UK gilts or US treasuries?

Thrugelmir

northbob wrote: »

When the next economic crisis hits and equities enter a bear market where will the money move to if not bonds?

Different asset classes have become highly correlated. There's next to nowhere to hide. Other than to be highly selective in a choice of particular investments.

northbob

Quite a few replies are advising not to hold bonds, better to hold cash, on the basis that bonds values must fall.

coyrls made the valid point that this is like market timing.

I am more cautious of holding bonds now, but taking up the point coyrls made, if an investor stands on the side lines waiting because equity markets are overvalued (as they could be now) they often give up years of gains as stocks often continue to climb despite valuations.

Why is the same not true with bonds? If I am holding 40% in cash could this not mean losing additional return bonds could offer over cash for years to come for however long rates remain low?

If rates can only go one way (up) and it must happen soon, and everyone know it, wouldn't bond funds have this priced in already?

grey_gym_sock

all this fear of bonds is way OTT, IMHO. talk of losing 50% is ridiculous (when the idea is to buy government bonds).

the fact is that nobody knows whether interest rates are going up or down next. they can go either way.

and while interest rate rises can cause bond prices to fall (and interest rate cuts can cause bond prices to rise), it's a bit more complicated than that. the price of (say) a bond that will be repaid in 10 years' time is determined by what "the market" expects interest rates to be over the next 10 years. how does that change when (for instance) the BoE raises bank base rate by 1%? it depends; but typically, by less than 1% per year over the full 10 years, because the markets were probably expecting a rate rise at some point, and this just makes it a bit sooner than they were assuming. also, they may decide that an early interest rate rise will nip inflation in the bud, and hence allow rates to be lower after a few years - which could even result in the 10-year bond's price rising after an interest rate rise - not in most cases, but it could happen.

for a rough idea of how much a bond fund could fall/rise after a 1% change in interest rate expectations (not the same as a change in the current bank base rate), look up the "average duration" of the fund.

for instance, vanguard global bond index fund apparently has an average duration of 6.8 years; that implies that if interest rate expectations rise by 1%, the fund might fall by (very roughly) 6.8% . and if interest rate expectations rise by twice as much (2%), the fund might fall about twice as much, too (even more approximately).

if that's too big a potential fall, then try vanguard global short-term bond index fund, which has an average duration of 2.8 years; which implies that after a 1% interest rate rise, it might fall about 2.8% . and so on.

now, what's the biggest plausible rise in interest rates we might see over the next few years? a few percent? so what's the biggest potential loss from a bond fund? and how does that compare to shares, which (i would always assume) have a risk of falling about 50% in the worst case?

to clarify: i am not very negative about shares. i just think there is always a possibility of big falls in shares. bonds can fall, but not nearly as far as shares can.

however, the point (which has already been made) that, if you're going to go for short-term bonds, then you might well get a higher return using cash instead, is valid.

if you do want a bond fund, then - assuming you will remain based in the UK - either a sterling-only fund, or a global fund which is hedged to sterling, makes sense - otherwise the fund will be much more volatile due to exchange rate fluctuations. the vanguard bond funds are fine for this.

northbob

Thank you for this grey gym sock.

Many posts have warned against bonds and advise cash. But 40% cash seems too cautious. My cash allocation would be £300K.

I am now thinking:
10% Vanguard Global Short Term Bond Index, Ave Maturity 2.8 years
5% iShares Global Government Bond ETF SGLO Ave Maturity 10 years - long dated but Govt. Credit AA, and if all the allocations are longterm hold and rebalance, is there not a case for buying when everyone else is fearful?
5% Gold ETF - to hold something less correlated with equities
20% cash - what is the best home for the cash allocation in a SIPP and ISA?

Any comments/observations welcome.

Thank you to everyone for taking the time to reply.

AlanP_2

Cash in a SIPP or ISA is not going to earn much at all in current market conditions.

Once the IFISA is fully available putting some of the cash into P2P via that could be an option for you to consider as the rates on P2P are typically higher to compensate for the higher risk.

EdGasket

northbob wrote: »

Quite a few replies are advising not to hold bonds, better to hold cash, on the basis that bonds values must fall.

coyrls made the valid point that this is like market timing.

Why is the same not true with bonds?

Because bonds behave differently to equities. Read a few books and take a look at what happened to bonds in the 1970's.

Old grey gym " talk of losing 50% is ridiculous"; not at all, War loan and Consols lost much more than that at one time, take a look.

Malthusian

northbob wrote: »

I am more cautious of holding bonds now, but taking up the point coyrls made, if an investor stands on the side lines waiting because equity markets are overvalued (as they could be now) they often give up years of gains as stocks often continue to climb despite valuations.

Why is the same not true with bonds?

The capital value of an equity is expected to increase over the years (as the global economy expands and prices rise). The capital value of a bond is expected to eventually be redeemed at par.

grey_gym_sock

northbob wrote: »

I am now thinking:
10% Vanguard Global Short Term Bond Index, Ave Maturity 2.8 years
5% iShares Global Government Bond ETF SGLO Ave Maturity 10 years - long dated but Govt. Credit AA, and if all the allocations are longterm hold and rebalance, is there not a case for buying when everyone else is fearful?

SGLO doesn't hedge against currency fluctuations, so i'd avoid using it. its price will go up and down due to shifting exchange rates, more than in response to changes in interest rate expectations. which doesn't make much sense, when bonds are supposed to be the more stable part of a portfolio.

nothing wrong with holding a mixture of a short-term and a longer-term bond fund. but make them both funds which are hedged to sterling.

look at it this way: suppose you hold 5% in a 10-year bond fund, and interest rates rise unexpectedly fast. in the worst case, perhaps it would fall 10% or 15% ... well, that would be a fall of 0.5% or 0.75% in the value of your whole portfolio. compare that to shares: if you hold 60% in shares, and they fall 50% in the worst case, that's a 30% fall in your portfolio. and yet people are scared of bonds: why?

you could perfectly sensibly put more in longer-term bonds if you wanted to: e.g. 20% in a short-term bond fund, and 20% in a 10-year bond fund. if the latter fell 15%, that would still only be a 3% fall in your whole portfolio.

and, as you say, all these fearful people may be wrong. many of them have been saying the same thing for a few years, and they've been wrong so far. however, they may be right eventually.

5% Gold ETF - to hold something less correlated with equities

a little gold is OK if you like that sort of thing. it isn't to my to taste, but each to their own. note that the price of gold is very volatile, so it doesn't give you stability. it does give you something with little correlation to equities.

20% cash - what is the best home for the cash allocation in a SIPP and ISA?

tricky, especially in a SIPP.

for an ISA, you could transfer it to a cash ISA which offers the new flexible withdrawals feature, and then withdraw the cash and put it in higher-paying current accounts, which might pay more even after paying tax on the interest. thanks to the flexible withdrawals feature, you are able to replace this cash in the ISA later on. however, there are limits to the amounts of cash you can get especially good rates on. or just transfer to a cash ISA, and leave it these: cash ISAs will at least pay a bit more than S&S ISAs on cash.

grey_gym_sock

EdGasket wrote: »

Old grey gym " talk of losing 50% is ridiculous"; not at all, War loan and Consols lost much more than that at one time, take a look.

those were undated gilts - which have the maximum possible sensitivity to changes in interest rates. and there are no longer any undated gilts in existence.

nobody has suggested buying anything longer-term than a bond fund holding an average of 10-year gilts. and most have suggested keeping at least some of a bond allocation shorter-term than 10 years. with this kind of approach, there is no way that there could be 50% losses.

you seem determined to cherry-pick the worst possible outcome for bonds.

you talked about a £100 bond paying 0.5% interest, and how it would fall to £50 if rates rose to 1% . this applies to an undated bond (which doesn't exist, and nobody has suggested buying if it does exist), and even then it would only fall 50% if interest rate expectation for the very long term rose from 0.5% to 1%, not just if bank base rate rose from 0.5% to 1% - which is very different.

but then you dismissed the significance of rates falling from 0.25% to 0.1% . well, by your logic, a £100 bond paying 0.25% should rise to £250 in that event: a gain of 150%!

such dramatic falls or rises are not going to happen with a 10-year bond fund. when undated gilts did fall a long way, that was over a period of decades, as interest rate expectations gradually rose by a huge amount. with a 10-year fund, the only issue is the changes in expectations that happen over the next 10 years (approximately), since after 10 years, the fund will have reinvested the proceeds of maturing bonds into new bonds, which will be paying higher rates, if interest rates have indeed risen. (which they may not have done, anyway.)

coyrls

northbob wrote: »

20% cash - what is the best home for the cash allocation in a SIPP and ISA?

Exactly, for a SIPP you're likely to be stuck unless you are on a (generally expensive) patform that allows you to hold cash in a deposit account. So, you're back to bonds. If you want to minimise risk then SPDR® Barclays 1-5 Year Gilt ETF would do it. For ISAs, once the money is out of an ISA wrapper, putting it back in will count towards your annual allowance which may or may not be a problem for you.