Bond bubble? Blunt question.

wardrobe

So i read on the daily mail website we could have a bond bubble about to go pop.(also a few other places over the last couple of months)

http://www.dailymail.co.uk/money/investing/article-2302885/Cash-seeping-bond-funds-IMA-data-shows.html

I've got £10K of Aberdeen High yield bond http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=N2FZ7&univ=O&pagetype=portfoliobreakdown

Are these what the article is talking about? I'm happy with the return I have had on them and so my instinct is to switch them to another fund.

Cheers
W

Linton

This fund invests in higher risk/higher return bonds - yield 8.5%. These bonds will tend to follow shares as in the bad times higher risk companies are more likely to go bust.

The "bubble" concern is more about the very low risk government bonds ("gilts") to which people have flocked in the recent troubled times. This has pushed the effective interest of such bonds to very low values.

Why should you being happy with the return lead you to sell them? Personally I tend to keep the funds that are providing a good return. In this respect funds are rather different to shares in my view.

grizzly1911

Linton wrote: »

.

The "bubble" concern is more about the very low risk government bonds ("gilts") to which people have flocked in the recent troubled times. This has pushed the effective interest of such bonds to very low values.

How would this bubble bursting manifest itself?

Linton

grizzly1911 wrote: »

How would this bubble bursting manifest itself?

A relatively large (20%?) drop in gilt based funds with a significant rise in interest yield. A gilt bubble burst would be a lot less spectacular than the bursting of a share bubble as gilts have a guaranteed investment return whereas shares can be worthless.

redbuzzard

There are also dire warnings of a junk / high yield bond bubble too, driven by loose money and low yields on government bonds.

A lot of Asian buyers including banks are allegedly leveraged too and this has led to a dramatic rise in issuance and questionable credit quality. When it starts to unwind and yields rise some of the buyers could get badly hurt through capital loss or default.

There are two articles on this in yesterday's Telegraph business section.

CoCo's are said to be surfing on the demand and come in for some criticism.

You do hope that Aberdeen have a strategy for this ...?

Ark_Welder

One of the issues with defining a bubble in bonds is that it usually just involves thinking about prices. The problem with this is that bonds will revert to their par value at redemption (assuming they don't default in the meantime) - and will do so regardless of what is happening to prices of other assets or bonds. So assuming a conventional bond trading at 120, it will get repaid at 100 whether it falls to 50 or rises to 150 before then.

Far better to think about yields, because this takes into account both current and new issues. And for new issues, the level of issuance. in the USA (largest junk bond market) the average yield on thee bonds is now 5.56% - a record low - and last year had the highest level of issuance ever, and that looks like it will easily be surpassed this year. All part of the same hunt for yield that is driving sections of the equities markets.

Question is, when will it end? Not an easy answer given that the drivers of the situation are so unusual. And whether to sell Aberdeen HY might also depend upon any other funds owned - both bonds funds and other asset types: i.e. if Aberdeen HY is 5% of your portfolio then keeping it is a realistic option, whereas if it is 100% then that in itself might be a reason to sell.

What should be taken into consideration with investment grade bonds though - both sovereign and corporate - is that they can counterbalance other asset classes, such as equities and junk bonds. As such, they can provide a portfolio's 'escape hatch' for when something negative and unexpected happens. I still retain exposure to different types of bonds for this reason (both through funds and a few direct holdings, although the funds have been reduced over the past year) even though I think they're over-priced.

System

Personally I hold a couple of strategic bond funds and am not going to let them go. I think its sensible to have bond allocation in every portfolio. The proportion of that allocation very much depends on personal circumstances, but I think its wise to have a mix of high yield and investment grade bonds. The key is always diversity.

wardrobe

Thank you everyone for your valuable information, (im not ignoring the replies, im digesting it all)

VT82

I've never bought bonds, but my understanding is that a bond's value will go down if either:

a) market rates go up
b) the issuer's perceived credit quality goes down

As such, bond's aren't really 'in a bubble', it's just that market rates (the yield curve, whether you're looking at gilts, libor swaps etc.) have gone down, stayed down, and gone down again over the past 4.5 years. That has made bonds more attractive, with almost anything launched now worth more than its face value.

The bubble would only 'burst' if market rates shot up, or some bizarre credit quality correction happened. The smart money is on rates either staying low, or normalising slowly in line with what has been priced into the markets. So any particular bond's value should either stay high, or reduce gradually to par, without having crashed in the meantime.

Lots of generalising going on, but I think there's only a risk of a crash in bond values if you think the yield curve (very loosely translated as what the market expects the average bank base rate to be over a given period) is going to shoot up above current expectations at some point soon. I don't.

sabretoothtigger

Bubble is a set of favourable conditions that belie the actual risk reward.

INAER AVIATION FINANCE 9.5% BDS 01/08/17 EUR50000`144A

9.5% and only 4 years left. The company needs to have enough cashflow to either pay the interest or pay out the par.
Alot of times they refinance the debt, we slide off the piste if alot of companies can no longer raise funds. That would probably force default

I own shares in companies paying 14% but its just a bridging loan really and literally have oil waiting to be sold. Why they cant get cheaper shows alot of risk perception I guess.

9.5% is already high, this company must be close(r) to the edge of what the market would consider at all

Krugman laughs his merry head off at the mention of default because gilts rely on a printable asset. That affects private companies as their 9.5% return is likely false in real terms, a soft default.
Why do you need money in 2017, will you retire then or it might be best to focus on multiple currencies

This fund is too western but Euro is supposedly a better currency then Dollars
http://www.munknee.com/2012/05/the-u-s-may-engineer-a-soft-default-heres-why-and-how/

Since 1980 inflation has stolen 80% of the dollar’s purchasing power.
Since 1980, the Fed has effectively given you new dollars for old dollars (at least in purchasing power value) at a ratio of 4 new for 1 old

I think that means a bond paying 2% or more every year and you could compound that interest, it would exceed the 80% losses in value but not by much.
We are looking at 80% losses in a decade maybe but many dont believe this possible, hence bad risk or bubble.

Ark_Welder

Article from today's Bond Vigilantes

http://www.bondvigilantes.com/blog/2013/04/04/caveat-emptor-new-deals-in-the-high-yield-market/