vanguard 40 vs 100

Mistermeaner

Hi

Question: seeing lots of negative stuff about bonds and the risk that if interest rates rise in next few years bond funds will drop in price.

Prior to this negativity towards bonds i understood that a fund more heavily weighted to bonds was a 'lower risk' option : eg vls40 is intrinsically a less risky fund than vls100

Given the possible impact on bond funds if interest rates rise does that alter peoples perceptiins of the relative risk in the vls40 / vls 100 (or indeed the other variants)?

Ryan_Futuristics

It's very hard to predict how bond funds will be impacted (partly because it's proving hard to predict how and when rates are going to rise)

A better way to think of it may be that bonds are looking expensive ... Bonds are trading high and yielding low - so if you buy or hold bonds now, you're probably not looking at a great risk/reward outlook (and funds will likely reflect that at some point)

It's very easy to be swayed by what's worked and looked robust in the past - and of course it benefits many fund managers to instil the idea that no one can make predictions ... Bonds still look expensive

But then so do US equities (and by a more concerning degree), which could be a long-term drag on a VSL 100 fund (where they make up almost 40% of the portfolio)

Just like bonds, US equities may have been in a long-term bubble, and look significantly overvalued

My advice if you really like the VSL funds and trust Vanguard (*shudders*) would be to buy the individual components

Avoid the US components for now (buy when the US index is back down to 2,000), and use Vanguard's Short-term Investment Grade bonds fund instead (as this is a new fund designed for rising rates - short duration means there shouldn't be so much risk to capital depreciation ... although yields are a predictably modest 2.05%)


Personally, with so many moving parts to investing in the mid-term, I'd look very carefully and broadly at the active vs passive debate

bowlhead99

ggb1979 wrote: »

Prior to this negativity towards bonds i understood that a fund more heavily weighted to bonds was a 'lower risk' option : eg vls40 is intrinsically a less risky fund than vls100

Given the possible impact on bond funds if interest rates rise does that alter peoples perceptiins of the relative risk in the vls40 / vls 100 (or indeed the other variants)?

There has always been a potential negative impact on bond funds if interest rates rise. What people are talking about is that the interest rates and bond yields in many parts of the world are close to all time lows, and therefore there would seem to be a greater risk of losing capital, lower possibility of capital growth, and generally lower annual interest to be earned from bonds today vs 5-10 years ago.

However, people have been saying this for quite some time, without serious money being lost since people started saying it.

The fact that bonds are more expensive than they used to be, does not make them riskier than equities or flip it around so that the VLS 100 is somehow a safer fund than a VLS 40. If equities crash, bonds are still a relative safe haven - with corporate bonds, companies will only really start to default on their bonds after the equity holders have lost everything, and major governments very rarely default on their bonds. So you can still get paid out if you hold to maturity, you just have a depression in prices which could be worse and longer with a long maturity bond.

Certainly with some special promotional bank current accounts paying 5% AER, compared to a 10 year bond yielding 3% or a longer term bond paying a bit more but with an even greater possibility of capital loss in the short to medium term, bond heavy funds are relatively less attractive than they once were if you want to preserve capital. Of course, those special promotional bank accounts are not available inside ISA wrappers or pensions and can only hold so much money anyway. But it is always worth considering what other non-equity options are out there.

The bond trackers used within the VLS have quite long average maturities - 13 years for the investment grade corporate bonds, 15 years for UK govt. They don't hold the bonds to maturity, merely seeking to match the average mix of bonds available in the market at a point in time. So that might be considered more risky than just buying some short dated bonds or bond funds which will literally be held until they pay out, rather than sold off at a future low price as market dynamics change in future years. Of course, the return on a super-safe bond is negligible, but it's better than a loss.

If you take the UK govt index fund, it is paying out a yield of about 2%; that's what its mix of underlying bonds is currently delivering. However, over the last 3 or 5 years it's given an average total return of 7-8% a year ; even in the last 12 months it's given a total return of 6%+. Much of the return comes from the rising prices. Clearly, if the prices are so high already, there is not enough headroom for them to keep going up and up and up. A bond is just a fixed amount of money borrowed with a promise to pay it back some day. Unlike an equity which benefits from a company earning more profits over time, a bond is only ever going to get paid out at its face value.

Some of these bonds are not going to get paid out for 30 years (average 15 years). So, as people like the safety of bonds they may bid those bond prices very high to receive the ongoing income for a very long time before we have to consider getting paid out. If sentiment reverses, and market interest rates for cash deposits and newly issued bonds increase, then old bonds are less attractive and s there is a serious risk that over the long long wait for maturity, prices come down a long way.

But the risk of lower prices due to changed interest rates or changed credit ratings has to be taken in context with the likelihood of that happening, or at least happening rapidly. Governments are keen to not increase interest rates very far very fast. Equities could drop 20% in a week or a month, 40-50% in a year. Bonds could certainly give back a lot of the previous years gains (which have been spectacular over the last decade considering the 'relative safety') but it is likely to be relatively slow and steady compared to equity valuation movements.

And certainly if everything was doom and gloom and equities were dropping disastrously, governments are less likely to want to put the brakes on the economy by raising interest rates to screw your bond prices, and the investors fleeing equities would be looking for new home for capital so would create bond demand. So whatever the current price of bonds, they should not move in the exact same way at the same times to the same extent as equities; they still function as a diversifier in a portfolio.

There are obviously lots of different types of bonds - long dated, short dated, government, index linked, corporate, high yield, domestic, international, different currencies. At different points in the economic cycle different types of bonds are more or less attractive and more or less at risk of gaining or losing capital value or yield. High yield bonds move more in step with equities as they rely on companies' profitability and creditworthiness to pay out. Government bonds do not.

Tactical or strategic bond funds that allow their portfolio mix to actively hop between bond sectors are an alternative to slavishly following an index of certain types of bonds that are out in the market, and I quite like some of them. There is no doubt that they are inherently more 'risky' than government bonds because they are further up the risk scale in terms of creditworthiness even as they flit between sectors.

Run well and steered correctly, they should probably give a better return than government bonds, and might be flat or go up when the government ones fall in capital value. Of course, just because something can give a higher return than something else, doesn't mean you should buy it. It might be wiser to buy a government bond that's 'destined' to lose 15% rather than buy a strategic bond that then loses 25% or an equity that loses 40%. There are people accepting zero or negative implied yield to maturity on some index linked bonds - this means they're expensive, but clearly there's still a demand to get a safeish zero with some inflation protection, rather than get a loss.

Ryan_Futuristics

Another concern could be how investors react to the first rates rise

I (perhaps prematurely) offloaded my Royal London Corporate Bond and Jupiter Strategic Bond funds a few months back - both great performers (Royal London's returned a fairly consistent 10%/year) - but this was when a rates rise seemed more imminent

The problem I foresaw though was a rush for the exits ... If investors get spooked by an approaching rates hike (and knowing the media these days ...), they could wreak havoc on bond funds, forcing them to sell off assets in the worst environment imaginable ... and there have been situations where funds have had to put the brakes on and stop investors withdrawing, while capital values could be in free-fall ... (Some asset managers out there are genuinely worried by this - more than necessarily the effects of a rates rise in isolation)

edinburgher

I'd not be in VLS40 unless I was already retired, even then I'd probably want more equities/the chance for growth. There are plenty of options if you decide to go with Vanguard.

I think that the US arm of Vanguard does a better job of pointing out the differences between the LifeStrategy products, focusing more on risk and invidual investor tolerance to it. Granted, it's a one size fits all approach, but looking at this page (and perhaps a more detailed risk tolerance assessment), might give you more of a 'feel' for what sort of product might suit you.

dunstonh

eg vls40 is intrinsically a less risky fund than vls100

Its not. VLS100 could lose 50% in value. VLS40 cannot (actually nothing says it cannot but if VLS40 lost 50% then VLS100 would be more still).

So, whilst bonds may have a period in future (and that period has been coming every year for the last 7 years according to some people but hasnt come yet) where they may see low growth/no growth/small losses on unit price. You have to remember the income will still come in and the losses will be lower than what equities are capable of.

enthusiasticsaver

I am considering the Vanguard LS60 as a first fund to invest in within an ISA at the grand age of 55 and have been investigating other mixed investment funds with moderate risk and have come across Blackrock consensus 85 which seems to be less bond heavy than the Vanguard but similar performance, which I know does not necessarily mean anything. Like others I have heard bonds may be a little overpriced so I am wondering if I should look further into the Blackrock. The Vanguard LS funds seem very popular though so as a novice investor I guess I am leaning towards them. Both of them seem to match my risk tolerance though. Any thoughts or advice from those of you who are obviously much more clued up than me?

Ryan_Futuristics

dunstonh wrote: »

So, whilst bonds may have a period in future (and that period has been coming every year for the last 7 years according to some people but hasnt come yet) where they may see low growth/no growth/small losses on unit price. You have to remember the income will still come in and the losses will be lower than what equities are capable of.

I think the only fair thing to say is that no one really knows for sure

The general consensus is that it's likely we will see rates rise from these historically low levels in the next year or two

And it's one thing to predict how this will impact bond funds, but another to predict how investors will react ... If the financial media manage to spook people, a clamber for the exits could conceivably see funds plummet ... Rising rates and mass-selling may be a perfect storm

dunstonh

Both of them seem to match my risk tolerance though.

They cant do.

BR Consensus 85 is higher risk than VLS60. Not just by a little bit but quite a few notches up the scale.

Also consider the L&G Multi-index funds which are similar in using passives but a wider range and will make active management decisions on the allocations and not fixed like some of the others.

I think the only fair thing to say is that no one really knows for sure

Absolutely. If you take the Donald Rumsfeld approach in that you know you dont know then you will be in a much better position when it comes to investing.

Rising rates and mass-selling may be a perfect storm

But even if does, the scale of the drop will likely be lower than the scale of drop that can and will occur (typically on a more frequent basis) than equities (albeit likely at a different time and different reason). Remember risk is looking down. Potential is looking up. The perfect storm is equities and bonds going down together (and property for good measure!)

enthusiasticsaver

Is BR Consensus 85 higher up the risk because of the higher level of equities or is it because it is more UK biased than US? Legal and General multi index is also on my list to look at so thanks for the pointer. I will have a look at that one. The advice everywhere seems to be for my risk profile I want multi asset but it is this passive v active debate and the idea that bonds are overpriced that is throwing me at the moment. I do not want to take undue risks with my capital but at the same time as the market is quite high at the moment I am just not sure I want to overpay for a fund leaning towards bonds simply because they are safe otherwise I may as well stay in cash isas.

Freecall

As much as I enjoy reading contributor’s opinions on what might happen to markets in the future (bond markets or otherwise), surely this is all just academic chit-chat.

The fact is that for the vast majority of markets that ordinary investors are likely to consider, there is a high level of both market knowledge and liquidity. This means that the price at which an investment trades is the distilled view of the entire investment world on what an investment is ‘worth’.

So unless you really have some inside knowledge that the market as a whole does not possess, trying to second-guess where things are going is futile.

The real issue is picking investments (or a portfolio of investments) that meet your needs.

On the whole, the VLS40 is likely to give lower returns but will be less volatile than the VLS100. It’s up to you, the question is, what are your specific requirements for your investment?