'Purest' global bond index fund

aroominyork

Every few months I compare my portfolio's performance to a benchmark of equity and bond index funds in the same proportions as my portfolio, eg if I hold 70% equities/30% bonds I compare with a notional portfolio of 70% equity index and 30% bond index. For the equity component I use HSBC FTSE All World Index and for the bonds I use Vanguard Global Bond Index (Hedged GBP). 

Yesterday I charted the Vanguard bond fund against LifeStrategy funds expecting to see a smooth curve as the equity element fell from 100% to 0% but instead I got these results for the last five years: 

VLS100... VLS80... VLS60... VLS40... VLS20... Vanguard Global Bond Index.

44.9%... 40.5%... 36.0%... 31.1%... 26.4%... 16.1%. 

So as the bond element within VLS increased by 20% performance worsened by between 4.4% and 4.9%, but jumping from VLS20 to 100% bonds worsened performance by 10.3%. 

Over one year there is also an apparent anomaly:

VLS100... VLS80... VLS60... VLS40... VLS20... Vanguard Global Bond Index.

0.5%... 2.1%... 3.6%... 5.0%... 6.3%... 6.1%. 

Is this because LifeStrategy uses more UK bonds/gilts than a global bond index? If so, should I assume this is a short-term variance and that UK bonds/gilts might underperform in the next five years? And then the crunch question: is this Vanguard fund the most appropriate bond fund to use as my comparator?  

eskbanker

aroominyork said:

Is this because LifeStrategy uses more UK bonds/gilts than a global bond index?

The detailed breakdown of VLS funds is published at sites such as https://www.vanguardinvestor.co.uk/investments/vanguard-lifestrategy-40-equity-fund-accumulation-shares/portfolio-data where you can see that, although Vanguard Global Bond Index is a significant component of the bond element, there is also a typically heavy slanting towards the UK with the other bond funds chosen.

aroominyork said:

is this Vanguard fund the most appropriate bond fund to use as my comparator?

It depends what you're trying to achieve - anything other than exact replication of the VLS holdings (adjusted on an ongoing basis) will obviously produce variances!

bowlhead99

aroominyork said:

Yesterday I charted the Vanguard bond fund against LifeStrategy funds expecting to see a smooth curve as the equity element fell from 100% to 0% but instead I got these results for the last five years: 

VLS100... VLS80... VLS60... VLS40... VLS20... Vanguard Global Bond Index.

44.9%... 40.5%... 36.0%... 31.1%... 26.4%... 16.1%. 

So as the bond element within VLS increased by 20% performance worsened by between 4.4% and 4.9%, but jumping from VLS20 to 100% bonds worsened performance by 10.3%. 

If you take the two extremes (VLS 100% equity at 44.9% return, and your bond index at 16.1% return), you could project what the other VLS variants might return.
80% equities and 20% bonds gives an expectation of 39.1%. Actual VLS80 = 40.5% . The actual return is about a thirtieth better than expected
60% equities and 40% bonds gives an expectation of 33%. Actual VLS60 = 36%. The return is about one eleventh better than expected
40% equities and 60% bonds gives an expectation of 27.6%. Actual VLS60 = 31.1%. The return is about an eighth better return than was expected
80% equities and 20% bonds gives an expectation of 21.9%. Actual VLS60 = 26.4% The return is about a fifth greater than expected (26.4 is about 20% greater than 21.9)

There are two things going on.

One is that actually the return from blending the two asset classes and rebalancing periodically to set ratios (as is done in the mixed asset variants) will not be the same as just holding them separately and getting a return at the end; there is a potential diversification benefit in performance  and volatility from mixing together asset classes that aren't fully correlated.

But the other thing is that the bond component being used in the mixed asset variants is not simply the 'global bond' index, it is a blend targeted at a UK retail investor who wants a Vanguard mixed asset product. And the complexity of the bond solution being offered in the various VLS packages will differ between a fund that does not use much bonds (80% equity and only 20% bonds = the bonds only being used to 'take the edge off' equity volatility) versus a fund that uses lots of bonds (only 20% equity and 80% bonds = mostly a bond fund).  So, I would not necessarily expect a linear response, or a smooth exponential response as you step it up a notch.,

If you are benchmarking your portfolio's returns, the comparator you use should be something that is offering the same risks as what you are using. 'Bonds' is a very broad category with as many, or more, niches than equities. As seen in the recent market turmoil there are major differences between a short dated gilt and a long dated index linked gilt and a medium dated emerging market government bond hedged to sterling and a high yielding corporate junk bond etc. So if your portfolio is deliberately an active mix of 10% index linked gilts, 5% TIPs, 10% short dated investment grade corporate, 5% junk and alternative strategies, it doesn't make sense to benchmark it against some general 'global bond' fund with average AA- rating and 7 year duration which gives returns you have decided you do not want and are not trying to achieve. You should benchmark it against a portfolio containing the weightings you actually used.

The question you are probably asking yourself is, I can see that I can create a custom benchmark by blending bond indexes to see what the returns from my personal mix of bond asset classes should have been, but how do I know whether that mix of bond asset classes was a good mix or a bad mix if I don't have some general yardstick for how other people allocate their bonds? 

The problem is that the global bond index is not telling you how the average investor such as yourself is allocating their fixed income investments. It is simply some aggregation of what a bunch of other individuals and entities with entirely different (and competing / contradictory) objectives have done.

So if insurance companies are holding x trillion of short dated investment grade corporate bonds, and US defined benefit pension funds are holding y trillion of US local government municipal bonds and z trillion of index linked treasuries, while hedge funds are holding b trillion of junk bonds, and sovereign wealth funds are holding c trillion of bank debt and retail investors are holding gilts in their ISAs and investment grade corporate bonds in their pensions etc etc... it is possible to index all that as some single measure of 'everything that exists, with some minimum liquidity criteria', but that is not what any of those other investors are actually holding for themselves, and it hardly seems relevant to what you, as an individual investor with particular objectives would want to achieve. 

The insurance companies with their specific and personal objectives don't want to hold 'everything that exists on the planet in the proportions that are available'. The banks and pension funds and sovereign wealth funds and high net worth family offices and active bond managers with their specific and personal objectives don't want to hold 'everything that exists on the planet in the proportions that are available'. They follow a plan for their own objectives. Vanguard are offering a global bond fund for the UK retail and institutional market and it only has five or six billion quid in it, while UK investors' holdings in the fixed income asset class would be measured in trillions. Because people invest in what they want, not what happens to exist.

So the idea that you should see how you are doing by arbitrarily comparing your bond mix to 'everything that exists as measured by the Bloomberg Barclays Global Aggregate Float Adjusted and Scaled Index in GBP', seems fundamentally flawed.

You have decided that for your own personal needs, you are going to hold a mix which has, say, 70% equity and 30% bonds. You didn't decide to hold those two major asset classes in the proportion that they exist in global float around the planet - because that would result in holding a lot more bonds than equities, and isn't suitable for your needs. So, you are not going to benchmark your returns to 70% global bonds and 30% global equities just because that's what exists. You have already identified that you should benchmark your returns to the type of asset mix that you actually have, which is the other way around. 

Then why should it be different when looking at how to benchmark subcomponents of the portfolio? Within the bond assets you hold, you are probably not holding the same split by credit quality, duration and type of issuer, that the 'global bond' index fund holds. Measuring your return against that is going to give a somewhat arbitrary result because it is an aggregation of what a bunch of other people with different objecives happen to be holding, and the mix of what they are holding is largely based on how many bonds, and of what type, corporates and governments have decided to issue. The sum total of what the governments and corporates have decided to offer, is not how you should decide what to hold. 

An analogy would be comparing your car to other road vehicles and wondering if you should perhaps add another three wheels because the average licensed road vehicle has more than the four you've got. But as you're not trying to transport an articulated lorryload of pallets or a busload of passengers, it doesn't matter what the average wheelcount or mpg measure of all vehicles happens to be. You decided to get a car, and within that, a particular class of car - whether you like the comfort, speed, practicality, economy, maintenance costs, towing capacity etc. To flip through the back pages of Car magazine and see what average price, number of doors, mpg, acceleration time is the 'weighted average', and play Top Trumps with your car against that theoretical car, is not something that needs to be done.

You hold a portfolio of assets in a mix you like. Perhaps your benchmarking should be against the volatility and total returns performance of other entire portfolios held in a mix that their managers like - you could find such funds within the 40-80% equities universe, some using more passive approaches for underlying assets (eg VLS, HSBC Global Strategy, Multi Index etc) and others more active, and some with static allocations and some dynamic. Or there are benchmarks used by pensions firms and wealth managers (eg MSCI WMA Balanced, ARC private client indices etc).

aroominyork

Thanks, esk. I had already looked at the holdings in VLS20 and noted it includes just under 20% Vanguard Global Bond Index, which I guessed (but was asking the question in order to check) indicates that the other bond components of VLS - which as you say are overweight to UK bonds - accounted for VLS's outperformance compared to the global bond index fund. 

What am I trying to achieve? To find a bond benchmark to compare to my actively managed bond funds. For equities, if I was invested solely in index funds I might use the HSBC fund; what would I use as an index fund for the bond element? 

(In reality I might want to be a bit UK overweight in equities, say 15%, so I should be taking an average of HSBC and VLS100, but I don't think that's relevant to this question.)

EDIT. I posted this before refreshing the page and seeing bowlhead's first post, which I'll read later this morning.

bowlhead99

aroominyork said:

What am I trying to achieve? To find a bond benchmark to compare to my actively managed bond funds. For equities, if I was invested solely in index funds I might use the HSBC fund; what would I use as an index fund for the bond element? 

(In reality I might want to be a bit UK overweight in equities, say 15%, so I should be taking an average of HSBC and VLS100, but I don't think that's relevant to this question.)

It is entirely relevant to the question because as you have noted, your equities performance is not intended to be a mix of 'all equities that exist', but a mix of equities weighted to business with operations in UK or listed on UK stockmarkets, and therefore it would be flawed to use a FTSE All World index to do that or to measure that.

Likewise it is going to be flawed to use a bond index which has the characteristics shown at https://www.vanguardinvestor.co.uk/investments/vanguard-global-bond-index-fund-pound-sterling-hedged-income-shares/portfolio-data when actually you are selecting fund managers to deliberately give you some other diversified mix in terms of credit quality, type of issuer, duration etc, just like your self-selected equity funds are deliberately not tracking global equities.

So you would create a custom benchmark by blending indexes together to more closely match what you are doing, or use the IA sector averages from Trustnet or Morningstar for gilt funds or strategic bonds funds or whatever it is you hold, or simply try to average together yourself the other funds available to the UK retail investor that you might have chosen to use but didn't for one reason or another.  See earlier (longer) post.

aroominyork

Thanks bowlhead. Very helpful. 

It's easiest to respond by first looking at equities. I take the point that I should benchmark against the average of HSBC All World and VLS100 as that is how I would invest if I went 100% passive. But I question "the comparator you use should be something that is offering the same risks as what you are using", because: 

... currently I track my equities by geographic region and the percentage invested in medium/smaller/micro companies (the latter drawn from Morningstar's portfolio page). So I know that I am moreorless invested:

US: 38% total, of which 23% is med/small/micro

UK: 13%, 65%

Developed Europe: 16%, 50%

Japan: 10%, 33%

Emerging markets: 12%, 28%

Developed AP: 10%, 46%. 

Trustnet tells me the FE of that portfolio is 75. HSBC FTSE All World Index is FE77 so we are fishing in similar ponds of volatility. If I look at the performance of my portfolio over time, listen to bostonerimus sitting like Jiminy Cricket on my shoulder and decide that trying to beat the market is a waste of time, I would sell my funds and split the money between HSBC All World and VLS100. So those two funds seem an appropriate point of comparison. 

Moving on to bonds, I would not necessarily sell my two active bond funds and buy "something that is offering the same risks as what you are using". But I do not know what I would use: maybe a global bond index, maybe a single strategic bond fund (most likely Jupiter). 

I guess the bottom line is that I need to be clear about what I am trying to achieve (going back to eskbanker's point). Is it to compare my portfolio's performance to its equivalent in passive funds, or to compare my portfolio's performance to how I would invest if I went 100% passive? And the answer is: probably a bit of both.

A_T

The Vanguard Global Bond Index is hedged to the pound. Maybe the "purest" instruments for comparison might be:
SPDR Bloomberg Barclays Global Aggregate Bond UCITS ETF
or
iShares Core Global Aggregate Bond UCITS ETF
both of which track the Bloomberg Barclays Global Aggregate Bond Index without hedging.

bowlhead99

aroominyork said:

Moving on to bonds, I would not necessarily sell my two active bond funds and buy "something that is offering the same risks as what you are using". But I do not know what I would use: maybe a global bond index, maybe a single strategic bond fund (most likely Jupiter). 

I guess the bottom line is that I need to be clear about what I am trying to achieve (going back to eskbanker's point). Is it to compare my portfolio's performance to its equivalent in passive funds, or to compare my portfolio's performance to how I would invest if I went 100% passive? And the answer is: probably a bit of both.

But the 'if you were 100% passive' on your portfolio as a whole, tracking the market values of global financial instruments would result in you having more bonds than equity, which you don't want, because that is not in line with your objectives, so you are not going to go '100% passive' on the whole portfolio in that sense. You have made a high level decision that more equities and fewer bonds is better.

And so likewise if you don't want to get the return from all the values of all the global bonds that exist, because that is not in line with your objectives, you wouldn't buy a global bond tracker. You might instead prefer Jupiter's approach of having a go-anywhere, high conviction fund taking account of credit conditions and macro factors, and end up with a 'barbell' holding that mixed high quality global bonds to preserve capital at one end with high yielding bonds to generate income at the other, and dips in and out of sectors based on the manager's judgement. 

So the choice is whether to benchmark your active/strategic fund against Jupiter or Jupiter's peers (which are contenders for your portfolio) or against a 'global bond index' which is a mixed bag of what insurance companies, banks, pension funds and local government entities around the world choose to hold. The global bond does not seem useful as a 'benchmark' of what returns you should 'expect' by generally holding bonds, unless what you want to hold, is that mixed bag.

The fact that Bostoner (or other posters we know from this forum, nothing personal of course) have done very well over the years by (e.g.) saving a large proportion of their earnings each year and investing in a mix of general bond and predominantly-US equity indexes over a multi decade period where bonds had a massive bull run and the US was the best place in the world to be invested... does not mean that you should seek to copy the approach, or benchmark yourself to the approach other than out of curiosity. As an approach that served the person very well, they'll no doubt continue it, because they no longer need to grow their portfolio or make much of a living from it - they have more than they could spend, and so no need to complicate things by doing something other than just picking the cheapest broad index in the shop, and know that there is some sense or structure behind it.  Others don't share their circumstances, so may look for other approaches.

Which means other benchmarks may be appropriate if they are comparing what they got versus what they could have got if they invested in something else that they might have actually chosen.

I agree with AT's comment above that if looking for a 'pure' benchmark per your thread title, anything hedged is not something 'pure' giving the result of a raw return.  However, it comes back to the 'compare to something else that they might have actually chosen' - and if the purpose of the bond slice of your portfolio is  to give plodding stability and take the edge off the volatility of equities, you may not be seeking to add to the currency swings in the equities part of your portfolio with more dollar and euro and yen swings on the bond side.

Of course, in decades of retirement as now, we will expect to be spending money on goods and services which ultimately have some component of their cost driven by foreign currencies because even if you only buy things with a price label in pounds from the UK high street, there are currency movements involved in materials costs and labour expectations feeding inflation or deflation in pounds pricing. So having a pile of US dollar bonds or Yen bonds and not hedging them, because you know you want more pounds if  dollars or yen get more expensive, can be absolutely fine. You might make other tweaks to other parts of your portfolio accordingly.

dunstonh

What am I trying to achieve? To find a bond benchmark to compare to my actively managed bond funds. For equities, if I was invested solely in index funds I might use the HSBC fund; what would I use as an index fund for the bond element?

Remember that fixed interest securities have the same diversification issues as equities.   You bond allocation should not be made up of just one bond type.    That would be similar to investing your whole equity content in European Equities only.

You frequently find it is broken down into gilts, index-linked gilts, investment-grade bonds and global bonds.  Sometimes high yield bonds are included for further diversification.    at the moment, index linked gilts, investment-grade bonds and global bonds are not particularly in favour.  Mainly as fixed interest securities are there to reduce portfolio risk but provide better than cash returns.    But at the moment, those things are not viewed by many as being ideal for risk reduction.    So, on fluid models, you are seeing allocations to investment grade, global bonds and index linked gilts cut right back (sometimes to zero depending on the target volatility range).   On static models, they will keep with them as static models do not consider things like volatility changes or value changes.   You are actually seeing cash being increasingly used to control volatility as it is viewed as the least worst option.

Prism

I sold my only bond fund, a global hedged tracker, in March. I can find no reason at all to buy it back on the foreseeable future. Those funds are now sat partly in infrastructure and partly in cash at 0%.  

aroominyork

Thanks A-T, bowlhead, dunston.

This shows, not for the first time, that bonds are more complex than equities. With equities you pretty much know where you are if you consider geography, market cap, sector and a fund manager’s approach. Three years into DIY investing I still can’t grasp how to assess gilts, index-linked gilts and the many different types of corporate bonds (yields, durations etc.).

However it does seem that while investing solely in a global index equity fund is not irrational, investing in a hedged global bond index is less sound. So to benchmark against Vanguard’s global bond index fund seems flawed because I would not choose it as an alternative to active funds, and as a comparator to my active bond funds it sets the bar rather low. There is no one-size-fits-all solution but it seems good enough to use Jupiter Strategic Bond, which I consider a well-managed and relatively conservative fund, as my point of reference.