Bond ETF Divergence from FTSE All Share

marathonic

Bond ETF Divergence from FTSE All Share

As a 30 year old, I currently have no allocation whatsoever in my pension fund to bonds.

I know the traditional advice is to slowly start switching towards them as you get older and have heard some of the 'crude' rules-of-thumb - such as maintaining an allocation towards equities of (110 - Age), the remainder being bonds.

This would imply that I should be 20% allocated to bonds. However, with 30+ years to retirement, I feel that, even with bonds fairly valued, 20% is excessive.

Add to that the general consensus that bonds are in a bubble, and my desire to invest diminishes even further.

However, the above chart is interesting and something that I'll be keeping an eye on. There may come a point where, although I feel that bonds are still overvalued, I may feel that equities are even more overvalued.

Obviously, I want to stay away from cash in my pension so I'll be having a look at the above chart every couple of months and could be invested in bonds to a certain extent towards the year-end.

What are your thoughts on bonds at current levels (include your investing timescale where possible as this will, obviously, impact investors decisions)?


NOTE: One problem with the bond ETF's is that they're quoted in dollars and the charts don't take this into consideration for comparing to the FTSE. However, the divergence from the DOW is even greater.

princeofpounds

Can't see the chart you link to, but I know the sort of point you are making. The thing is, you need to be ultra careful because you can draw entirely different conclusions depending on the start point of such a chart. Bond markets worldwide have been in a central-bank fuelled bull market, which is now being 'tapered'. So recent underperformance vs equity can easily be seen as a correction of abnormal previous outperformance. That's not to say buying bonds is bad right now, I don't know for sure. Just making a point on interpretation.

bowlhead99

Yields on 10-year gilts have been in the 2.4-2.5% range recently, compared to only a little above 2% a month ago, and under 2% a bit before that. So gilts (and with them, corporate bonds) are getting relatively cheaper.

Of course, if you go back to finance articles in newspapers in autumn 2010, they were talking about the yields hitting "new lows" at the 2.95% level, which is where yields had got to in March 2009 when QE kicked off. And we are not even back there, yet.

So, bonds are still very expensive from a historical perspective (10-year gilts were at 4% or more pretty much all through the 60s, 70s, 80s, 90s, 00s).

While it is tempting to avoid investment grade bonds and gilts at these prices (and as someone in my 30s, and something of a gambler, I don't have much exposure myself), they do have a place in a portfolio, because other things like equities are also expensive - at least relatively, compared to other parts of the economic cycle - particularly in some parts of the world. Given the economy at the moment, bonds are moving in the same direction as equities to an extent (e.g. recently when those in charge talk about ending QE, both equities and bonds take a hit), which is a little unusual and so you might think they add nothing.

But even if you don't intend to retire for 30-40 years (and finish living some 30-40 years after that), it would be quite useful if at some point when all your equities get 40-50% cheaper, rather than cursing and panicking, you can sell some bonds which only lost 25% of their value and top up your equities.

The question is simply when will that happen. If you stay in equities you might have a lot more absolute value to survive a fall. If you wait to the end of the year to move from equities to bonds you might be doing it at less favourable prices (both selling equities and buying bonds) than you could today.

It's a tough call to make because there's no right answers without hindsight. I'd suggest that if you are trying to time the market you should probably be looking at the charts more frequently than once every couple of months, as a lot can happen in a short space of time. How long did it take FTSE 100 to go from 6400 to 6800 and back down to 6100 recently? Of course the way to make money is to know where the charts are going to go next, which is impossible.

Others don't subscribe to the idea of market timing being practical and would say you should move to your 'ideal' long term allocation now. It sacrifices 'up-side' because bonds surely can't move too much higher (though clearly they can go a bit higher, because as per your chart, they've just fallen 5%), but bonds can still protect in a bear market which is their purpose for a long-term investor. If that were not the case, given equities outperform bonds over any 30 year period, a 30-year old retiring in 35 years would have zero bonds, which has not been the traditional (100 or 110 -minus-your-age) advice. The issue is just that the protection will not be as good as if you had been able to buy the bonds 30% cheaper than they are selling for, today.

marathonic

princeofpounds wrote: »

Can't see the chart you link to, but I know the sort of point you are making. The thing is, you need to be ultra careful because you can draw entirely different conclusions depending on the start point of such a chart. Bond markets worldwide have been in a central-bank fuelled bull market, which is now being 'tapered'. So recent underperformance vs equity can easily be seen as a correction of abnormal previous outperformance. That's not to say buying bonds is bad right now, I don't know for sure. Just making a point on interpretation.

I realise where you are coming from and agree that bonds are in bubble-territory.

However, some might argue that all assets are in bubble-territory. With the amount of QE happening, investing appears to have become a matter of buying the 'least-bubbly' asset as opposed to buying undervalued assets.

marathonic

bowlhead99 wrote: »

But even if you don't intend to retire for 30-40 years (and finish living some 30-40 years after that), it would be quite useful if at some point when all your equities get 40-50% cheaper, rather than cursing and panicking, you can sell some bonds which only lost 25% of their value and top up your equities.

Whilst your entire post was good, this is the quote that stuck out for me. Something for me to ponder for the week I think....

kidmugsy

Why not go for (say) 80% equity, 20% cash? Then if equities fall you have the cash to pick up some bargains. Unlike bonds, the cash won't fall.

marathonic

kidmugsy wrote: »

Why not go for (say) 80% equity, 20% cash? Then if equities fall you have the cash to pick up some bargains. Unlike bonds, the cash won't fall.

Because cash will be guaranteed to lose to inflation every year. The idea of being in bonds, for me, would be that they should beat inflation in most years and only be used to increase equity exposure after huge falls, such as those experienced in 2008-9.

The above is all in relation to my pension investments. If it were investments with a shorter timescale, I'd probably have a different attitude.

marathonic

There is now an 18.26% difference in YTD performance between BND and the FTSE All Share. This compares to 13.76% on the date of the original post - meaning that it would have been a losing proposition for me to allocate some of my fund towards bonds at that point (which I didn't).

Looking at exchange rates, given the fact that BND is quoted in USD, you'd have got $1.491 for every pound on July 5th and, today, would need to pay $1.615 for every pound. This increases the discrepency in performance further.

It's hard to know what to do with all assets looking pricey. I think, as advised above, the best advice is to just plough on with the regular monthly contributions.

bigadaj

marathonic wrote: »

Because cash will be guaranteed to lose to inflation every year. The idea of being in bonds, for me, would be that they should beat inflation in most years and only be used to increase equity exposure after huge falls, such as those experienced in 2008-9.

The above is all in relation to my pension investments. If it were investments with a shorter timescale, I'd probably have a different attitude.

I'd agree with kidmusgy, I'd keep in cash cuRrenlty and wait for the bond allocation to make more sense in time given risk versus reward. Nothing to stop allocation being varied over time, and high quality bonds are still expensive. I'm still keen on equities in general mainly because Yields are standing up quite well, everything is affected by qe and monetary policy but it's something relatively solid to hang your hat in in my opinion.

BLB53

Tim Hale (Smarter Investing) suggests 4% in equities for each year you intend to invest. So, long as you are OK with the greater volatility of shares, no reason why you should not continue 100% equities. Revue in 10 years.

marathonic

BLB53 wrote: »

Tim Hale (Smarter Investing) suggests 4% in equities for each year you intend to invest. So, long as you are OK with the greater volatility of shares, no reason why you should not continue 100% equities. Revue in 10 years.

Yeah, I'm comfortable with the risk in equities but like to have some opinion on where looks better to be invested from time to time.

At the moment, the difference in performance between the S&P 500 and the BND (Vanguard Total Bond Market ETF) for the year-to-date has exceeded 30% (link below):

Google Chart Here!

Obviously, this cannot go on forever. There will come a point when one, or both, will go into a downward trend but such a large difference in performance cannot possibly continue and one would expect, over the long term, the returns to edge towards their long-term averages.

I believe the expected long-term difference between the performance of bonds when compared to the performance of the stock market is in the region of 3-4%.