 1-3 year bonds do not have much downside but the upside is minimal. So what is wrong with holding GBP or USD cash rather than those type of bonds? In an equity downturn you can use the cash to buy more equities in just the same way that you would propose to sell 1-3 year bonds and use the cash to buy more equities.

    The medium (5-8yr) ones are not much more lucrative than the short dated ones, and have more chance to fall in value in the short term.

    Is there a good reason to buy only UK gilts, or is it worth also holding US treasuries?
    As you mentioned in another part of your post, in the long term your living costs will not be in GBP. And presumably when your equity downturn happens, you will be looking to buy not just some GBP equities but also some USD equities. So it would make sense to not restrict yourself to holding just UK bonds; US ones (and potentially other countries / currencies) can certainly be worth having, for currency diversification.

    If US treasuries is it necessary to hold the GBP fund or is it OK to hold the USD version as my long term living costs will not be in GBP anyway and I already hold all my equity holdings in GBP funds so I already have GBP currency exposure (which am happy with and I want to continue holding my investments in the UK).
    If you decide to buy a fund that's holding US treasuries, which are dollar assets, it really doesn't matter if you are buying a version of the fund which is priced daily in pounds or in dollars.

    Say you hold $1000 of treasuries. It doesn't matter if the manager tells you you have 500 units at US$2 a unit, or 770 units at GB1 a unit, or 90000 units at 1 Eurocent a unit, because either way you still have $1000 of US treasury assets.

    If the exchange rate changes from 1.3 to 1.5, then the $1000 of treasuries bought in dollars would still be worth $1000, although that is now only worth 667.

    If you had bought the dollar version of the fund you would still have 500 units and they would still be $2 each and still worth $1000. If you had bought the GBP priced version your 770 units are only worth 86p each and still worth $1000 overall. So you have not gained or lost any dollars, because whatever 'version' of the fund you buy, whatever they choose to publish the price in, you are still holding $1000 dollars.

    From this you can see that your currency risk comes from the choice of underlying assets held, not the currency they show the price in. Whichever version, your US treasuries are still worth $1000, and whichever version, you can still sell them and get 667 cash. You don't take on risk or avoid risk by changing the display price of the fund you buy that holds the dollar assets.

    There is a practical issue that if you are buying the funds on a UK broker platform, and you have GBP in your bank account to buy the fund, and you choose to buy a fund which publishes its daily prices in dollars, your broker might need to do a currency conversion to buy you dollars to buy into the fund, and the broker's fx fee for doing that might be a percent or so.

    Whereas if instead you bought the class of fund priced in GBP, the broker does not charge you a commission for the conversion, and the fund itself would convert the GBPs received from new subscribers at a very low fx commission cost. So, for administrative cost and convenience you might prefer to use the GBP-pricelisted version of the fund, even if it is a fund that exclusively holds US assets.
    Last edited by bowlhead99; 21-09-2016 at 1:33 PM.
    • northbob
    • By northbob 21st Sep 16, 1:54 PM
    • 16 Posts
    • 1 Thanks
    northbob
    • #5
    • 21st Sep 16, 1:54 PM
    • #5
    • 21st Sep 16, 1:54 PM
    Thank you for the fund currency explanation. I see that the GBP version makes sense for the practical reasons rather than any currency hedging advantage.

    Textbook 'balanced' portfolios normally have an allocation to bonds. But I've now had two replies suggesting a 40% allocation to cash would be better. Now I am even more uncertain as I have another decision to make instead of just which bonds.
    • AndyT678
    • By AndyT678 21st Sep 16, 2:19 PM
    • 608 Posts
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    AndyT678
    • #6
    • 21st Sep 16, 2:19 PM
    • #6
    • 21st Sep 16, 2:19 PM
    Textbook 'balanced' portfolios normally have an allocation to bonds. But I've now had two replies suggesting a 40% allocation to cash would be better. Now I am even more uncertain as I have another decision to make instead of just which bonds.
    Originally posted by northbob
    If you're an institutional investor with 1,000,000,000 to play with then a 40% allocation in bonds makes a lot of sense because you won't get much of a return on cash.

    As a retail investor with a much smaller pot and access to promotional interest rates the decision is very different. When you can get 3% - 6% risk free on cash there's no reason to touch govt bonds IMO.

    I have a small amount in corporate bonds but nothing apart from that.
    • northbob
    • By northbob 21st Sep 16, 2:34 PM
    • 16 Posts
    • 1 Thanks
    northbob
    • #7
    • 21st Sep 16, 2:34 PM
    • #7
    • 21st Sep 16, 2:34 PM
    3%-6% risk free on cash? Anything offering those returns must have a risk. Sorry I just find the 'risk free' claim hard to believe. If it's something like P2P that isn't risk free so maybe 5% of my pension and savings but not 40%.

    To stay within the FSCS savings compensation limits per bank would require me to spread it to the maximum amount allowed between 6 unconnected banks and earn very little interest - a few higher interest 5,000 or 20,000 deposits wouldn't be enough.
    Last edited by northbob; 21-09-2016 at 3:17 PM.
    • bowlhead99
    • By bowlhead99 21st Sep 16, 3:28 PM
    • 4,652 Posts
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    bowlhead99
    • #8
    • 21st Sep 16, 3:28 PM
    • #8
    • 21st Sep 16, 3:28 PM
    3%-6% risk free on cash? Anything offering those returns must have a risk. Anything with those returns doesn't sound like where I want the safe 40% of my portfolio. Sorry I just find the 'risk free' claim hard to believe.

    To stay within the FSCS savings compensation limits per bank would require me to spread it to the maximum amount allowed between 6 unconnected banks and earn very little interest - a few higher interest 5,000 or 20,000 deposits wouldn't be enough.
    Originally posted by northbob
    The 3-6% is genuine but as you say it is for a few higher interest deposits of the odd 5k here or 500 a month drip-fed there, using a number of banks. If the 40% of your portfolio is in the region of 250-300k (six unconnected banks) then you are not going to hit anything close to 3-6% as an average.

    However, 1% would be achievable easily enough, as you are never going to move this non-equities part of your porfolio to go down to 0% in this part of your portfolio and so do not need it all instant access; some could be on 1-2yr+ deposit, and even the instant access stuff pays more than 1-3yr gilts.

    Whereas, no UK gilt with a maturity lower than 8 years has a yield of greater than 0.5%: see table of yields here https://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3

    You had said you were willing to put half your bonds (i.e 150k?) into 1-3 year gilts and as you can see from the table they are yielding 0.1% or less. Up to 5 years they are yielding 0.25% or less and only at 8 years plus do you breach 0.5%. To do that is surely completely mad, when you can get a whole percent from the banks.

    As an alternative to needing to split your cash over many banks to keep within the insured/ compensation limits, you can use National Savings & Investment products which are treasury-backed - no FSCS needed as they will not go bust, the government can print as many pounds as it wants and so their safety is basically as good as a gilt. http://www.nsandi.com/income-bonds pay 1% at the moment and can be withdrawn penalty free with zero notice. The account limit is a million.

    If you are a huge bank or institutional pension fund and can't use that 1% account because you have a billion not a million, then you would have to buy a short dated gilt paying 0.1%. A small investor like yourself should not do that.

    There is just one 'but...' ; we had said before that you should not just restrict your short term bonds to UK Gilts because that misses the currency effect of having US treasuries and you should have a bit of both (if not even more, like the equivalents from Germany or Japan). Whereas if you use cash as a proxy for gilts, then if you put the whole 300k in a GBP bank account or NS&I account, you would miss out on that currency aspect and so your performance might be materially different - perhaps for better, or perhaps for worse.

    So if you wanted that currency exposure - which does make logical sense if you are not going to be in the UK forever and you may be expecting to buy a significant level of non-UK assets when you increase your equities exposure in future - you would need other currency bank accounts. Foreign currency bank accounts, especially in the UK where there is little demand for them, do not pay great rates. Citi are doing something like 0.1% on dollars. However, you can try offshore, where an account in Isle of Man operated by Nationwide will pay 1% on deposits of $25k+ (promotional rate expiring after 12 months, dropping to 0.25%) or Lloyds International offer 0.75% for a 1 year fixed term deposit.

    Those would be covered by the IoM equivalent of FSCS but still relatively low risk.

    HTH
    • jimjames
    • By jimjames 21st Sep 16, 4:32 PM
    • 10,445 Posts
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    jimjames
    • #9
    • 21st Sep 16, 4:32 PM
    • #9
    • 21st Sep 16, 4:32 PM
    3%-6% risk free on cash? Anything offering those returns must have a risk. Sorry I just find the 'risk free' claim hard to believe. If it's something like P2P that isn't risk free so maybe 5% of my pension and savings but not 40%..
    Originally posted by northbob
    Absolutely risk free and absolutely genuine and has been available on limited amounts (around 100k) for at least 4 years. I have all my cash at 5%.
    Bowlhead gave the comprehensive answer but I really can't see the point in holding gilts in a portfolio when the yield is low and they only seem to be likely to go one way.
    Last edited by jimjames; 21-09-2016 at 4:35 PM.
    Remember the saying: if it looks too good to be true it almost certainly is.
    • northbob
    • By northbob 21st Sep 16, 4:42 PM
    • 16 Posts
    • 1 Thanks
    northbob
    bowlhead99

    Thank you for that great information.
    NS&I income bonds looks a possibility. The fact there is instant access makes a difference as putting the cash into a fixed term account would make it unavailable for rebalancing.

    As straight UK Govt gilts offer so little, is there a case for a global Government bond fund or with some high quality corporate?

    10% into:
    NS&I income bonds as a proxy for cash holdings

    10% each into:
    Vanguard Global Bond Index Fund GBP Hedged Acc IE00B50W2R13, Yield 1.64%, YTD return 5.76%, (64% Govt. 36% corp & other) Credit Quality A, Average Maturity 7 years

    Vanguard Global Short Term Bond Index IE00BH65QG55, Yield 0.87%, YTD return 2.0%, (60% Govt. 40% corp & other) Credit Quality A, Average Maturity 2.8 years

    iShares Global Government Bond ETF SGLO IE00B3F81K65 (fund size $915m) 100% Govt. Credit AA, Average Maturity 10 years

    Or (for the bonds holding) just the last two - not sure if the first adds that much that a mix of the second two does not offer.
    Last edited by northbob; 21-09-2016 at 4:48 PM.
    • bigadaj
    • By bigadaj 21st Sep 16, 6:49 PM
    • 7,383 Posts
    • 4,419 Thanks
    bigadaj
    The problem is that bonds have always been considered the boring steady element of most portfolios, with lower volatility.

    If you check some of the bond funds, then they have had huge gains over the last few years, what goes up may well equally come down, so there's a reasonable chance of significant capital losses in the next few years. There's certainly less potential for upside return.

    The reduction in interest rates has affected many areas, people obviously want to diversify away from equities, and this has resulted in some of the steadier investment trusts going into significant premium, infrastructure funds becoming very expensive etc

    Cash held in a safe environment currently doesn't look too bad, though we'll see if inflation does take off in the coming months and years.

    People are looking towards p2p, and it offers the potential for good returns if risks are managed, whether issues around capital losses arise in the future we'll have to wait and see.
    • EdGasket
    • By EdGasket 22nd Sep 16, 12:10 PM
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    EdGasket
    I don't think the OP understands bonds. They are not 'safe' and very sensitive to interest rates. As interest rates are only likely to go up from here you would do well do steer clear of fixed-rate bonds which will lose capital value as interest rates rise. You could easily lose 50% of your capital in bonds!

    e.g why would anyone pay 100 for a bond paying 0.5% if interest rates in the cash market returned 1%? Answer they wouldn't, they would likely pay something nearer to 50 for a 0.5% bond in that case. At the moment bonds are priced such that they return next to nothing because cash returns are next to nothing, pension funds are required to hold a certain amount of bonds whatever, and the government through QE is forcing the price of bonds up artificially. Bond prices will crash sometime soon.
    • northbob
    • By northbob 22nd Sep 16, 3:14 PM
    • 16 Posts
    • 1 Thanks
    northbob
    I don't think the OP understands bonds. They are not 'safe' and very sensitive to interest rates. As interest rates are only likely to go up from here you would do well do steer clear of fixed-rate bonds which will lose capital value as interest rates rise. You could easily lose 50% of your capital in bonds!

    e.g why would anyone pay 100 for a bond paying 0.5% if interest rates in the cash market returned 1%? Answer they wouldn't, they would likely pay something nearer to 50 for a 0.5% bond in that case. At the moment bonds are priced such that they return next to nothing because cash returns are next to nothing, pension funds are required to hold a certain amount of bonds whatever, and the government through QE is forcing the price of bonds up artificially. Bond prices will crash sometime soon.
    Originally posted by EdGasket
    Thank you.
    • northbob
    • By northbob 22nd Sep 16, 3:16 PM
    • 16 Posts
    • 1 Thanks
    northbob
    So lots of caution about holding any bonds. So I am looking at having 40% of my pension and savings in cash. Thank you all for the comments and thoughts.

    Some questions in response to the replies so far:

    I accept bonds are not totally safe, but is it not true that all balanced portfolio advice (Hale, Bogle, Browne, Swedroe etc) includes them because:

    1. less volatile than equities
    2. diversification as less correlated with equities
    3. biggest losses not as great as biggest equity losses

    But despite this bonds are best excluded from balanced portfolios now?

    If balanced portfolios are to have no bonds where is the diversification to come from?

    When the next economic crisis hits and equities enter a bear market where will the money move to if not bonds?

    If bonds that crash before or with equities where will the money moving out of bonds move to? Only cash?
    • EdGasket
    • By EdGasket 22nd Sep 16, 3:34 PM
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    EdGasket
    But despite this bonds are best excluded from balanced portfolios now?

    If balanced portfolios are to have no bonds where is the diversification to come from?

    When the next economic crisis hits and equities enter a bear market where will the money move to if not bonds?

    If bonds that crash before or with equities where will the money moving out of bonds move to? Only cash?
    Originally posted by northbob
    I would say they are best excluded from balanced portfolios now. The investment managers may not be able to do that if their fund states it is 40% or whatever in bonds and that is their mandate. They could move to short-date bonds to mitigate any falls.

    Next economic crisis - if that turned out to be high inflation then cash and bonds would be hit but probably not equities. Money might move to hard assets such as property, gold, oil, resources.

    There is also index-linked gilts to consider; a better bet than fixed-rate right now in my opinion but still overpriced and subject to interest rate hikes.
    • coyrls
    • By coyrls 22nd Sep 16, 4:53 PM
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    coyrls
    I’m not disputing claims that bonds represent “bad value” now; however for balance I would point out that bonds have had a phenomenal run over the last few years during which the vast majority of commentators were claiming that bonds represent “bad value”. It’s quite surprising that many people who would condemn trying to time equity markets are quite happy to advocate timing bond markets. If, as you suggest, you stick to relatively short term bonds, you will address interest rate sensitivity, all be it at the potential cost of immediate returns. You might also looks at a conservatively managed active bond fund such as Moneybuilder Income.
    • northbob
    • By northbob 22nd Sep 16, 5:59 PM
    • 16 Posts
    • 1 Thanks
    northbob
    coyrls

    That is a very good point. If I had posted that I was starting a balanced portfolio for the long term, at current values it could also be said equities are over valued so dont hold any. So not holding any bonds because of current values is like timing the market. Which is not a good idea as it is not possible.

    I see a case for not putting as much in bonds as I had considered but for a smaller allocation does anyone have any thoughts about the 3 funds I shortlisted in the earlier post?
    Last edited by northbob; 23-09-2016 at 8:04 AM.
    • EdGasket
    • By EdGasket 22nd Sep 16, 7:52 PM
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    EdGasket
    Ref previous two posts; the thing is that interest rates can't go any lower and the US economy is heating up so rates there WILL go up in the next few months. It is not a case of trying to 'time' the bond market; the bond market moves inversely to interest rates and as interest rates are as low as they are gonna go and the FED has already signalled rate rises, we are at the top of the bond cycle.

    Northbob - if you must have gilts then get a short-dated fund but as everyone is trying to tell you, you might just as well have cash right now because your bonds aren't going to return you anything.
    • coyrls
    • By coyrls 22nd Sep 16, 9:51 PM
    • 532 Posts
    • 459 Thanks
    coyrls
    Ref previous two posts; the thing is that interest rates can't go any lower
    Originally posted by EdGasket
    You reckon? The Bank of England is hinting at a reduction to 0.1%. The expected US rise has been postponed.
    • coyrls
    • By coyrls 22nd Sep 16, 10:01 PM
    • 532 Posts
    • 459 Thanks
    coyrls
    does anyone have any thoughts about the 3 funds I shortlisted in the earlier post?
    Originally posted by northbob
    I hold Vanguard Global Short Term Bond Index. One point to note for your circumstances is that it's hedged to sterling, which for most UK investors is a good thing but it won't give you the US $ link that you were asking about. As you point out, the YTD return has been 2%, not the 0.5% being quoted in other posts. As it is a short-term bond fund, it has low sensitivity to interest rate changes.
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