Bonds (huh)... what are they good for?

Temrael

Hi all,

I've got 13 years to go until (hopefully) early retirement, so a longish time frame still, and have a reasonably balanced portfolio of shares, corporate and government bonds and a bit of cash.

I know opinions on this are probably quite strong/polar but I'd be interested in your considered/reasoned thoughts about the usefulness of bonds in your portfolio? Have any of you been tempted to substitute bonds for some other asset class?

Obviously bonds look expensive right now and as rates around the world begin to rise again, bonds will come under pressure. I know that some sort of "bond armageddon" has been prophesied repeatedly for years and that (other than a bit of a recent dip) has failed to materialise. I've even read someone say that bonds in a portfolio at the moment was like choosing to fly in a plane you knew there was a bomb on (though even then, I think he was conceding they still had their place!).

I'm sure that things are not as grim as that. Conventional, sensible wisdom states that "sure, bonds go up and down a bit but they don't correlate with equities and when bonds drop it's only by a small percentage when compared to equities". They therefore form a valuable, "calming" role in a portfolio.

I was interested though to read this article that makes the case that this is largely just what we've been used to in the last 35 years or so and that viewed on a longer time horizon, bonds have been known to be much more volatile asset class (we've been a bit spoilt).

It got me wondering whether the balance of risk/reward of bonds was worthwhile. Even ignoring the imminent worries about a bond crash.

Have any of you substituted bonds in your portfolio for something else that you hope will provide a bit of a return but isn't quite as "racy" as equities?

Property and commodities, whilst obviously providing diversification, are not going to steady the ship.

Is cash king? Obviously you need to work cash hard across the high interest current accounts and regular savers to even match inflation and not lose out in real terms.

Do you look to P2P (less risk than equities probably but largely untested by a really nasty economic shock)?

Genuinely interested in your approaches.

Thanks very much,

Ray_Singh-Blue

My investment statement used to call for 60% equities and 40% bonds,for all the usual reasons.

A couple of years ago I got cold feet about bonds though. I think bond funds are all but certain to drop in value as interest rates rise. Unless we enter a period of true (nominal) negative interest rates, but that just feels too weird to actually happen in reality. So I so no reason to buy them, and therefore no reason to hold them.

My "new" asset allocation (as of 2014) calls for equities 60%, cash or bonds 20% and commodities or bonds 20%. At the end of 2016 allocation was stocks 57%, cash 24%, commodities 19%.

That cash is in a ladder of fixed term ISAs currently returning an average of 1.7%, wiith no prospect of capital loss (unlike bond funds)

The commodities are in a number ETFs & have been very volatile,as you say.

At some point in the future I expect to get back into bonds. I think the return of a positive real yield on inflation linked bonds might be my trigger to consider it, but have not yet decided.

Morphoton

When I started my SIPP back in 2008 I had an allocation of 75% equities and 25% UK Indexed linked gilts. The real yield on the IL Gilts is now ~minus 1.5%. Because of this, whilst I have not sold any UK IL Gilts, on rebalancing I now purchase US IL gilts through the iShare ITPS. US IL Gilts have a real yield that is positive (if only just). Currently I have ~18% UK Gilts and ~7% in ITPS. I think QE by the BoE has made UK gilts just too expensive.

Temrael

Thanks both, that's interesting.

Of course, there's a strong chance that reducing bonds too much will just just serve to hurt returns in the long run (i.e. we could miss out on some growth).

For me though, that potential downside feels like it's outweighed by the risk that a sustained longer drop in bonds does the same thing. I'm pretty much on track at the moment (getting towards the figure I need for early retirement) and I don't need massive growth. I'd rather limit my future returns a bit but remove the risk of bonds going bang in a big and longterm way, and therefore pulling my portfolio backwards. We've not seen them do that for 35+ years, but we know that historically they can.

I'm tempted to reduce my bonds a little and expand the cash side of the portfolio a bit, working it hard on the high interest current accounts/regular savers as there's still some I've yet to do.

EdGasket

I'd only consider short-dated bonds right now. If interest rates move up then the capital value of bonds will slide. To answer the title (reference to Edwin Starr's War song) ....Absolutely Nothing! (well almost)

Temrael

Thanks for that, yep certainly shorter duration are more tempting at the moment.

EdGasket wrote: »

To answer the title (reference to Edwin Starr's War song) ....Absolutely Nothing! (well almost)

I can't take credit for the cleverness of that, it was the title of an article I read on Bonds somewhere on line.

Morphoton

If you hold UK gilts individually you can have the certainty of knowing the income and capital return which you do not have with a bond fund for which there is no maturity date, or even cash as the interest rate may change.
With 13 years to go you can buy the conventional 4.75% 2030 UK Gilt which has a yield to maturity of ~1.64% as of today 12 Jan 2017. i.e it will cost you~£139 for £100 nominal stock and you will get £4.75 interest per year and your £100 capital back in 2030 (the 13 years interest minus the capital loss results in the 1.64% yield). Obviously the price may change between now and 2030, but if you hold to maturity it does not matter.
See the the BoE's DMO (Debt Management Office) website for daily prices/yields etc of all the UK gilts.
For Indexed Linked gilts there is the 2029 0.125% IL gilt with a yield of RPI (Retail Prices Index) MINUS 1.8%. This works the same as above but the yield is linked to the RPI. This looks poor value now but if inflation went to say 4-5% or even higher and interest rates did not increase then RPI -1.8% may be better than the alternatives. It also gives you insurance of unexpected inflation increases.
So it depends on what interest rate you can get on cash and what you think inflation will do as to what will be the best policy. A mixture of the above can obviously be done.

Linton

Temrael wrote: »

......

Property and commodities, whilst obviously providing diversification, are not going to steady the ship.
..

Yes, commodities are a little exciting for nervous investors. However Property is different. If you go for a fund that invests in property company shares the price will vary mostly in line with the wider market. However there are "direct" property funds that own office blocks, shopping malls, doctor's surgeries etc. These are very much more stable as their price is based on a surveyors assessment of the capital value and the rental income. So I believe direct property funds can form a useful addition to bonds in a balanced portfolio.

Glen_Clark

The personal investor can do better in retail savings accounts than bonds. But the large fund manager doesn't have that option. If he has to hold cash he is pretty much stuck with bonds even at negative rates. If managing a pension fund for example, he may be forced to keep a percentage in cash based investments. Where his liabilities (eg paying pensions in Sterling) , he may have to keep some investments in the same currency for safety.

EdGasket

Glen_Clark wrote: »

The personal investor can do better in retail savings accounts than bonds.

Not if you have a S&S ISA or SIPP; then you are pretty much in the same boat as the 'fund manager' i.e. cash earns nothing and bonds very little with a risk of capital decline against rising interest rates.

AlanP_2

Linton wrote: »

Yes, commodities are a little exciting for nervous investors. However Property is different. If you go for a fund that invests in property company shares the price will vary mostly in line with the wider market. However there are "direct" property funds that own office blocks, shopping malls, doctor's surgeries etc. These are very much more stable as their price is based on a surveyors assessment of the capital value and the rental income. So I believe direct property funds can form a useful addition to bonds in a balanced portfolio.

I've been looking for a property fund that is in "direct property", ideally global, and struggled to find one.

No doubt down to my incompetence.

Can you point me at a couple please?


Thanks