Bond Funds

saintbert

Hi there,

Hope someone can help a newish DIYer.

Over the last few months I have been building a fund portfolio through a discount broker service, up to now mainly investing in shares. I have done some research on achieving a balanced portfolio and am now considering adding bond funds.

With potential interest rate rises, is this a good idea at the moment?

Any views please.

Thanks

cheerfulcat

Hi,

Bonds, like property, have seemed expensive for quite a while now but seem to continue to defy gravity. You know the risk ( interest rate rises ); I suppose every investor has to make up his or her own mind as to how likely that is to happen. I have only very little exposure to bonds and have to say I wish I hadn't taken quite such a negative view these last three years...I am more and more inclined to the opinion that it is impossible to time the market.

dunstonh

On a balanced portfolio, the lower volatility of the bond funds offsets the higher risk funds that you will have on the portfolio. If you want a balanced portfolio, you need them to be able to include those higher risk funds otherwise your portfolio would become weighted towards the higher risk end of the scale.

They can prove to be valuable, not so much for the rate of return they offer but when you rebalance your portfolio. Especially after a period when the stock markets have dropped.

Chrismaths

There are those who say that you should include bond funds in your portfolio no matter what to provide a lower risk element to aid rebalancing. This is perfectly reasonable, and I do have a small bond weighting for this reason. However, for your average retail punter, who is paying around 1% annual charges or more on a bond fund, it just doesn't pay at the moment.

Forgive me for getting a bit technical, but at least it will give your more to research! Most BBB bonds (the lowest investment grade rating) are yielding around 90bps over gilts. That means that for the extra risk of lending your money to a company described as "medium quality", you get 0.9% extra interest compared to lending it to the government. That means that if you invest into an investment grade corporate bond fund, you will pay more than the risk premium!

What this means to me, is that you buy gilts before investment grade corp bonds. It's slightly different in the High Yield arena (the riskier end of the spectrum, those below BBB), where the risk premiums are significantly greater. I invest at institutional level, so I only pay around 0.5-0.7% annual charges on bonds, and I'm still likely to favour cash or gilts personally.

The key is to make sure you have lower risk funds (or cash!) in your porfolio, otherwise it is a bit like driving a porsche with the accelerator glued to the floor - you do really well when the road is straight, but you are likely to crash if you come up against a corner. Be disciplined, and rebalance.

Hope this is of some use.

[edit] Dh always types faster than me...[/edit]

dunstonh

i may have been faster typing but i do like the way you word yours.