Bonds - still so confusing...

aroominyork

dunstonh wrote: »

At this point in the cycle, HYBs are generally considered more favourable.

Mine are certainly outperforming the cautious strategic funds. So how do I get an understanding of bond – or broader – cycles, and what type of bonds to invest in when? Should I now be moving all my bonds into high yield?

dunstonh

So how do I get an understanding of bond – or broader – cycles, and what type of bonds to invest in when?

Knowledge and experience. You need to put the research and education in if you want to get to that depth of knowledge.

Should I now be moving all my bonds in high yield?

In most cases, no. HYB typically have higher risk. So, HYBs increase the volatility rating of your portfolio. So, whilst in term of bonds, they are the most attractive for upside. They are also pretty heavy on the potential downside. Not far off equities in some cases.

You have to balance your portfolio to on both the upside potential and the downside potential. If you went all HYB and general equities you could be looking at 45-50% loss potential. The HYBs would not give you much downside protection at all. The other types of bonds are there to give you diversification (as in most cases they are not correlated) and downside protection. They are not there to give you the best return.

aroominyork

Experience comes with time; this forum is my main source of knowledge.

If I understand correctly, dunstonh, there is nothing too wacky about having 10% of my portfolio in HYBs and 20% in cautious strategic. Is that right?

Does it seem curious that a moderately cautious portfolio has all its bond allocation in HYBs or (possibly answering my own question) does that depend on how the rest of the portfolio is invested? For example, since it also has 15% in property and some in targeted return could those holdings provide the cautious and the HYBs the intermediate?

dunstonh

If I understand correctly, dunstonh, there is nothing too wacky about having 10% of my portfolio in HYBs and 20% in cautious strategic. Is that right?

Nothing wacky there.

Does it seem curious that a moderately cautious portfolio has all its bond allocation in HYBs or (possibly answering my own question) does that depend on how the rest of the portfolio is invested?

Yes. The volatility rating of a portfolio can be tugged in different directions depending on the underlying assets. If you increase a percent here and means you may have to tweak a percent there and a bit more on another one.

For example, since it also has 15% in property and some in targeted return could those holdings provide the cautious and the HYBs the intermediate?

Bricks and mortar property funds can pull that risk level down but property share can push that risk level up. Diversification can pull the risk score down a bit too if the quality of diversification is good.

By targetted return do you mean absolute return funds? These can range for very low risk to very high risk. Just because a fund is an absolute return fund does not mean it is low risk.

chiang_mai

One field of thought is that bonds are a drag on the performance of an equity-based portfolio and that given that the income from bonds is far smaller than that of equities, the only compelling reason to hold them is as an insurance against a drop in the value of equities - the issue here is funds preservation rather than the search for yield.

But if an investor is unsure of the validity of that insurance, reducing the drag on the equities portfolio by putting the money from bonds into low yielding cash deposits, achieves the same goal and assures the integrity of the funds preservation insurance, albeit the upside is limited.

I think people sometimes get hung up on asset balancing within a portfolio whereas asset balancing can be done across all assets including cash in bank accounts, the effect is the same, cash is preserved and interest income is earned. Perhaps you should ask yourself why you want to hold bonds in the first place and whether that reason better lends itself instead to cash holdings or investment in equities (profit vs preservation).

aroominyork

Dunston, it was targeted return, I think an Invesco fund aiming for x% above Libor over x years.

Chiang, I take on board your comment, hence wondering a couple of posts back about moving some of my bond/non-equity allocation into p2p. I recently dipped my toe in through Ratesetter and feel ready for Funding Circle when they open for ISAs later this year.

chiang_mai

FWIW I hold bonds in two ways, firstly as a part of Mixed Asset products where I rely on fund managers to manage. In the second way I hold three bond only funds that I have researched and feel comfortable with albeit I track their performance weekly. Those funds contain mid/high credit bonds with short durations, my reasons for holding them are upside gain and downside protection, a sort of cake and eat it scenario which I am comfortable I will at least partially achieve - my asset balancing is done overall and includes low yielding cash in banks. And I also hold an index-linked gilts fund which has surprised in times of stress, in normal markets it is however a drag on overall performance.

point5clue

I've seen a lot of statements on the prices of bonds changing with interest rates - my question:

Do the prices change when the interest rate changes, or when there is an expectation of a change ?

e.g. it is highly anticipated that UK base rates will go up before the end of the year - will the market have already priced that in ?

aroominyork

point5clue wrote: »

I've seen a lot of statements on the prices of bonds changing with interest rates - my question:

Do the prices change when the interest rate changes, or when there is an expectation of a change ?

e.g. it is highly anticipated that UK base rates will go up before the end of the year - will the market have already priced that in ?

I think this is a great question, because so often you read that this, that and the other has already been priced in to a share/bond/currency price, to the point where it sounds like the markets barely need open more than once a year because every foreseeable event has already been priced in.

chiang_mai

On 17 September the BOE announced interest rates would rise sooner rather than later, the impact on bond fund prices was immediate. Since I track the performance of a new portfolio I've recently constructed I saw the impact of that news on my bond holdings although those funds have now recovered hence the rise is not priced in. It was that event that made me dig more deeply into what makes bonds tick and I've adjusted my holdings accordingly.

Also to consider: when we talk about interest rate rises and bonds falling, historically we're talking about whole percentage points rather than two small fractions over a year, the size of the rise or fall is therefore critical to the impact outcome.