Using LifeStrategy 20 as a Bond Fund

aroominyork

older_and_no_wiser said:

As someone who's unsure of what bond fund(s) to invest in as part of a retirement portfolio, would simply choosing the Vanguard LifeStrategy 20 be a good move? This is obviously 80% bond funds of different durations, grades etc. It's trusting in Vanguard to pick the right mix.

I do this. I hold a couple of strategic bond funds and wanted to complement them with a gilt/govt-heavy index fund. I compared the bond element of VLS to Vanguard's global bond fund using a simultaneous equation (doubling the returns of VLS40 and then subtracting VLS80's returns to give a 100% bonds return) and it performed better than the global bond index, so I chose VLS and reduced my equity tracker a bit to compensate for the 20% equities. I re-ran the calculation a couple of days ago and the difference was not as great. I have no real insight into why the two funds hold different bonds - I would be interested to know.

I would like to know what proportion of the VLS bonds are gilt/govt rather than corporate bonds but cannot find that info. Can anyone source it?

tebbins said:

4. The VLS range also do not hold inflation-linked bonds. Whether you want to hold these is a whole other debate, the target retirement fund range does hold individual, short-duration inflation-linked gilts i.e. not in a fund as with its other holdings. Depending on your investment platform you could buy such individually, or iShares offer a range of UK and hedged US inflation-linked bond funds.

The top ten holdings shown on HL says 7.42% is in Vanguard UK inflation-linked gilt index.

masonic

tebbins said:

masonic said:

tebbins said:

3. Vanguard have a US government bond fund hedged into GDP, with a yield around 1.1-1.2% (treasury . gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield) over an 8 year maturity. This is much less volatile and higher yielding, though not much better than cash. If you want safe, low volatility bonds, I personally would go with that.

This is an interesting approach, although looking at current data, the effective yield to maturity at the end of July was 0.8%, and a Trustnet comparison report puts the 3 year volatility at 4.4% vs 3.1% for a currency hedged global bond tracker (I used the iShares one, AGBP). It could be useful if wishing to avoid certain geographic regions.

The 0.8% is at the end of June, the treasury website provides more up to date and accurate yield information, as do iShares funds (e.g. GOVT). For some reason both Vanguard and iShares show numbers below what treasury.gov shows, perhaps they net off the OCF + transaction costs?
In any event you get a higher yield with the same lack of currency risk, less interest rate/maturity volatility, and a comparably creditworthy government.

The Vanguard website quotes at the top of the table "As at date 31 Jul 2021". I don't think you can simply deduce the effective YTM of a bond fund by taking the weighted average duration of the fund and comparing it to the computed yield curve. The fund will contain bonds of short, medium and long duration in varying amounts, which will produce a yield that could diverge. For example, a fund holding 100% medium dated bonds would not be expected to have the same yield as one that holds 50% short and 50% long dated bonds to give the same average duration (1 year @ 0.08, 20 year @ 1.85, mean 0.97; 10 year @ 1.29). The fund currency and hedging may also have some impact.

I only used the iShares fund as it had a 3 year history, while Vanguard did not, but conclude from this that the global hedged index is lower volatility than the US hedged index, while being very similar in duration and yield.

JohnWinder

I don't know what bonds are in the VLS20, and it’s not hard to calculate that if you hold 90% equities and 10% VLS20 that you’ve got a 92/8 portfolio, so it doesn’t seem a crazy idea. Nonetheless, I’ll ask why not just get a bond fund worth 8% of your portfolio? It’s exactly the same asset allocation, but you might have more control over what the bonds were.
Which bond fund(s) would you pick? You could choose the credit-risk safest possible, and hold x% as those bonds; or you choose a credit-risk less safe one, but you’d need to hold more than x% to get the same ‘protection’ in a market meltdown. Folk here recently shared thoughts on how much bigger x should be for the same protection as x% with the safest bonds, but why bother messing around trying to figure that out, just get the safest bonds. If you don’t like their returns now, don’t get so much of them and hold more stocks; or if you’re feeling nervous, get some more of the bonds.

Alternatively there are strategic funds (eg Jupiter, Allianz). These have sightly higher ongoing charges and are actively managed.

You’d choose a bond fund based on its credit risk, its interest rate (duration) risk, whether it has inflation linked bonds, the reputation of the managing company, follows a reputable index if it’s a tracker, and the cost; I suppose liquidity, buy/sell spread, premium/discount to NAV and a few others are important as well, but I can’t remember them.  Can Jupiter of Allianz squeeze any more out of a government bond fund than you’ll get in another government bond fund of the same duration? Can’t imagine it’s even possible; if so, don’t pay any more for the name.

and held tight during any crash with enough cash to ride it out (2+ years), is there even a reason to hold bonds?

2+ years? Are you kidding? The 1929 crash lasted 15 years, with a couple of ‘buts’. Half way through that 15 years the stock market came back to a positive return (but you had to have reinvested all dividends, and inflation allowed for) for 3 months, and then dived again only to return to its inflation adjusted level (having reinvested all dividends again) in 1945.  Unless one had a stroke of genius management during that three month recovery, you got to 15 years and still didn’t know if it would dive again. That’s when your faith in 90-100% stocks gets tested.

We know from history, that the market will always recover

...'recovered', past tense. Guessing the future is tricky, especially if you don’t have 15 more years to live.

When you choose which bond fund(s) to get, consider inflation linked bonds. You'll weep when you learn the return is now -2% (I'm guessing) when comparable nominal bond funds return 0.5% (another guess), but when inflation is 2.5% both funds are returning exactly the same in inflation adjusted terms (which is what you need). Either fund would satisfy if inflation stayed and moved as it was predicted to do; but when you inflation rises unexpectedly, the linkers fund will keep up while the nominal bonds' value will be trashed unless deflation bails them out. The value of holding both is simply that, however unpopular they may be.

masonic

JohnWinder said:

When you choose which bond fund(s) to get, consider inflation linked bonds. You'll weep when you learn the return is now -2% (I'm guessing) when comparable nominal bond funds return 0.5% (another guess), but when inflation is 2.5% both funds are returning exactly the same in inflation adjusted terms (which is what you need). Either fund would satisfy if inflation stayed and moved as it was predicted to do; but when you inflation rises unexpectedly, the linkers fund will keep up while the nominal bonds' value will be trashed unless deflation bails them out. The value of holding both is simply that, however unpopular they may be.

I find inflation linked bonds a tricky one. A low cost tracker will hold Gilts with a YTM of -2.5%, which is a real return of zero when inflation is at 2.5%, but these are considerably more volatile than nominal bonds, in part due to the higher weighting of very long dated linkers, which have the greatest price volatility and interest rate sensitivity. If opting for a short-dated fund, then YTM will be more negative, around -3%, but it would take quite a bit of inflation for these to break even with nominal bonds (3.5-4%). It has been suggested that a mix of long dated linkers and cash can be used as a proxy for the short dated variety, but in so doing you only get fractional index linking. I don't think a currency hedged global variant would work in this instance, because local currency inflation and exchange rates are linked (so the hedging and foreign inflation would presumably be in conflict).

There are some low cost active funds in this sector that perhaps can extract some extra value by trading different durations, but it then gets very hard to set expectations.

Edit: I suppose one should factor in that Gilts are still linked to RPI for a while longer, so those with duration of <8 years are a bit more valuable.

bostonerimus

People will want to complicate this, but the answer is "yes adding VLS20 will be a perfectly fine way to include bonds in your portfolio". If you are in the accumulation phase and plan to reinvest interest back into VLS80 and have a long term (ie > 10 years) horizon, then you will probably be ok. But if you are looking to take income out of bonds right now I can't see how you can make much money.

If you are nervous about the highs we are seeing in equity markets I would convert some profits to cash or very short term bonds as well. If you have any debt you should look at paying that off if you are paying any rate that's higher than you'd get in a saving or bond account and look at making extra mortgage payments.

older_and_no_wiser

JohnWinder said:

2+ years? Are you kidding? The 1929 crash lasted 15 years, with a couple of ‘buts’. Half way through that 15 years the stock market came back to a positive return (but you had to have reinvested all dividends, and inflation allowed for) for 3 months, and then dived again only to return to its inflation adjusted level (having reinvested all dividends again) in 1945.  

I know this is an emotive topic, but how likely is a crash of 1929 proportions to happen again? These days with the advances in technology, global communication and government/industry knowledge from history....would such a crash and long term recovery timescale ever happen? 

Sorry if I've not articulated that too well, but hopefully you get my point. We are a smarter society with safeguards in place to avoid such a meltdown. Yes we had 9-11, the dot com bubble, a banking crisis and a global pandemic on a scale never before seen. The economy bounced back quicker each time. We learn from each event.

Am I overly optimistic? 

older_and_no_wiser

I should have mentioned that global government banking methods such as QE and interest rate changes to combat local and global crises seem to be used more effectively in recent history....which could prevent an extended period of market downturn.

This is me thinking aloud. I'm by no means a financial whizz or economist! 

Perhaps I should stop posting now as I'm really not qualified to provide any valuable input! I'm just trying to learn as I go and try to protect my investments as best I can. Bonds just confuse me, but the chap on the Pension Craft YouTube channel does explain it all really well in one of his videos.

tebbins

Deleted_User said:

tebbins said:

3. Vanguard have a US government bond fund hedged into GDP, with a yield around 1.1-1.2% (treasury . gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield) over an 8 year maturity. This is much less volatile and higher yielding, though not much better than cash. If you want safe, low volatility bonds, I personally would go with that.

I don't think that works, because you lose in hedging costs what you gain in higher interest rates.

If you buy $100m-worth of US treasuries, and hedge your currency exposure by taking out a forward contract to buy £s (however many you can get) for $100m next month, then the number of £ you get will be lower than today's £/$ rate, because the contract is priced based on today's exchange rate adjusted to allow for the different prevaling interest rates in £ and $.

By that logic the hedged Euro and Japanese bond funds should be yielding the same. You should be right however the market will never be perfectly efficient.
 However I do stand corrected by @masonic re: the yield.

masonic

Deleted_User said:

masonic said:

Have you checked the yield to maturity on UK government bonds bought today? Anything under 10 year duration can be beaten by an instant access savings account. It's unlikely there will be further capital gains to be had on long dated gilts.

Long-dated gilts are more volatile, and that is that point of them: in what the Bank of England judges to be bad times, long-dated gilts are pretty likely to rise, because the BoE will cut rates, both base rate (the shortest interest rate, viz. over 1 day) and long-term rates (which they can do using QE). It's not about whether this is likely to happen; it's about these being the tools the BoE has ready to roll out in a crisis.

On a more technical point, after the BoE's recent warning to banks that they should be prepared to handle negative base rates, the minimum rate the BoE can set is no longer 0%, but perhaps c. -0.5%. That minimum applies to be base rate (and I'd guess that a -0.5% base rate would put savings accounts on precisely 0%, considering that you can get about 0.5% now with base rate at 0.1%, and savers would be resistant to negative savings rates), and to YTMs on gilts. Larger capital gains on long-term gilts would be follow if their YTMs were approaching -0.5%.

However, although cash + long-term gilts would be my approach, I think VLS20 is OK.

My comment was in the context of the idea that "Assuming a 10+ year investment timeline, one could take the Lars Kroijer approach and opt for a single(?) local currency fund of UK government bonds with dates matching the investment duration." That isn't something that is going to fare well today. The highest YTM available (on a Gilt maturing in 2065) is 1%, compared with 1.7% on a FSCS protected 5 year fixed term saver (or 1.35% for a cash ISA equivalent). Anything matching a real world investment horizon is going to be worse than that.

Personally, I'm holding a mix of cash and mostly long dated bonds, although I'm not exactly thrilled about it! In a post-Covid, roaring 20s, inflationary scenario, the BoE may be rising interest rates to keep inflation under control, although I have no idea how much inflation they'd consider too much. It's good to keep in mind that there is some further potential downside in interest rates.

coastline

Maybe a bit more volatile but you could move part into CGT or PNL ?

Chart Tool | Trustnet