Bonds newbie

Thrugelmir

chucknorris wrote: »

so maybe I haven't quite got there yet, but I see them as mainly protection from a share price crash.

QE and an era of low interest rates has resulted in a close correlation between asset classes. As investors chase yield. A different sitituation to the past. When there was an argument for holding both asset classes in order to provide a degree of protection.

bowlhead99

chucknorris wrote: »

I just want less risk than a portfolio holding 65% equities, hence something like 40% equities and 25% bonds. I would tend to go for safer companies (but I know no company is 100% safe), in this current market I'd probably be happy enough with a yield from about 3 to 3.75%.

At the moment as you know, base rate is 0.25%, 6 month Libor about 0.5% and 12 month Libor about 0.75%. So, you should expect that 'safer companies' are not going to be offering you 3.75%.

For example, Scottish & Southern Energy Sept 2022 (XS0095371638) would yield 1.43%, National Grid Feb 2024 (XS0094073672) would yield 1.76%, Severn Trent Water Utilities Finance Feb 2024 (XS0094475802) is at 1.9%, HSBC Bank plc (XS0088317853) July 2023 2.24%, Vodafone (XS0181816652) Dec 2025 2.38%, Procter & Gamble (XS0158603083) Jan 2033 , 2.24%.

Those companies probably aren't going to go bust in the next 5-15 years (although as you say, you never know) but neither are they yielding anything close to 3.75% on your investment.

There's a Direct Line bond (XS0773947618) with 24.5 years to run which is currently yielding 6.4% but will they still be around to pay out that tier of bondholders in 2042? The coupon for that is over 9% so you can imagine if you wanted to sell it early you would be set to lose a chunk of capital, as it's only the high current price of the bond which is making it yield 'only' 6% instead of the headline coupon. Likewise you can buy Lloyds Bank preference shares (LLPC) for 170p so that their 9.25p per year coupon works out at over 5.5%, but they rank for payment behind all bondholders and they don't have to pay out the coupon each year unless they are also declaring an ordinary share dividend. If they went back to a market price of 100p or below instead of 170p because of increased interest rates and reduced creditworthiness, that's quite a hit to take on the capital (I do still hold a few though).

So, you are not going to get a yield of 3.75% from "nice, safe bonds". There should be no probably getting an overall long term total return of that level if you are holding £40 equities for every £25 bonds as you propose. However, that's 'total return' including capital gains and you are specifically seeking a 'yield' ie cash payouts as income - while shares on average do not pay particulalrly high dividends, especially overseas oness. To get an average yield of the 3.75% level overall when the bonds mentioned above are only paying 1-3% you would need to restrict yourself to very high yielding shares in relatively few industry sectors which would be quite risky (not to mention being at odds with your indexing strategy and having a high overseas equity component within overall equities.

chucknorris

bowlhead99 wrote: »

So, you should expect that 'safer companies' are not going to be offering you 3.75%.

For example, Scottish & Southern Energy Sept 2022 (XS0095371638) would yield 1.43%, National Grid Feb 2024 (XS0094073672) would yield 1.76%, Severn Trent Water Utilities Finance Feb 2024 (XS0094475802) is at 1.9%, HSBC Bank plc (XS0088317853) July 2023 2.24%, Vodafone (XS0181816652) Dec 2025 2.38%, Procter & Gamble (XS0158603083) Jan 2033 , 2.24%.

Those companies probably aren't going to go bust in the next 5-15 years (although as you say, you never know) but neither are they yielding anything close to 3.75% on your investment.

The companies that you listed are probably a bit 'safer' for those that I expect to invest in, and I haven't even looked at bonds yields yet, 3% to 3.75% was simply a guess. For me it is more about the diversification of my portfolio, than the yield. But I have to ask:

Why would anyone accept the very low yields for the 'very safe' company's that you listed? Help me out here please (open to anyone), why would someone invest in a bond paying far less than the rate of inflation? I'd rather remain doing as I am and accepting more risk, and at least giving myself a chance of a positive real return, rather than just giving up and accepting a loss. For example the lowest bond yield that you quoted only gives a net yield of 0.858% (after 40% tax, and that doesn't take the fees into account!).

EDIT: With regard to equities, I'm probably going to be substantially invested in vhyl which currently yields about 3.7%. Although I will also probably stick with one of my current investments British Land which yields around 4.7% (on the price paid).

bowlhead99

chucknorris wrote: »

Why would anyone accept the very low yields for the 'very safe' company's that you listed? Help me out here please (open to anyone), why would someone invest in a bond paying far less than the rate of inflation?

Well, as you've probably noticed, cash is also paying far less than the rate of inflation (I mentioned the Libor rates in the same post) unless you are only investing relatively small amounts of money. If you are a large institutional investor like a pension fund or a city council or sovereign wealth fund who wants to put millions or billions somewhere that it won't be subject to the chance of a 50% decline in an equities crash - bonds (whether or not held to maturity) can make plenty of sense.

A small retail investor can put his £2k in his high interest current account but a large institutional investor cannot, so if Vodafone want to raise a billion of finance by issuing long term fixed interest debt, the rates are going to be driven by market demand from the institutions who are comparing that opportunity to other things of comparable risk in the market

For example the lowest bond yield that you quoted only gives a net yield of 0.858% (after 40% tax, and that doesn't take the fees into account!).

Well if you take 40% tax off 0.25% in a bank account you get 0.15%, so the yield is still over five and a half times the base rate. And remember the price of bonds (just like shares) is set by the huge wall of institutional money that needs to be deployed, and many of those institutions won't pay tax (pension funds, governments, nonprofit foundations) or will pay much lower than 40% tax (corporates, international investors) or are happy to invest in sterling or dollar-based investments despite UK inflation risk because their home currency is so unreliable (lots of African, Asian, Russian or Latin American investors).

It doesn't make an investment in a bond issued by a single UK or multinational utility company or bank a sensible thing to do for the average UK retail investor. If you are investing your personal wealth and the total portfolio is several millions, then individual bonds or shares might be more efficient than they are for the average UK investor who only has a few thousand; but you're still not in the same position as the big boys investing billions, so copying their techniques is not necessarily the way to go.

Although I will also probably stick with one of my current investments British Land which yields around 4.7% (on the price paid).

A key thing to recognise is that 'the price paid' at some old point in history should not be relevant in the context of what returns you are getting NOW on the amount of value you could have NOW instead of that investment.

Otherwise it's possible to get caught in silly mistakes, e.g. imagine having a fund that quadrupled in value over a couple of decades (7% a year, no more than average returns) and only yielding 1% on its value at the moment but you call the income '4% on the price paid' and think it is better than other funds that are paying 3% on the price you would pay now.

Good luck with your plans anyway.

chucknorris

bowlhead99 wrote: »

A key thing to recognise is that 'the price paid' at some old point in history should not be relevant in the context of what returns you are getting NOW on the amount of value you could have NOW instead of that investment.

Please don't mention current savings rates, at the moment we are waiting to find and buy a house, and we have the cash to buy outright in instant savings accounts, we feel like we are being mugged.

Actually I only recently invested in British Land, the price has not changed that much since then, I just worded it badly, I was trying (but obviously failing) to explain my motivation at the time of investing.

Well bonds are obviously not for me, of course I understand why institutional investors accept such low (real term negative) returns, in fact, my wife (who is an actuary) were talking about that very point over dinner this evening. But I really don't understand why typical investors on this forum would? Especially when you consider the potential capital loss if (when) interest rates go up. I would rather take my chances with equities that may lose value, than invest to take a certain loss. I really can't understand why other (non institutional) investors would, I guess that I don't make a very good bear. Not sure what I will do now, I think that I will look into the possibility of defensive equities as an alternative strategy.

Thanks for your input, it is just as valuable to find out something will not work well for you, as something that will. Rather than hastily make an investment that doesn't matched to your requirements.

bowlhead99

chucknorris wrote: »

Not sure what I will do now, I think that I will look into the possibility of defensive equities as an alternative strategy.

Thing is, so-called 'defensive' equities have risen substantially since interest rates fell to the floor and everyone started piling their money into whatever could pay a dividend, offer capital growth, and maybe not fall so much as cyclical stocks in a recession or market downturn.

If you look at popular fund 'Fundsmith', it holds a concentrated portfolio of stocks and the manager likes strong profitable global brands. Consumer staples have been its largest sector and the top ten holdings over those last five years have included consumer staples / defensives such as Philip Morris (tobacco), Imperial Tobacco, Pepsi, Dr Pepper, Johnson & Johnson, Colgate, Diageo, Reckitt Benckiser, Microsoft etc. OK - Microsoft is Tech but their products are ubiquitous with a virtual global monopoly on office productivity software, desktop operating systems etc and they have been a profitable dividend payer for years so you might see them as more akin to a defensive stock than a trendy dotcom stock.

That fund is up over 170% in five years. That's a lot to potentially unwind.

You may find that using defensive equities, certain types of infrastructure stocks etc as 'bond proxies' is something that comes undone if/when market conditions cause bonds and their substitutes to fall out of favour. It is difficult to know 'where to hide' if you are trying to preserve capital but unwilling to use bonds or investment trusts with a cautious / capital preservation strategy, and predominantly want to consider index-based investing for your equities exposure (rather than managed funds), yet demand a high level of income at the same time.

Thrugelmir

chucknorris wrote: »

Actually I only recently invested in British Land, the price has not changed that much since then, I just worded it badly, I was trying (but obviously failing) to explain my motivation at the time of investing.

Having an insight and understanding into a particular company/ market sector/industry is no bad thing. I know someone who very successfully traded ARM shares over many years. Their only sole share investment. If you've worked in the particular industry as well there's a lot to be said for gut instinct. Difficult to rationalise but you just know.

Worth remembering that it's the BOE driving Corporate Bond yields down. With their stated aim of acquiring £10 billion through the Asset Purchase Facility - Corporate Bond Purchase Scheme.

ams25

Very much relate to your post...as a relative bond newbie also but having recently stopped work, needed to move from a very high equity allocation to something safer. Ie around 55% in equities.

Currently have c.20% in bonds, c.12% cash, 4% property (funds) and 8% absolute return and wealth preservation funds. About a third of the cash is p2p earning decent returns to date (4-10%).

I've read lots about bonds..common headlines range from imminent crash (every year for the last few) to stay the course it will be fine. Clearly there is risk of capital loss I understand that but like everyone else I don't know how it will pan out..but having a % in bonds for portfolio diversification still seems a viable portfolio strategy. I'd be happy if they hold real value for now so don't have great expectations. The bonds in my portfolio have done ok over the last 6 and 12 months with US interest rates already increased and uk rate increases clearly sign posted. For what its worth I've selected strategic bond funds with strong track records so putting faith in 'experts' that they are (clearly) better equipped to find the best opportunities than me (or index funds in this case). Time will tell if this was wise or not.

In normal times I'm sure I would have a higher allocation of bonds but have decided not to make it zero (as some clearly have).

ams25

Thrugelmir wrote: »

Worth remembering that it's the BOE driving Corporate Bond yields down. With their stated aim of acquiring £10 billion through the Asset Purchase Facility - Corporate Bond Purchase Scheme.

from the BoE website:

The Corporate Bond Purchase Scheme started on 27 September 2016. On 27 April 2017, the Bank announced that it had completed the operations necessary to achieve the current target for corporate bond purchases totalling Stg 10 billion.

Forthcoming Operations

The Bank has now completed the operations necessary to achieve the current target for corporate bond purchases totalling Stg 10 billion, on a trade date basis. Therefore there will be no Corporate Bond Purchase Scheme operations until further notice.

Does this mean it's priced in? Or further programmes could follow?

Thrugelmir

ams25 wrote: »

Does this mean it's priced in? Or further programmes could follow?

Means that the BOE purchasing has driven prices high and yields low. Some investors of course sold out for the available capital gain on offer.

Like the Fed in the US. Appears that the BOE's stimulus programmes have ended. Now we await the slow process of unwinding. When Companies come to refinance debt in the years to come in the future. They may have to offer higher coupons to attract investors.

Bond funds that hold RMBS or other variable rate debt instruments offer some upside.