"Bonds in a bubble" - What does that mean?

bowlhead99

A_Flock_Of_Sheep wrote: »

Sorry another question. I often see Bond Funds titled as "Strategic Bond". What does that mean with Strategic?

The concept of bonds runs a whole spectrum of risk from traditional developed country government gilts of long duration (30 years) and short duration (a few years), to so-called 'investment grade' corporate bonds which are issued by companies rather than governments but considered low risk, to high yield corporate bonds (so-called 'junk' bonds in terms of their riskiness and credit rating, but paying higher interest rates), to emerging market government or corporate bonds which might have high interest rates but also less familiarity combined with, in some cases, the risks of the loans being in dodgy foreign currencies which may be less stable than dollars or pounds.

High yield bonds are normally more correlated to stock markets, because lower equity markets might imply the companies behind them could go bust. While gilts or investment grade corporate are the opposite and more desirable when markets are rocky.

A 'strategic' bond fund, unlike the funds which just invest in one main type of bond, or a fixed proportion of different types, will have a remit to vary their holdings of different classes of bonds to generate an optimum return. So from time to time, they could be heavy on gilts and light on junk bonds and emerging, or the opposite, depending on their strategic view of the world and their thoughts on the outlook for the domestic and international economies.

While you could go for a fixed mix of bonds of different classes, it would seem to make sense for a novice investor to trust a fund manager to make strategic choices from time to time and take the headache (of yield-seeking while bubble-avoiding). Of course, then you get the question of which manager to trust, and need to beware that many of them have done well in recent years as bond price rises have grown substantially regardless of type, so it's harder to split the good ones from the average.

Couple of paragraphs from recent relevant Morningstar article . Not saying it's right or they don't have any vested interest [my comments to help you make sense of it]:

The search for yield combined with unconventional monetary policies has pushed spreads lower, increasing the correlation of corporate bonds with government bonds, and therefore their interest rate sensitivity. [they are saying the 'spread' of price or yield of investment grade corporate over gilts is low and they're not much higher yielding than gilts these days] There are also early signs of a recovery in the US housing market which could help produce self-sustaining growth that would push the unemployment rate below the 6.5% target set by the Federal Reserve (FED) earlier than expected; this could precipitate talks of a rate rise as early as 2014, which would have disastrous consequences for government bond markets around the world.[because if general interest rates rise, the existing bonds paying a fixed yield are worth much less than the all time high prices they're currently at]

Against this backdrop, strategic bond funds may have an increasingly important role to play within an investor's portfolio. In a difficult macroeconomic environment for bonds, such funds’ flexibility and ability to allocate within the different areas of fixed income markets – including government bonds, investment grade, high yield bonds and emerging market debt – on a global basis is particularly appealing.

junglejame911

I understand the strategic bonds idea but how do “passive bond” funds work? What I mean is the relatively low cost Vanguard products (Lifestrategy 60 – where 40% of the holding is in bonds for example)?



How are the bonds selected? Particularly as bonds mature and therefore are replaced, is there a way of “tracking” the bond market akin to the major stock indices?



I notice from this particular fund breakdown, the bonds held are mainly short dated gilts, (maturity 2015-17) therefore one would expect that provided interest rates don’t rise significantly in this period (as seems likely) these are likely to be fairly stable. It’s what happens after that I am not clear about.

IronWolf

A_Flock_Of_Sheep wrote: »

I need bonds to balance a portfolio but its the bonds in a bubble that concern me. Does this apply to bond funds too as I would use a bond fund as a balance rather than owning directly.

I am guessing bonds in a bubble means bond funds are currently over priced and when the bubble bursts its goodnight vienna cheerio money as the price per unit cascades through the hull to the sea bed

If you buy a bond fund I would make sure it invests in mainly shorter term maturities. That way you wont be suffering huge capital losses in the event of a downturn, and as the bonds mature they will be reinvested faster into better yielding issues.

Money market funds are the ultimate example of this, but they only invest in government bonds with very short maturities so with current interest rates you're better off using a bank account unless you have substantial funds to invest.

grizzly1911

IronWolf wrote: »

If you buy a bond fund I would make sure it invests in mainly shorter term maturities. That way you wont be suffering huge capital losses in the event of a downturn, and as the bonds mature they will be reinvested faster into better yielding issues.

Money market funds are the ultimate example of this, but they only invest in government bonds with very short maturities so with current interest rates you're better off using a bank account unless you have substantial funds to invest.

The the 2 or 3 I have found mirror that last comment.

A couple of my other corporate bond funds have gone into stagnation mode at present.

A_Flock_Of_Sheep

I am now wondering if to I invest x% in equities leaving x% in cash to buy stocks at a low point. It's actually quit hard to take a decision in this climate.

IronWolf

Always a good idea to have cash on hand to buy if a good opportunity arises.

gadgetmind

A_Flock_Of_Sheep wrote: »

I am now wondering if to I invest x% in equities leaving x% in cash to buy stocks at a low point. It's actually quit hard to take a decision in this climate.

You mean a 50% cash allocation? That's massive! I usually run at 5-10% cash.

The problem with holding cash as an opportunity fund is that it's also often a big fat missed opportunity fund!

finebone

Are index-linked gilts, or funds that invest in them, in a similar bubble?
Or do you think they are still worth buying as insurance against inflation really taking off?

sabretoothtigger

worth buying as insurance against inflation really taking off?

The best ones were the PO certs, buy for 100 and sell for 100 but the real glts come at a premium which makes less point to it because that premium is lost


The real confusion is vs loss of value. A bubble would mean they wont come anywhere close to returning the original value or purchasing power so a sterling bubble
Bonds weigh heavily on that as we run so much debt vs our GDP or exports so there can be a total lack of demand for the currency if those holders realise they dont own a useful product. Like the houses that were cheaper to rent, it knocks onto excess supply and makes it further true that sterling is freely available.
Sterling can be rented, nobody has to own a long term bond

pqrdef wrote: »

The difference is that bonds don't just keep on rising, even during inflation (unless they're index-linked)


So people don't just keep buying them on the assumption that there's always a profit in it.

Even index linked can lose value as stated inflation can lag the reduction in ability to buy things, it can be inaccurate especially personally.
Bonds can lose all value and a house wont unless the land is seized

QE will mean there is always buyers so long as they can sell at a higher price then they buy
Its likely the 30 year bonds are already in lala land because our low base rate has stained their accuracy.
People will buy when theres no profit because they dont realise, if they ever had accurate predictions I think they are lost now with 4 years of QE.
The big missing factor from this thread is liquidity, we all assume we have immediate access but when theres a bank run its obvious it can be bone dry. BOE or UK DMO can have a bank run of sorts no matter what Krugman or others say

gadgetmind

finebone wrote: »

Are index-linked gilts, or funds that invest in them, in a similar bubble?
Or do you think they are still worth buying as insurance against inflation really taking off?

Yes and maybe.

Inflation linked gilts are currently priced with a negative real return to maturity. This means that buying them means you'll lose some of your future purchasing power as the price for retaining the rest of it.

Personally I hold corporate bond ETFs (a mix of SLXX and ISXF as I hold a lot of bank paper elsewhere), a couple of strategic bond funds (that mainly hold linkers and are short on fixed), and the aforementioned bank paper, which is some directly held preference shares and a fund that specialises in financial capital.

Buying this fund was *most* unlike me, but it's played out exactly as I predicted. Shame I didn't have more confidence!