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  • FIRST POST
    • aroominyork
    • By aroominyork 8th Oct 17, 5:07 PM
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    aroominyork
    Bonds - still so confusing...
    • #1
    • 8th Oct 17, 5:07 PM
    Bonds - still so confusing... 8th Oct 17 at 5:07 PM
    A few months into DIYing I still find bonds are the sector I don’t sufficiently understand (despite having read bowlhead et al from dawn til, well, an hour or two after dawn).

    Equities, by comparison, seem relatively straightforward. Either go passive, or choose your geographies, sectors and company sizes then sit back and hope. Why do bonds confuse me so? They are meant to be the main way to balance risk in a portfolio, but much of what’s written is about their downside, eg of the 20-30 year bond run reversing. A few days ago I read in a post a rule of thumb that during an equities crash, bonds go up 0.5% for each % that equities fall, and while I wish it were that simple I fear it’s not.

    I am approaching this with a retirement portfolio with a ten year horizon invested 65% equities, 30% bonds, 5% property/other. The bonds are 10% higher risk (Schroder High Yield Opps and GAM Star Credit Opps), 18% strategic (Royal London Ethical and Morgan Stanley Sterling Corporate) and 2% within VLS.

    I understand (I hope correctly) that as long as interest rates remain low and no sectors of the economy goes wotsits-up, the high yield funds will perform better. So I have two questions. The first is whether, if there is a bond bear market, do investors hang on to their bonds (high yield and cautious/strategic) the way they hang on to equities after a crash, waiting for them to recover, or is the strategy different for bonds?

    My second question is about the role of strategic bonds, whose rises have generally slowed in the last year; is this because the managers see an interest rate rise, the end of the bond bull market and/or an equities correction as more imminent and so are investing more cautiously? And if so, what can I reasonably expect to happen to these funds when one or both of those events happen? If there is not a good chance of the ‘equities down 1%, bonds up 0.5%’ scenario playing out, and given the warnings about the end of the bond run, do bonds have too many more potential downsides than upsides for them to be a worthwhile investment?

    The cause of the next crash will presumably affect bonds as much as equities. Presumably, if it was not caused by the banks (as 2007/8) and was not in sectors where the banks were exposed, then bond funds invested heavily in banks/financials would be safe havens.

    So that’s my conundrum, having a chunk of my portfolio invested for reasons I don’t fully understand (and, I expect, writing a number of things in this post which demonstrate that).
Page 3
    • ColdIron
    • By ColdIron 10th Oct 17, 6:25 PM
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    ColdIron
    At a high level you can think of bonds on a sliding scale from sovereign debt (gilts, US treasuries etc) through strategic and corporate bonds to high yield and emerging market debt. The left hand of the spectrum would be low yield with little prospect of capital gain but offer reasonable protection against volatility. The right hand offers quite a bit more yield (clue's in the name) though is likely to move in the same direction as equities in distressed conditions. Corporate and strategic bonds would sit somewhere between the two. If you know what job you want your bond holding to do it should be easier to identify which ones will achieve that objective

    There's no reason to take on more risk than necessary, particularly if you exchange it for income or yield that you don't need with 10 years to retirement. Perhaps cross that bridge when you come to it

    If you are worried about chasing different funds in different conditions and want a more hands off approach then strategic bonds may be useful. They are less constrained and can range across the bond spectrum, the bond fund manager will be better informed than you, let him earn his fee

    If this was my portfolio and I wasn't happy with my somewhat fixed bond allocation I might sacrifice some or all the HYB for strategic funds. If I felt it was too cautious then I'd target equities in exchange for the same. I can't see a good case to increase the HYB element. But it isn't my portfolio and there is nothing too wacky about it so leaving it as it is wouldn't be the worst decision you ever made

    Just my view and, as ever, it's all about opinion. BTW the two 'strategic' bonds in your OP aren't, they are in the Sterling Corporate sector. Look for funds in the Sterling Strategic sector like M&G Optimal Income and Jupiter Strategic Bond (not a recommendation)

    Sorry if this brings on another bout of - Why isn’t there a “throws hands up in the air” emoji?!'
    • Alexland
    • By Alexland 10th Oct 17, 7:50 PM
    • 736 Posts
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    Alexland
    +1 for the M&G Optimal Income fund. It's expensive but with the increased risks currently facing bonds it could be worth having some serious experience on you side. As you identified this is a lot harder than investing in stocks. I am a fan of M&G and think they are under-recommended in these forums. You can get it in the M&G ISA wrapper for no extra cost.
    Last edited by Alexland; 10-10-2017 at 7:57 PM.
    • chiang mai
    • By chiang mai 10th Oct 17, 8:50 PM
    • 88 Posts
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    chiang mai
    I don't know if there's any such thing as a hands-off approach to managing the bond element of an investment portfolio, other than perhaps buying managed Mixed Asset funds whereby the investor chooses the percentages and leaves management to the fund manager. Apart from that and in binary terms, you either hold bonds or you don't, if you hold them you have to choose them, monitor them and be prepared to react as conditions change, just as you do with equties. When it comes to choosing them: it's been said by others that current conditions favour high yield bonds, my experience favours short-term durations and high creditworthiness. You seem to believe that your current bond holdings mix is not right and you have ideas how to adjust it. But then you're looking for a mechanism to take over all future decision making relative to those bonds and I have no answer for that and I'm not sure there is one, other than to treat them the same way you do equities through research, selection and monitoring and that doesn't appear to suit - sorry I can't be more helpful, maybe others have more ideas.
    • Audaxer
    • By Audaxer 10th Oct 17, 8:59 PM
    • 641 Posts
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    Audaxer
    +1 for the M&G Optimal Income fund. It's expensive but with the increased risks currently facing bonds it could be worth having some serious experience on you side. As you identified this is a lot harder than investing in stocks. I am a fan of M&G and think they are under-recommended in these forums. You can get it in the M&G ISA wrapper for no extra cost.
    Originally posted by Alexland
    That's good news as I recently purchased M&G Optimal Income fund as part of my income portfolio as it appeared to me to contain good quality bonds and the value didn't drop as much as some other similar funds in 2008.
    • aroominyork
    • By aroominyork 10th Oct 17, 9:08 PM
    • 296 Posts
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    aroominyork
    Really helpful ColdIron and Alex. I hadn't realised the difference between corporate strategic and 'pure' strategic. I recently read about and bookmarked M&G Strategic Corporate Bond but now I realise it is more constrained than Optimal Income. And if, as you say ColdIron, if I want the manager to earn his money - despite balking at the comparative high fees in relation to return compared to equities - I should give him/her maximum flexibility, yes?

    I would be interested in any other views on the view of focusing on equities and strategic bond funds and cutting out high yield bonds.

    PS Optimal Income's top ten holdings are all German. What should I read into that please?
    PPS Am flying to Tokyo tomorrow but will doubtless sneak away from my wife to continue this conversation as the mist is starting to clear.
    Last edited by aroominyork; 10-10-2017 at 10:04 PM.
    • Alexland
    • By Alexland 10th Oct 17, 10:03 PM
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    Alexland
    M&G Optimal Income's position is 126% long and 43% short on bonds (so there is something clever going on which is not immediately obvious) giving an overall 83%.

    The fund is 60% Europe (inc 31% Eurozone and why not Germany) and 40% Americas and very heavy in consumer cyclical and heathcare sectors. I guess that's where the manager sees the opportunities.

    Also the maturity distribution is very short, medium or long with not much between. I am not sure there is any advantage but maybe it makes it easier for the manager to operate or with historic churn they have bunched up a bit.
    • aroominyork
    • By aroominyork 10th Oct 17, 10:48 PM
    • 296 Posts
    • 72 Thanks
    aroominyork
    The fund is 60% Europe (inc 31% Eurozone and why not Germany) and 40% Americas and very heavy in consumer cyclical and heathcare sectors. I guess that's where the manager sees the opportunities.
    Originally posted by Alexland
    It's basically German government issue and American corporates.

    So what I am understanding is that the strategic funds (the ones that are not corporate strategic) let me invest my bond allocation in a fund that will adapt for me in the way I want, and if I want a small quasi-equity punt on something like GAM Star Credit Opportunities' subordinates approach I can add that on.

    PS So comparing my ex-IFA's approach (which under-performed VLS, as I expect most do), he had equities for high risk, HYBs for medium and property for low. My semi-passive DIY would be equities for high and strategic bonds for the rest. Is that a sound approach?
    Last edited by aroominyork; 10-10-2017 at 11:08 PM.
    • ColdIron
    • By ColdIron 10th Oct 17, 10:50 PM
    • 3,660 Posts
    • 4,401 Thanks
    ColdIron
    M&G Optimal Income's position is 126% long and 43% short on bonds (so there is something clever going on which is not immediately obvious) giving an overall 83%.
    Originally posted by Alexland
    These are the long and short positions, subtract one from the other and you get the net. Have a look for Asset Allocation in
    http://quicktake.morningstar.com/DataDefs/FundPortfolio.html
    • chiang mai
    • By chiang mai 11th Oct 17, 12:11 AM
    • 88 Posts
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    chiang mai
    I'm in favour of any solution that meets the needs of the OP but be aware that the M&G Optimal Income fund is expensive with a 3% entry charge plus the FT rates the credit level as low whilst MS rates it as medium. That said the effective duration is very positive at only 1.98% and the maturity distribution looks very favourable, the fund managers track record, however, is not brilliant.
    • aroominyork
    • By aroominyork 11th Oct 17, 5:28 AM
    • 296 Posts
    • 72 Thanks
    aroominyork
    I'm in favour of any solution that meets the needs of the OP but be aware that the M&G Optimal Income fund is expensive with a 3% entry charge plus the FT rates the credit level as low whilst MS rates it as medium. That said the effective duration is very positive at only 1.98% and the maturity distribution looks very favourable, the fund managers track record, however, is not brilliant.
    Originally posted by chiang mai
    I don't quite see this. HL has no spread, and the manager is Alpha rated on Trustnet.

    A word about FE ratings please. They seem to use volatility as a proxy for risk, so GAM Star Credit Opps, which I currently hold, has had a very smooth upward journey for some years which I assume explains its FE of 22. But surely it is more prone to downturn than Optimal Income, which is rated 28?
    Last edited by aroominyork; 11-10-2017 at 5:40 AM.
    • bowlhead99
    • By bowlhead99 11th Oct 17, 8:12 AM
    • 6,987 Posts
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    bowlhead99
    I don't quite see this. HL has no spread, and the manager is Alpha rated on Trustnet.
    Originally posted by aroominyork
    The published entry charge is archaic and would be discounted to zero with nearly all UK distributors / platforms - may be different if you are located in Asia and looking into UK products from afar.

    The 'manager track record is not brilliant' may come from looking at the 3 years performance which shows it to be 'only' in line with the average of the rest of the sterling strategic bond sector (4.2% vs 4.1%). They have moved a little early to reduce duration and be defensive against interest rate rises and so have missed the opportunity to make higher returns which some of the top performing groups have made. Still, that's not a bad thing as you are paying for their judgement so you expect them to exercise it for a long term payoff not short term 'wins'.

    If you look at the five year returns they are now close to 1% a year above the sector average but it's by looking at 10 year returns you will see that they have pretty much doubled the performance of some rival funds by only losing a much smaller amount in the 2007-2008 credit crunch and starting to recover from it faster. So, no real 'performance issues', it is a good fund and I am using it in my parents' ISAs. However, if they are positioning defensively and keeping duration short for lack of good opportunities at the moment you would not expect to see exciting returns.
    A word about FE ratings please. They seem to use volatility as a proxy for risk, so GAM Star Credit Opps, which I currently hold, has had a very smooth upward journey for some years which I assume explains its FE of 22. But surely it is more prone to downturn than Optimal Income, which is rated 28?
    The trustnet risk scores are derived from looking at the weekly volatility going back eighteen months to three years with a decay factor so that more recent events are given more weight than older ones.

    As a scoring system they can be a handy ready-reckoner because they are relatively simple and intuitive to get your head around; they do give more weight to recent swings (which could help recognise recent market conditions); they are a relative measure (ie. FTSE100 at 100) rather than an absolute one; and they are not limited to one fund sector (i.e. you can compare a debt fund against a property fund or equities fund or absolute return fund).

    However - covering just 3 years of data is going to ignore the fact that 9-10 years ago there was a global financial crisis in which M&G Optimal Income did well and a lot of its peers did not. And while you can see that a fund scoring 20-30 is currently much less volatile than one scoring 150-160, it is less useful for comparing one in the low 20s with one in the high 20s. The numbers are just saying that they are giving ballpark similar results with one a little lower than the other but it is not a forward-looking measure that tries to make a prediction about whether one will go up or down in a significant market event.

    For example maybe you could have two funds that happened to get a '30' rating over a time period even though one was going up when the market went up and one was going down when the market was going up because they have opposite strategies but averaged out to the same score over the time period. Knowing something goes in a smooth line rather than a very jagged one does not tell you the direction of the line and if you don't know the reason for the next market swing you can't use a volatility score to predict how well you will fare.

    ...he had equities for high risk, HYBs for medium and property for low. My semi-passive DIY would be equities for high and strategic bonds for the rest. Is that a sound approach?
    You say he 'had' HYBs for medium. But he is your ex-advisor not a current advisor of yours. Would he still have them for medium today or next year or forever? Maybe not because the IFA's job is to consider what asset classes will do the job in the context of the risk profile and the answer won't always be the same.

    You mention he used property for low risk which is unusual given cash and short-dated gilts are clearly lower risk than property. But property can be lower risk than HYBs. So that part of his portfolio might be better described as 'lower' risk rather than 'low' risk while still aiming to hit your returns target. Still, the takeaway point is that he used property in the portfolio and most advisors would use property in a portfolio as it is a useful diversifier from equities and bonds - a different asset class with different returns in different market conditions. I use property in my portfolio too. No reason to shun an asset class unless you have a small portfolio where sticking 5-10% in that class doesn't make much absolute difference to outcomes.

    Whereas, you are shunning property to focus on getting a strategic bond manager to handle all your 'non-equities' stuff. It's true that the two main components of most portfolios are equities and bonds which have very different return characteristics (albeit with a whole variety of sub-categories within each of the two classes). IMHO, no reason to ignore commercial property funds which provide rental income and potential for capital appreciation. Unless you are just working with a small portfolio and trying to simplify as far as possible. Though if that's the case (i.e. simplistic small portfolio) it might be more sensible to use a fund manager who would deploy your money across multiple asset classes rather than have one on the strategic equities side and one on the strategic bond side.
    • aroominyork
    • By aroominyork 11th Oct 17, 10:11 AM
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    aroominyork
    Point taken about property and maybe that's the next stop on the knowledge train! Do you know of any previous threads which give a good overview of the sector and the fund options within it?

    This article chimes with much in this thread about bonds http://www.morningstar.co.uk/uk/news/128683/4-questions-to-ask-before-buying-a-strategic-bond-fund.aspx. The M&G fund seems to fit well but I'd like a second to spread the risk and would appreciate thoughts on other options alongside Jupiter.

    Many thanks all - this has been very helpful.
    • chiang mai
    • By chiang mai 11th Oct 17, 10:30 AM
    • 88 Posts
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    chiang mai
    I don't know much about HL so perhaps they waive the 3% entry fee, dunno, but the fee exists and is displayed prominently on MS, TN and the FT..

    Here's the fact page on the fund from the FT, they rate the credit quality of the bonds held in the fund as low and the fund in general likely to be influenced by interest rates changes. Those things are not to be confused with the fund risk that you refer to although they are one aspect of it.

    https://markets.ft.com/data/funds/tearsheet/summary?s=gb00b1vmcy93:eur

    In looking at fund managers: I like to look at their past performance and the performance of other funds they manage or have managed in the past. It's in that context that I don't view the subject fund managers performance as anything more than average. And I personally don't care that much about the so called alpha rating given to fund managers by Trustnet, my experience is that they can be very hit and miss and have more to do with advertising revenue than is desirable.

    EDIT TO ADD: apologies that I hadn't seen BH's post before typing my reply, I wasn't aware of the entry fee treatment in the UK, not so in Asia. Points regarding FM performance also taken on board.
    Last edited by chiang mai; 11-10-2017 at 11:00 AM.
    • chiang mai
    • By chiang mai 12th Oct 17, 12:43 PM
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    chiang mai
    The case against HY bonds as a hedge:

    "Additionally, investors ploughing into high yield debt in the hopes of diversification are running a “dangerous investment strategy” as the asset class moves in the same direction as equities".

    https://www.trustnet.com/news/764569/why-youre-wrong-to-dismiss-gilts-in-favour-of-high-yield-bonds?utm_source=Trustnet%20Newsletters&utm_campai gn=1b9a06c247-20171012_Investor10_12_2017&utm_medium=email&utm_t erm=0_2314bd04ee-1b9a06c247-77275453
    • bigadaj
    • By bigadaj 12th Oct 17, 2:38 PM
    • 10,803 Posts
    • 7,100 Thanks
    bigadaj
    The case against HY bonds as a hedge:

    "Additionally, investors ploughing into high yield debt in the hopes of diversification are running a “dangerous investment strategy” as the asset class moves in the same direction as equities".

    https://www.trustnet.com/news/764569/why-youre-wrong-to-dismiss-gilts-in-favour-of-high-yield-bonds?utm_source=Trustnet%20Newsletters&utm_campai gn=1b9a06c247-20171012_Investor10_12_2017&utm_medium=email&utm_t erm=0_2314bd04ee-1b9a06c247-77275453
    Originally posted by chiang mai
    For the average investor a high yield bond is oxymoronic. Bonds are supposed to provide the water to the whisky if equities, to steal a Tim hale ism, so investing in risky bonds defeats the object in the first place, it's not just the current crazy negative interest rate and qe obsessed economic era we live in.
    • aroominyork
    • By aroominyork 12th Oct 17, 3:03 PM
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    aroominyork
    For the average investor a high yield bond is oxymoronic. Bonds are supposed to provide the water to the whisky if equities, to steal a Tim hale ism, so investing in risky bonds defeats the object in the first place, it's not just the current crazy negative interest rate and qe obsessed economic era we live in.
    Originally posted by bigadaj
    What do you mean the average investor? Do you mean only professional investors should mess with them? How do you feel about IFAs including HYBs in their ready-made portfolios? I also wonder whether they really should be seen as akin to equities - is that slightly hyperbolic - or maybe half way (ish) between cautious bonds and equities? It sounds a little extreme to suggest that they do not really have a role in the spread of investments.
    Last edited by aroominyork; 12-10-2017 at 3:07 PM.
    • chiang mai
    • By chiang mai 12th Oct 17, 9:38 PM
    • 88 Posts
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    chiang mai
    There's nothing defensive about a high yielding bond, so yes, they are akin to equities, Include them in a portfolio by all means but not as a risk counterbalance.to equities since their low or poor credit rated contents puts them at risk of default. From Investopedia: "The final warning is that junk bonds are not much different than equities in that they follow boom and bust cycles". http://www.investopedia.com/articles/02/052202.asp
    • aroominyork
    • By aroominyork 13th Oct 17, 11:58 AM
    • 296 Posts
    • 72 Thanks
    aroominyork
    The case against HY bonds as a hedge:

    "Additionally, investors ploughing into high yield debt in the hopes of diversification are running a “dangerous investment strategy” as the asset class moves in the same direction as equities".

    https://www.trustnet.com/news/764569/why-youre-wrong-to-dismiss-gilts-in-favour-of-high-yield-bonds?utm_source=Trustnet%20Newsletters&utm_campai gn=1b9a06c247-20171012_Investor10_12_2017&utm_medium=email&utm_t erm=0_2314bd04ee-1b9a06c247-77275453
    Originally posted by chiang mai
    Thanks for this link, featuring an interview with the manager of a gilt fund who recommends investing in gilts.
    Last edited by aroominyork; 13-10-2017 at 12:04 PM.
    • chiang mai
    • By chiang mai 13th Oct 17, 12:23 PM
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    • 17 Thanks
    chiang mai
    You've already had recommendations for high yield bond funds but without any supportive reasons why, other than now is the right time in the cycle, whatever that means. I thought the article I provided might at least allow some balance to that and from somebody actually in the business and prepared to see his words in print. If you can find a more convincing argument from any professional source, let's all take a look at it! Having said those things, I'm very happy to try and contribute towards helping answer your queries about bonds and other aspects of investments, but not at the cost of ingracious replies!
    Last edited by chiang mai; 13-10-2017 at 12:30 PM.
    • aroominyork
    • By aroominyork 13th Oct 17, 1:12 PM
    • 296 Posts
    • 72 Thanks
    aroominyork
    I did not mean to be ingracious but was pointing out that articles, or interviews with mangers of, funds in a specific sector surely need to be taken with more than a pinch of salt.

    But your reply leads me into a related issue of how to assess sectors at a point in time. High yield bonds have done extraordinarily well over recent years due to a mix of macroeconomic factors which played to their strengths. They may have some risks akin to equities but they are presumably unlikely to continue accurately mirroring the ups and downs of equities over the coming years. So, when trying to construct a portfolio, how do you choose the right instruments for any given macroeconomic circumstance? For example, I might think that interest rates will rise more slowly than the market generally forecasts, that the UK economy will grow but at a slower rate than other Western countries, and that Sterling is unpredictable. If I am investing for 10+ years and have a moderate risk appetite, how do I turn my views into the right mix of instruments? This, I think, is where relatively inexperienced DIY investors can come unstuck - we try to pick good funds within sectors, eg by liking M&G Optimal Income because the manager did well in 2008, but there is a gap in our knowledge about how to match our hunches about the economic outlook to the most appropriate allocation between different instruments.

    Whereas IFAs will invest your funds based on a series of questions to determine your risk appetite, I can imagine a questionnaire for novice DIY investors which also has questions about their views on the economic outlook (with plenty of space for 'do not know' answers) and then suggests the sectors in which they should invest.
    Last edited by aroominyork; 13-10-2017 at 1:14 PM.
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