Bond funds - pointless?

EdGasket

deadpeasant wrote: »

Forum-psychotherapy in action: seeing my thoughts in words on the screen makes me feel so much better. I'm going to hang on to my gilts rather than tinker with cash and market-timing.

Re the conventionals, I'm switching from the HSBC index to (10% of) the Vanguard LifeStrategy 80%, so Mr Vanguard can worry about rebalancing my conventionals from now on.

Re the IL, I see that active v. passive management doesn't seem to matter much. L&G IL Idx (TER 0.25%), Royal London IL (0.43%) and Henderson IL (1.19%!!!) seem to give comparable results net of fees. But HL's platform charges are £24/yr on L&G, £12/yr on Royal London and £0 on Henderson.

Lastly, gadgetmind seems not to have mentioned Smith & Wmson Short-Dated CB on this thread. I don't much like its 1% TER, but it seems to offer low-volatility returns that beat easy-access savings, more liquidity than fixed-rate savings, and tax-free interest (when wrapped) for those whose cash ISAs are maxed out. A nice alternative to dry-powder cash for the next round of bargain equities?

If HL's platform is charging you £24 a year to hold L&G's IL fund then I would find yourself a different broker. e.g. TD Waterhouse charges nothing. Why pay ??

Ark_Welder

Google Equities can outperform bonds in a liquidity trap from the FT for a very interesting article

deadpeasant

Ark_Welder wrote: »

Google Equities can outperform bonds in a liquidity trap from the FT for a very interesting article

Thanks for this, but my macroeconomics is roughly on the level of John Craven's Newsround. Could you please clarify a couple of quotes from it:

"Even if we make the extreme assumption that yields decline from current levels all the way to the 1.3 per cent lower limit in the next 12 months, then total bond returns would be limited to a maximum of 7 to 8 per cent in the US, Germany, and the UK."

Does the phrase "total bond returns" correspond, very very roughly, to the annual growth of a bond index fund?

"On the other hand, if economies escape from the liquidity trap and yields begin to rise to a more normal historic level, capital losses could be very large."

Does this mean, very, very roughly, that my gilt fund holdings could plummet?

IronWolf

deadpeasant wrote: »

Thanks for this, but my macroeconomics is roughly on the level of John Craven's Newsround. Could you please clarify a couple of quotes from it:

"Even if we make the extreme assumption that yields decline from current levels all the way to the 1.3 per cent lower limit in the next 12 months, then total bond returns would be limited to a maximum of 7 to 8 per cent in the US, Germany, and the UK."

Does the phrase "total bond returns" correspond, very very roughly, to the annual growth of a bond index fund?

"On the other hand, if economies escape from the liquidity trap and yields begin to rise to a more normal historic level, capital losses could be very large."

Does this mean, very, very roughly, that my gilt fund holdings could plummet?

Basically yes.

A bond has a par value, usually 100, and it pays coupons, which are the interest payments. At the moment the UK government can borrow at 2% which means when you buy a new bond at £100, you get £2 a year.

But the bonds the UK government previously issued paid much higher interest, say £5. Now it doesn't make sense to have 2 interest rates, so the price of these old bonds rises, until the yield is 2%.

So in the future, if markets want higher interest rates from the UK government, say 5% again, these old bonds will fall in price until the yield is 5%, back to 100, and the 'new' 2% bonds will fall below 100 until the yield is 5%.

(all the above assumes these bonds mature at the same time for simplicity)

So all bonds prices come down. And capital loses can be quite severe, its not quite as simple as halving capital to double interest payment, because you have the return of the capital, which is fixed at par value at a point in future. e.g. a bond maturing next year at 2% interest rate. If interest rates went to 4%, this bond wouldnt sell for 50, because next year you get £100 paid back on maturity. There is a formula for calculating bond yields including the compound interest rate on the capital but I cant do it in my head

gadgetmind

deadpeasant wrote: »

Does this mean, very, very roughly, that my gilt fund holdings could plummet?

Plummet is perhaps a bit strong, but losses of 5%-10% are perfectly possible and unless the markets continue to be irrational, it's quite likely. The potential upside, even if yields do dive down to 1.3%, is limited.

This is what people call "asymmetric" risk - the most likely scenario is a fair loss and the least likely scenario is a very modest gain.

Of course, this is what everyone thought at the start of 2011 and gilts then went on to be the best performing asset class, but whereas equities can have almost unlimited upside as companies grow their profits, gilts really can only go so far.

I have greatly reduced my exposure to gilts, which is a decision I'm happy with even though there is a chance it will turn out to be the wrong one!