Bond Bubble

SallyG

http://blogs.telegraph.co.uk/finance/ianmcowie/100022038/bond-bubble-fears-and-why-i-have-taken-the-biggest-bet-of-my-life/
“There are risks in both bond and equity markets, of course, but the risks in equity markets are well known. We believe that at some point a wave of money will flood out of bonds and into equities. If you are invested in the wrong part of the market, you will incur big losses.”

About one third of my managed pension fund's in bonds - will the fund manager be offloading bonds and buying shares?
Just wondering which of the fund mantras takes precedence : "long term capital growth" or investing according to some definition so as not to wander outside his benchmark?

Linton

If high grade bonds increase in value more than shares the fund manager will tend to sell bonds, not to guess the future market, but rather to keep the bond/equity balance in line with the fund's strategy. Conversely bonds will be bought as their price falls.

I cant see people incurring big losses from high grade bonds compared to those we have seen from shares as the price of such bonds is prevented from too much variation by the guaranteed redemption at maturity preceded by the guaranteed interest.

Low grade (but very high return) bonds tend to roughly follow equity prices as when the economy is weak share prices are low and low grade bonds are more likely to default.

jamesd

The fund manager in a balanced managed fund should already have been selling gilts and high quality bonds to keep their percentage of the fund value within its target range. That's a straightforward asset allocation approach.

A fund manager will have constraints within which they are required to work. That will normally include maximum and minimum ranges for the percentage held in each type of investment. They can be large or small ranges depending on the fund and the manager's brief. These limits take precedence over achieving long term growth because it is necessary to adhere to them to be investing in the way described for the fund and to match the desired risk tolerance of investors who chose that fund.

How much gilts and other high quality bonds are affected will depend in part on how long it is until the bond matures. Defensive approaches involve bonds with maturities of up to a couple of years. Bonds with maturities of say twenty years will be more greatly affected by increases in interest rates or inflation than shorter term bonds because there is a longer term over which the value will be reduced by inflation or increases in other interest rates. Longer term gilts are likely to see a value drop of 30% or so as interest rates in the UK return to normal.

You can protect yourself from these things in many ways, such as by using global as well as purely UK funds.

Another defensive approach is to use lower grade/high yield and non-UK bonds because those are less affected by changes in interest rates and inflation in the UK. Funds in the strategic bond sector have flexibility in choosing which types of bond to use and are likely to favor the high yield bonds over gilts at the moment because of the balance of risks. The same increase in economic confidence that produces an increase in interest rate s and gilt prices will decrease the chance of high yield bonds defaulting due to the more benign economic conditions.

A third defensive approach is to switch some money from bonds to commercial property funds that own actual buildings. The sector is somewhat unpopular at the moment and an economic recovery is likely to increase the value of commercial property.

gadgetmind

jamesd wrote: »

A third defensive approach is to switch some money from bonds to commercial property funds that own actual buildings. The sector is somewhat unpopular at the moment and an economic recovery is likely to increase the value of commercial property.

I also increased my property exposure during 2012, both commercial and PFI infrastructure, but I used close-ended vehicles as I've been bitten by exit restrictions on property funds in the past.

bigadaj

Just wonder what is happening now with life styling of pension funds, are we potentially looking at future claims of negligence if high quality bonds are being accrued at excessive levels by those nearing retirement?

gadgetmind

I've told my group pension company in writing not to make any changes to my asset allocation on my behalf as I will continue to do this myself using the online facilities.

rpc

bigadaj wrote: »

Just wonder what is happening now with life styling of pension funds, are we potentially looking at future claims of negligence if high quality bonds are being accrued at excessive levels by those nearing retirement?

If the investor has chosen a lifestyling fund and the pension provider clearly spells out how much will be moved out of equities when, I don't see how there can be any negligence. The pension provider is simply doing what the customer has signed up for.

If it was an advised pension, things might be different but for an unadvised pension I don't see how a provider of a fixed lifestyling option has any discretion to do anything other than rigidly execute the lifestyling asset shift.

bigadaj

rpc wrote: »

If the investor has chosen a lifestyling fund and the pension provider clearly spells out how much will be moved out of equities when, I don't see how there can be any negligence. The pension provider is simply doing what the customer has signed up for.

If it was an advised pension, things might be different but for an unadvised pension I don't see how a provider of a fixed lifestyling option has any discretion to do anything other than rigidly execute the lifestyling asset shift.

Agreed but public feeling and the media will point to another fault with the finanical system whether justified or not.

In this specific case then significant losses are a likely outcome (though nothing certain as has been evidenced in Japan), the main unknown is the timespan over which this will unwind.

In this specific case then lifestyling would be the default approved approach to be used by the majority; what would be the advice of an IFA, both in general and if specifically asked about the current risks with bonds? And would these be objective or overridden by FSA guidance which itself could be deemed to be inappropriate.

jamesd

rpc wrote: »

If the investor has chosen a lifestyling fund and the pension provider clearly spells out how much will be moved out of equities when, I don't see how there can be any negligence. The pension provider is simply doing what the customer has signed up for.

The investor probably signed up for risk reduction in the years before retirement, not specific investments.

Take a look at say FL Lifestyle Retirement 2015 AP and its short description "To provide an appropriate mix of assets for investors who wish to build capital to purchase a pension in or around the year 2015."

That appears to me to be an explicit delegation acceptance by the fund manager that they will select an appropriate mix of assets for annuity purchase at that target year.

If the fund manager today picked 75% gilts and 25% cash as what to switch to and did that move in say late 2013 I think an investor would have a good case for them not picking "an appropriate mix of assets" for the circumstances and hence failing to comply with the fund's declared objectives.

bigadaj

Interesting point James, might be something to make the money managers sweat.

In such a case what is the low risk alternative, presumably to be largely in cash for the final couple of years, though if this is money market then ther have been cases of volatility when investors thought it was just like a bank account.

gadgetmind

bigadaj wrote: »

In such a case what is the low risk alternative

Anything short-dated and/or index-linked is as close as you'll get.

I quite like the approach of the likes of Henderson Diversified Income Trust. Clearly this is much further up the risk scale than holding a big old basket of gilts but do you really want all of your eggs in that one basket?