UK gilts or US treasuries?

northbob

I hold index trackers for global equities, Vanguard Lifestyle 100 60%, and 10% each in global small cap, high dividend yield, and emerging markets. OK until now but I want reduce equity exposure to around 60% with the rest in bonds, a small amount of cash and/or gold not too much.

I know bonds are unlikely return as much as equities but in an equity downturn bonds should fall less and can be sold to rebalance buying more equities at the lower price. I explain this in case anyone wonders why I would want to hold bonds.

For lowest risk I think only top quality Government bonds not corporate.

Is there a good reason to buy only UK gilts, or is it worth also holding US treasuries? If US treasuries is it necessary to hold the GBP fund or is it OK to hold the USD version as my long term living costs will not be in GBP anyway and I already hold all my equity holdings in GBP funds so I already have GBP currency exposure (which am happy with and I want to continue holding my investments in the UK).

So UK gilts or US treasuries, or both, or if US treasuries in my situation should I still get the GBP version? I favour half in short 1-3 years and half in medium 5-8 years for stability and lower risk.

Thank you for reading.

jimjames

With current rates would it not be better to just hold cash?

northbob

I like I said I don't want to hold too much cash. I will hold some in bank savings but i want to stay within compensation limits and have some in NSI. But I dont want to hold 40% of my investments in cash.

bowlhead99

northbob wrote: »

I know bonds are unlikely return as much as equities but in an equity downturn bonds should fall less and can be sold to rebalance buying more equities at the lower price. I explain this in case anyone wonders why I would want to hold bonds.

For lowest risk I think only top quality Government bonds not corporate.

Well, the return on the short dated 1-3 year bonds are nominal, pretty close to an interest-free bank account. Easily beaten with high street bank accounts assuming you are not trying to do it inside a pension wrapper where such bank accounts aren't available. Obviously if it's 40% of your entire wealth, it might be too mich to get the top bank account rates designed to entice small customers, but you can still get half a percent or more.

The 1-3 year bonds do not have much downside but the upside is minimal. So what is wrong with holding GBP or USD cash rather than those type of bonds? In an equity downturn you can use the cash to buy more equities in just the same way that you would propose to sell 1-3 year bonds and use the cash to buy more equities.

The medium (5-8yr) ones are not much more lucrative than the short dated ones, and have more chance to fall in value in the short term.

Is there a good reason to buy only UK gilts, or is it worth also holding US treasuries?

As you mentioned in another part of your post, in the long term your living costs will not be in GBP. And presumably when your equity downturn happens, you will be looking to buy not just some GBP equities but also some USD equities. So it would make sense to not restrict yourself to holding just UK bonds; US ones (and potentially other countries / currencies) can certainly be worth having, for currency diversification.

If US treasuries is it necessary to hold the GBP fund or is it OK to hold the USD version as my long term living costs will not be in GBP anyway and I already hold all my equity holdings in GBP funds so I already have GBP currency exposure (which am happy with and I want to continue holding my investments in the UK).

If you decide to buy a fund that's holding US treasuries, which are dollar assets, it really doesn't matter if you are buying a version of the fund which is priced daily in pounds or in dollars.

Say you hold $1000 of treasuries. It doesn't matter if the manager tells you you have 500 units at US$2 a unit, or 770 units at GB£1 a unit, or 90000 units at 1 Eurocent a unit, because either way you still have $1000 of US treasury assets.

If the exchange rate changes from 1.3 to 1.5, then the $1000 of treasuries bought in dollars would still be worth $1000, although that is now only worth £667.

If you had bought the dollar version of the fund you would still have 500 units and they would still be $2 each and still worth $1000. If you had bought the GBP priced version your 770 units are only worth 86p each and still worth $1000 overall. So you have not gained or lost any dollars, because whatever 'version' of the fund you buy, whatever they choose to publish the price in, you are still holding $1000 dollars.

From this you can see that your currency risk comes from the choice of underlying assets held, not the currency they show the price in. Whichever version, your US treasuries are still worth $1000, and whichever version, you can still sell them and get £667 cash. You don't take on risk or avoid risk by changing the display price of the fund you buy that holds the dollar assets.

There is a practical issue that if you are buying the funds on a UK broker platform, and you have GBP in your bank account to buy the fund, and you choose to buy a fund which publishes its daily prices in dollars, your broker might need to do a currency conversion to buy you dollars to buy into the fund, and the broker's fx fee for doing that might be a percent or so.

Whereas if instead you bought the class of fund priced in GBP, the broker does not charge you a commission for the conversion, and the fund itself would convert the GBPs received from new subscribers at a very low fx commission cost. So, for administrative cost and convenience you might prefer to use the GBP-pricelisted version of the fund, even if it is a fund that exclusively holds US assets.

northbob

Thank you for the fund currency explanation. I see that the GBP version makes sense for the practical reasons rather than any currency hedging advantage.

Textbook 'balanced' portfolios normally have an allocation to bonds. But I've now had two replies suggesting a 40% allocation to cash would be better. Now I am even more uncertain as I have another decision to make instead of just which bonds.

AndyT678

northbob wrote: »

Textbook 'balanced' portfolios normally have an allocation to bonds. But I've now had two replies suggesting a 40% allocation to cash would be better. Now I am even more uncertain as I have another decision to make instead of just which bonds.

If you're an institutional investor with £1,000,000,000 to play with then a 40% allocation in bonds makes a lot of sense because you won't get much of a return on cash.

As a retail investor with a much smaller pot and access to promotional interest rates the decision is very different. When you can get 3% - 6% risk free on cash there's no reason to touch govt bonds IMO.

I have a small amount in corporate bonds but nothing apart from that.

northbob

3%-6% risk free on cash? Anything offering those returns must have a risk. Sorry I just find the 'risk free' claim hard to believe. If it's something like P2P that isn't risk free so maybe 5% of my pension and savings but not 40%.

To stay within the FSCS savings compensation limits per bank would require me to spread it to the maximum amount allowed between 6 unconnected banks and earn very little interest - a few higher interest £5,000 or £20,000 deposits wouldn't be enough.

bowlhead99

northbob wrote: »

3%-6% risk free on cash? Anything offering those returns must have a risk. Anything with those returns doesn't sound like where I want the safe 40% of my portfolio. Sorry I just find the 'risk free' claim hard to believe.

To stay within the FSCS savings compensation limits per bank would require me to spread it to the maximum amount allowed between 6 unconnected banks and earn very little interest - a few higher interest £5,000 or £20,000 deposits wouldn't be enough.

The 3-6% is genuine but as you say it is for a few higher interest deposits of the odd £5k here or £500 a month drip-fed there, using a number of banks. If the 40% of your portfolio is in the region of £250-300k (six unconnected banks) then you are not going to hit anything close to 3-6% as an average.

However, 1% would be achievable easily enough, as you are never going to move this non-equities part of your porfolio to go down to 0% in this part of your portfolio and so do not need it all instant access; some could be on 1-2yr+ deposit, and even the instant access stuff pays more than 1-3yr gilts.

Whereas, no UK gilt with a maturity lower than 8 years has a yield of greater than 0.5%: see table of yields here https://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3

You had said you were willing to put half your bonds (i.e £150k?) into 1-3 year gilts and as you can see from the table they are yielding 0.1% or less. Up to 5 years they are yielding 0.25% or less and only at 8 years plus do you breach 0.5%. To do that is surely completely mad, when you can get a whole percent from the banks.

As an alternative to needing to split your cash over many banks to keep within the insured/ compensation limits, you can use National Savings & Investment products which are treasury-backed - no FSCS needed as they will not go bust, the government can print as many pounds as it wants and so their safety is basically as good as a gilt. http://www.nsandi.com/income-bonds pay 1% at the moment and can be withdrawn penalty free with zero notice. The account limit is a million.

If you are a huge bank or institutional pension fund and can't use that 1% account because you have a billion not a million, then you would have to buy a short dated gilt paying 0.1%. A small investor like yourself should not do that.

There is just one 'but...' ; we had said before that you should not just restrict your short term bonds to UK Gilts because that misses the currency effect of having US treasuries and you should have a bit of both (if not even more, like the equivalents from Germany or Japan). Whereas if you use cash as a proxy for gilts, then if you put the whole £300k in a GBP bank account or NS&I account, you would miss out on that currency aspect and so your performance might be materially different - perhaps for better, or perhaps for worse.

So if you wanted that currency exposure - which does make logical sense if you are not going to be in the UK forever and you may be expecting to buy a significant level of non-UK assets when you increase your equities exposure in future - you would need other currency bank accounts. Foreign currency bank accounts, especially in the UK where there is little demand for them, do not pay great rates. Citi are doing something like 0.1% on dollars. However, you can try offshore, where an account in Isle of Man operated by Nationwide will pay 1% on deposits of $25k+ (promotional rate expiring after 12 months, dropping to 0.25%) or Lloyds International offer 0.75% for a 1 year fixed term deposit.

Those would be covered by the IoM equivalent of FSCS but still relatively low risk.

HTH

jimjames

northbob wrote: »

3%-6% risk free on cash? Anything offering those returns must have a risk. Sorry I just find the 'risk free' claim hard to believe. If it's something like P2P that isn't risk free so maybe 5% of my pension and savings but not 40%..

Absolutely risk free and absolutely genuine and has been available on limited amounts (around £100k) for at least 4 years. I have all my cash at 5%.
Bowlhead gave the comprehensive answer but I really can't see the point in holding gilts in a portfolio when the yield is low and they only seem to be likely to go one way.

northbob

bowlhead99

Thank you for that great information.
NS&I income bonds looks a possibility. The fact there is instant access makes a difference as putting the cash into a fixed term account would make it unavailable for rebalancing.

As straight UK Govt gilts offer so little, is there a case for a global Government bond fund or with some high quality corporate?

10% into:
NS&I income bonds as a proxy for cash holdings

10% each into:
Vanguard Global Bond Index Fund GBP Hedged Acc IE00B50W2R13, Yield 1.64%, YTD return 5.76%, (64% Govt. 36% corp & other) Credit Quality A, Average Maturity 7 years

Vanguard Global Short Term Bond Index IE00BH65QG55, Yield 0.87%, YTD return 2.0%, (60% Govt. 40% corp & other) Credit Quality A, Average Maturity 2.8 years

iShares Global Government Bond ETF SGLO IE00B3F81K65 (fund size $915m) 100% Govt. Credit AA, Average Maturity 10 years

Or (for the bonds holding) just the last two - not sure if the first adds that much that a mix of the second two does not offer.

bigadaj

The problem is that bonds have always been considered the boring steady element of most portfolios, with lower volatility.

If you check some of the bond funds, then they have had huge gains over the last few years, what goes up may well equally come down, so there's a reasonable chance of significant capital losses in the next few years. There's certainly less potential for upside return.

The reduction in interest rates has affected many areas, people obviously want to diversify away from equities, and this has resulted in some of the steadier investment trusts going into significant premium, infrastructure funds becoming very expensive etc

Cash held in a safe environment currently doesn't look too bad, though we'll see if inflation does take off in the coming months and years.

People are looking towards p2p, and it offers the potential for good returns if risks are managed, whether issues around capital losses arise in the future we'll have to wait and see.