How does my bond tracker lose value!?

gribbon

They say never invest in something you don't understand, and I've now come across something I can't get my head around.

Part of my (passive) portfolio is in a UK govt bond tracker (L&g all stocks guilt index). Albeit a small percentage.

I understand the fundamentals of how bonds work, the government issues them with a guaranteed return each year until the date they are paid back.
If the above is accurate, I don't follow how a gilt tracker can lose value. Eg the above tracker was down 0.26% yesterday. Can anyone explain how that is possible when the tracker is wholly investing in something which provides a guaranteed return each year?

Many thanks.

Aretnap

The bonds can be bought and sold over the course of their lifetime, and the price rises and falls depending on the market's expectations of future inflation, interest rates etc.

If you have a long dated bond which was issued before the financial crisis and pays a coupon of (say) 5% then people will be willing to buy it for more than it's face value - because 5% is better than any guaranteed return you can get at the moment, so it's worth paying a premium for.

OTOH if you've got a gilt paying something like 1% and people expect interest rates to go up soon then you might find that nobody is willing to pay face value for it - because they expect to be able to get a better return than 1% soon enough.

So bond prices fluctuate - just not (usually) as wildly as share prices. The value of your fund is quoted in terms of the market value of all the bonds it holds today - so it can go down as well as up.

masonic

It is pretty simple - there is a secondary market for gilts. Any time you sell units in a gilt fund you will be selling into the market for whatever price someone else is willing to pay for those assets. Only if you buy individual gilts directly and hold them to maturity will you get a fixed return.

jamesd

If you want something that works as you expect you might consider P2P. These also have a secondary market but it's typical to just hold until maturity so you can ignore the fluctuations in value.

You can expect bond funds to decrease in value as interest rates go up. That's how the higher interest rate is delivered to the bond buyers. If you use a fund you can't avoid this capital money loss. You can if you hold bonds directly or use P2P, because that lets you just hold until maturity.

racing_blue

Gribbon you ask "HOW does my bond tracker lose value" which is a question I pondered at length before deciding to invest instead in cash and commodities for the "non-equity" part of my portfolio.

My take, The quick answer is that the value of bonds is simply the mathematical sum of their redemption value at term plus any yield in the meantime.

Right now I might pay £1 for bond A, based on the maths. However I also need to consider what else I could do with £1. If interest rates rise and I can get a better return elsewhere, then I might only be willing to pay 80p for bond A. So the value of the bond has dropped.

This is why bond funds can and have fallen and risen by as much as 20% in a year.

If you look at the performance of bond funds in recent years, they have risen. Can they rise forever? Can interest rates get any lower? You answers to these questions will probably guide you in your decision whether to invest further in bond funds.

There is a lot of information about this in the bogleheads wiki

FatherAbraham

jamesd wrote: »

If you want something that works as you expect you might consider P2P. These also have a secondary market but it's typical to just hold until maturity so you can ignore the fluctuations in value..

Unless there are excessive defaults on repayments, in which case the OP would lose money.

James, you really do have an idiosyncratic understanding of risk. Some of the ideas you post are clearly inappropriate.

Warmest regards,
FA

bigadaj

FatherAbraham wrote: »

Unless there are excessive defaults on repayments, in which case the OP would lose money.

James, you really do have an idiosyncratic understanding of risk. Some of the ideas you post are clearly inappropriate.

Warmest regards,
FA

So would you consider the p2p option more or less risky than bonds currently?

Id be tempted to say less with reasonable spread and diversification.

Mirno

Depends who's bonds you're buying, and to whom you lend money!
Anyone fancy buying Greek bonds at the moment?

bigadaj

Mirno wrote: »

Depends who's bonds you're buying, and to whom you lend money!
Anyone fancy buying Greek bonds at the moment?

Exactly, Greek bonds are worth a punt at a penny in the pound.

arbster

Mirno wrote: »

Depends who's bonds you're buying, and to whom you lend money!
Anyone fancy buying Greek bonds at the moment?

I've been wondering when Funding Circle will post a slew of Loan Requests entitled "Greece Part X", featuring their new "E" risk band...

jamesd

FatherAbraham wrote: »

Unless there are excessive defaults on repayments, in which case the OP would lose money.

While there's no guarantee it's hard to actually lose money on the platforms that have protection funds or well secured loans.

FatherAbraham wrote: »

James, you really do have an idiosyncratic understanding of risk. Some of the ideas you post are clearly inappropriate.

I don't have a wrong view of their risk level. The difference is probably just me knowing more about them than you do and to some extent comparing them de novo with existing investments.

Normal bonds today have a realistic prospect of a 30% capital loss as rates rise, plus their usual volatility. None of the mainstream protected or secured UK P2P platforms has the prospect of a loss of that magnitude. More realistically, they just don't have a prospect of a loss at all and their volatility is extremely low.

To lose money on the protected ones - those with a pot to provide the money - there would need to be total loses across all loans that are sufficient to drain whatever amount is in the protection fund pot. Individual loan losses won't do it, so individual loans are safe from default risk. The issue with these is a sustained period of defaults or potential hiccups if the platform fails and the FCA-mandated process for ongoing running off of the loan book doesn't work smoothly. There's money to be made from the loan servicing so I expect that another provider would want to take over the business. That's what's happened so far in the UK ones that shut down, if they didn't just repay all lenders their whole capital and take on the remaining loans themselves.

The secured ones have normal security. Loss potential on these depends on the quality of the security among other things like the normal underwriting practices. Some platforms don't have particularly good security or underwriting, others seem to. Even the ones with less good security and underwriting seem not to have led to losses for lenders who were reasonably diversified, though they probably do have some customers with a net loss if they did little lending on an unfortunate combination of loans, so didn't acquire a diversified portfolio.

Before there's an actual loss, the losses would also have to be more than the interest paid. That's quite tough as a hurdle for some of them, due to the level of interest rates being high.

At the moment a reasonable selection of P2P has a way better risk profile than a bond fund. Instead of a near certainty of a loss there's no real prospect of a loss.