DIY plan review on the eve of crystallisation

gm0

The confusion of the bonds discussion matches my own.  My current design for minimal risk assets for short term SORR buffer is cash. (Cash funds, Deposit, PB etc. all the usual suspects). I plan to re-examine gilts, linkers and short corporate >A funds (value type companies - Unilevers or similar). I may dabble more or not.  Or buy a few short duration quality gilts/bonds in a ladder. Central banks may make this still less attractive.  Given the investment purpose (short term income substitution and achieving inflation hedge - whole or partial) - there seems little point in targeting longer bonds and adding the associated base rate rising risk to capital.  

We covered this topic where I asked about it as I too was (and am) puzzled as to what is best for the minimal risk assets.
I'll have some bonds around via multi-asset or wealth preservation no doubt.

But in assessing bond funds conceptually against very negative market "stress test" scenarios I am underwhelmed by holding great swathes of US corporate B and worse - this being held up by central bank magic.  And it will be for an undefined while yet.  But not forever. And probably not for 20-40 years. 

There was already an issue with US credit market quality deteriorating and bloat returning pre-Covid. At least according what read like cogent analysis articles in the Economist.   I am not "bullish" or "bearish" about it. 

I am just unconvinced that the -ve equities correlation will hold for the shonkier corporate stuff in some developed markets in whatever form of PE revaluation cycle we go through next.  Which we undoubtedly will.  We know that but not when. That being so I am not sure I want lots of it. Or if I do have it then I want to trade some risk+yield for quality and a better chance of the -ve correlation standing up when the screaming is happening

I don't understand EM bonds - gilts or corporate (in terms of how they differ and behave).  But when developed market demand disappears a level of EM volatility is assured

gm0

Dead_Keen.  Thank you for your suggestions - I will look into CAF. 

A tiny errata tweak to what you suggested re indexation:
Some of the many types of protection and LTA enhancement are CPI indexed. And some are not. 

Fixed Protection is not indexed so the LTA stays the same once registered / when tested by entering drawdown and again at 75
Or you can say it shrinks in "real" terms by inflation for 20+ years - pulling inflationary growth on risk taken during drawdown into the penalty charge alongside the real.  This topic and the pensions and generational wealth transmission policy arguments around it are well covered on other threads

Thrugelmir

cfw1994 said:

Thrugelmir said:

shinytop said:

I don't know what your 'number' is nor how much you have.  But if a variable WR of 2.5-3.5% needs another Plan B then we're all in trouble!  You can't plan for everything; there comes a point when you have to accept that s&*t happens and you just have to roll with it;  Plan B becomes simply "spend less money".  What's your Plan C if your investments return significantly more that 3.5%?   

In the midsts of a global pandemic the level of optimism is quite surprising. As if all the woes are going to be washed away on a wave of free printed money and paper assets that exchange hands at ever increasing prices. 

Thrugelmir, I get the distinct impression you don’t feel the future is too bright.  You are clearly welcome to that view: I’ll continue to be more optimistic......once the vaccines spread (& around the world, into 2022), I can foresee things picking up like they did in the Roaring Twenties!

The future does indeed look bright in so many ways. However I'm naturally more cynically towards the expectation of investors and future medium term market returns. There's a raft of challenges that lie ahead on a global level. There's not going to be a switch moment when all the lights come back on. More the realisation that the damage done is considerable and permanent. Recovery is going to be a long hard grind.  Bound to be a correction or two along the way. All the eggs in one equity basket isn't a comfortable place to be either. There's a lot of high risk/ high volatility portfolios out there. 

JohnWinder

gm0 said:

The confusion of the bonds discussion matches my own.
We covered this topic where I asked about it as I too was (and am) puzzled as to what is best for the minimal risk assets.
But in assessing bond funds conceptually against very negative market "stress test" scenarios I am underwhelmed by holding great swathes of US corporate B and worse - this being held up by central bank magic.  And it will be for an undefined while yet.  But not forever. And probably not for 20-40 years. 

I am just unconvinced that the -ve equities correlation will hold for the shonkier corporate stuff in some developed markets in whatever form of PE revaluation cycle we go through next.  Which we undoubtedly will.  We know that but not when. That being so I am not sure I want lots of it. Or if I do have it then I want to trade some risk+yield for quality and a better chance of the -ve correlation standing up when the screaming is happening

I think you've got it all covered. At some point I stop agonising over the tiny unknowns, and forget about how many angels can dance on the head of a pin. But a couple on non-angelic thoughts:

We can't lament that minimal risk assets have poor returns. They have to have the worst returns if they are to have the least risk, broadly speaking. I suppose they could have fabulous returns if we all raised our productivity massively.

Target longer bonds? As a starting point, the optimal bond duration should be the one that matches the duration of your spending needs. Longer bonds should have better interest rates - good, but more price sensitivity to rate changes - bad, but that doesn't matter if they're duration matched to your needs. Close duration matching can be done with a bond ladder or a pair of long and short duration funds, but this is almost angel stuff. Simple folk might choose moderate duration funds and be done with it.

I wouldn't say inflation hedging should be short term on the eve of a 25 year retirement.

Surely shonkier corporate bonds will be well correlated with equities in the same market as they're both high-ish risk.

Thrugelmir

JohnWinder said:

gm0 said:

The confusion of the bonds discussion matches my own.
We covered this topic where I asked about it as I too was (and am) puzzled as to what is best for the minimal risk assets.
But in assessing bond funds conceptually against very negative market "stress test" scenarios I am underwhelmed by holding great swathes of US corporate B and worse - this being held up by central bank magic.  And it will be for an undefined while yet.  But not forever. And probably not for 20-40 years. 

I am just unconvinced that the -ve equities correlation will hold for the shonkier corporate stuff in some developed markets in whatever form of PE revaluation cycle we go through next.  Which we undoubtedly will.  We know that but not when. That being so I am not sure I want lots of it. Or if I do have it then I want to trade some risk+yield for quality and a better chance of the -ve correlation standing up when the screaming is happening

Surely shonkier corporate bonds will be well correlated with equities in the same market as they're both high-ish risk.

If a company fails then it's both the bond and equity holders that get wiped up. Holding both asset classes in the same company provides no diversification. 

Linton

Thrugelmir said:

JohnWinder said:

gm0 said:

The confusion of the bonds discussion matches my own.
We covered this topic where I asked about it as I too was (and am) puzzled as to what is best for the minimal risk assets.
But in assessing bond funds conceptually against very negative market "stress test" scenarios I am underwhelmed by holding great swathes of US corporate B and worse - this being held up by central bank magic.  And it will be for an undefined while yet.  But not forever. And probably not for 20-40 years. 

I am just unconvinced that the -ve equities correlation will hold for the shonkier corporate stuff in some developed markets in whatever form of PE revaluation cycle we go through next.  Which we undoubtedly will.  We know that but not when. That being so I am not sure I want lots of it. Or if I do have it then I want to trade some risk+yield for quality and a better chance of the -ve correlation standing up when the screaming is happening

Surely shonkier corporate bonds will be well correlated with equities in the same market as they're both high-ish risk.

If a company fails then it's both the bond and equity holders that get wiped up. Holding both asset classes in the same company provides no diversification. 

Holding corporate bonds does not provide protection in the event of a complete failure but it does provide protection against a major fall in that interest will still be paid even if dividends are cut.

gm0

My point was different and naturally subjective. 

Equities and Bonds have a level of negative correlation in general historic volatility.  But not always.  Textbook and backtest.
My belief is that poorer quality bonds issued in loose credit conditions (pre global crash) or pre covid in US corporates according to some observers are not as likely to be benefical due to both credit default losses (bankrupt/chapter 11 etc) in a future "event"  and also that in a volatile and extreme situation (hypothetical - but they turn up sometime) they are not the destination of a flight to quality that historically treasuries or gold have provided  for those investors fleeing markets and locking in their losses.  Not for a second recommending that behaviour but quality FI (bonds) have often gone up at those moments partly from that effect.

So when "bad things happen + it's time" a severe PE correction happens alongside a peculiar political, policy and trade situation and we find out.  I am unconvinced that bond funds stuffed with dubiously issued stuff is a well packed parachute that will work.  It might or it might not depending upon the situation and accompanying real economy conditions.

So my belief system is that Gilts/Treasuries will work better than corporate B - but the yields while the clock runs down pre-event are natually highly inferior and even negative.  All one can do is pick a poison one prefers according to need and risk appetite.  
I *know* I don't understand these funds properly and that they are likely better than buying individual company bonds and concentrating the default risk thereby.  I just find the mix of bonds in some of the offer too spicy for the purposes that I want them. i.e. Shorter horizon income. Diversification and -ve correlation to equities.  Total risk taken - chosen position on efficient frontier.

I think this "stuffed with riskier stuff" effect is likely influenced by fund manager competition and benchmarking. General dash for yield in a time of historic low rates.  Again - I am likely only seeing an outside layer of the onion. 

Nonetheless it influences me to look for bond funds which have an average duration matched to my needs which I think means short/medium 5<x<15.  And which do not have a lot of lower grade higher risk stuff making up the weight of the fund as this moves it closer to the risk asset I have alongside. So funds skewed the other way.  Diversified across regions yes but not too heavy on US and EM "B" or worse.  Skewed to quality.  Finding something suitable to these biases is still on my todo list.

I would welcome any fund suggestions to go and explore from people who have already gone down this path and reached similar subjective conclusions

JohnWinder

gm0 said:

Equities and Bonds have a level of negative correlation in general historic volatility.  But not always.  Textbook and backtest.
So my belief system is that Gilts/Treasuries will work better than corporate B - but the yields while the clock runs down pre-event are natually highly inferior and even negative.  All one can do is pick a poison one prefers according to need and risk appetite.  

I think this "stuffed with riskier stuff" effect is likely influenced by fund manager competition and benchmarking. General dash for yield in a time of historic low rates.  Again - I am likely only seeing an outside layer of the onion. 

Nonetheless it influences me to look for bond funds which have an average duration matched to my needs which I think means short/medium 5<x<15.  And which do not have a lot of lower grade higher risk stuff making up the weight of the fund as this moves it closer to the risk asset I have alongside. So funds skewed the other way.  Diversified across regions yes but not too heavy on US and EM "B" or worse.  Skewed to quality.  Finding something suitable to these biases is still on my todo list.

I would welcome any fund suggestions to go and explore from people who have already gone down this path and reached similar subjective conclusions

I still think you've got all this covered. Couple of points:

Asset correlations are not fixed; what they were last year/decade may not be what they are next. But you'd have known that. So, not to rely on them with too much precision I suppose.

The efficient frontier changes with time also. The asset mix on the best part of the curve this year might be very different in a decade or less. Pretty sure that's right.

High yield bonds should, that's a big should, give the same risk adjusted return as government bonds because the market agrees on the probability or the proportion of them that will fail, and prices them accordingly to compensate for the failures by better yields. So if you choose high risk bonds, as for equities, you do yourself a favour by broad diversification as in a fund - unless you're more of a gambler than I am and are prepared to lose out big for a win out big prospect. Gov bonds ought not default, so you only need diversification of duration (unless you have a specific duration need).

Choosing a bond fund with a duration to match your spending needs is good, but the fund's duration doesn't change while a retiree's spending duration keeps shortening. Not serious, but better to be aware before buying than after.

JohnWinder

'In my opinion, adding high-yield adds clutter and complexity, and doesn't accomplish anything that just upping the stock allocation won't accomplish. Also, regardless of whether you think high-yield belongs in a bond index, high-yield is only about 5% of the bond universe and putting it in or keeping it out is not hugely important.....'

I won't quote the rest or copy the charts, but sometimes this guy just seems to nail it, especially when he agrees with me.

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=338896&p=5791078&sid=49cf36e6c76672cd57489f9d03ce12f5#p5791078

Linton

gm0 said:

My point was different and naturally subjective. 

Equities and Bonds have a level of negative correlation in general historic volatility.  But not always.  Textbook and backtest.
My belief is that poorer quality bonds issued in loose credit conditions (pre global crash) or pre covid in US corporates according to some observers are not as likely to be benefical due to both credit default losses (bankrupt/chapter 11 etc) in a future "event"  and also that in a volatile and extreme situation (hypothetical - but they turn up sometime) they are not the destination of a flight to quality that historically treasuries or gold have provided  for those investors fleeing markets and locking in their losses.  Not for a second recommending that behaviour but quality FI (bonds) have often gone up at those moments partly from that effect.

So when "bad things happen + it's time" a severe PE correction happens alongside a peculiar political, policy and trade situation and we find out.  I am unconvinced that bond funds stuffed with dubiously issued stuff is a well packed parachute that will work.  It might or it might not depending upon the situation and accompanying real economy conditions.

So my belief system is that Gilts/Treasuries will work better than corporate B - but the yields while the clock runs down pre-event are natually highly inferior and even negative.  All one can do is pick a poison one prefers according to need and risk appetite.  
I *know* I don't understand these funds properly and that they are likely better than buying individual company bonds and concentrating the default risk thereby.  I just find the mix of bonds in some of the offer too spicy for the purposes that I want them. i.e. Shorter horizon income. Diversification and -ve correlation to equities.  Total risk taken - chosen position on efficient frontier.

I think this "stuffed with riskier stuff" effect is likely influenced by fund manager competition and benchmarking. General dash for yield in a time of historic low rates.  Again - I am likely only seeing an outside layer of the onion. 

Nonetheless it influences me to look for bond funds which have an average duration matched to my needs which I think means short/medium 5<x<15.  And which do not have a lot of lower grade higher risk stuff making up the weight of the fund as this moves it closer to the risk asset I have alongside. So funds skewed the other way.  Diversified across regions yes but not too heavy on US and EM "B" or worse.  Skewed to quality.  Finding something suitable to these biases is still on my todo list.

I would welcome any fund suggestions to go and explore from people who have already gone down this path and reached similar subjective conclusions

Perhaps I have missed it - but precisely what is the objective of your non equity investments?  May be if you looked at things from a strategic level top down the implementation would be clearer.

For example from my situation the objectives/solutions are:
1)  Steady income regardless of market conditions at sufficient level to meet my day to day expenses.  This implies guaranteed income in the short/medium term.  The implementation has been deferring SP,  annuities taken out prior to 2008, and an income portfolio at 30% of investible wealth.
2) Sufficient guaranteed capital to meet any short/medium term expenses beyond (1) including major one-offs such as expensive holidays.  Implementation: Cash, 15% of my investible wealth.
3) Medium term security from market events. Implementation: Wealth Preservation portfolio based on CGT and Troy Trojan: 20% of investible wealth 
4) Long term protection from inflation and top-up of the WP and income portfolios. Implementation: 100 % equity Growth Portfolio: 35% of investible wealth.  I am slowly reducing the Growth Portfolio as I get older.

Overall the allocation is: 56% equity, 20% Fixed Interest, 15% cash, 9% other. The FI split is 17% normal government bonds, 23% index linked bonds, 50% corporate bonds, 10% other (mainly cash).

So a pretty normal retirement allocation.  However there has been no need for deep soul searching about what kind of bonds to buy.  The bonds are whatever the individual fund managers think appropriate to meet their specific remit.  None of the bonds are assigned to short term risk mitigation, that job is entirely done by cash.   Use the right tools for each job.