Bond Malaise

theblueflash

Completely get all the commentary around Bond fears and the worries around 60/40 funds, inflation having big impact etc. 

Are those fears primarily on GOV bonds - are there similar outlooks for Corporate Bond market. I have some cash in Fidelity MoneyBuilder Income which is a mix of both? 

JohnWinder

If you own a nominal (not inflation linked) bond, you know exactly how much principal will be returned at maturity and how much each coupon will be. Inflation will reduce the purchasing power of both of those types of payment, so whether it's a government bond or a corporate bond (as long as it's a fixed rate bond which is commonest), inflation will have the same impact....other things being 'normal' as usual. If the inflation is part of a financial crisis, then the corporate bonds would likely drop in value more than the government bonds, as folk fear there may be defaults on coupon payments or principal repayment.

Is that what you're getting at?

theblueflash

Yes - thank you. So if inflation is the big worry, then actually 100% Government Bonds - if you’re going to hold any Bonds at all, are actually less risky as a bigger proportion of default risk is removed with GOV bonds? 

JohnWinder

Yes, clearly. But you'd anticipate their return would be less that corporate bonds. Investors in efficient markets are offered rewards for taking more risk: corporates are more likely to default, so the yield is higher commensurate with the market's view on how much default is expected. Which kind of leads you to think: why would you bother trying to choose corporate bonds when you can simply hold more equities for more return and more risk? Not that it would be a crime, but there's something to be said for keeping it simple.

But don't forget, nominal government bonds will be hammered if inflation goes nuts. You get protection from that with inflation linked bonds.

MK62

JohnWinder said:

Yes, clearly. But you'd anticipate their return would be less that corporate bonds. Investors in efficient markets are offered rewards for taking more risk: corporates are more likely to default, so the yield is higher commensurate with the market's view on how much default is expected. Which kind of leads you to think: why would you bother trying to choose corporate bonds when you can simply hold more equities for more return and more risk? Not that it would be a crime, but there's something to be said for keeping it simple.

But don't forget, nominal government bonds will be hammered if inflation goes nuts. You get protection from that with inflation linked bonds.

.....but, with UK inflation linked bonds at least, do you actually get any "real" protection at the moment, at current valuations? 

MarkCarnage

MK62 said:

JohnWinder said:

Yes, clearly. But you'd anticipate their return would be less that corporate bonds. Investors in efficient markets are offered rewards for taking more risk: corporates are more likely to default, so the yield is higher commensurate with the market's view on how much default is expected. Which kind of leads you to think: why would you bother trying to choose corporate bonds when you can simply hold more equities for more return and more risk? Not that it would be a crime, but there's something to be said for keeping it simple.

But don't forget, nominal government bonds will be hammered if inflation goes nuts. You get protection from that with inflation linked bonds.

.....but, with UK inflation linked bonds at least, do you actually get any "real" protection at the moment, at current valuations? 

You get inflation protection, you just don't get a positive real return......unless of course real yields become more negative during your holding period. 

JohnWinder

MK62 said:

.....but, with UK inflation linked bonds at least, do you actually get any "real" protection at the moment, at current valuations? 

Different parts of a portfolio offer different benefits and different shortcomings. Stocks are fabulous, except they have a habit of massive value drops. Cash is versatile, but returns are poor on average. High quality bonds offer price stability, but returns can be lousy. Linkers handle inflation well, but yields are negative. There isn't an all singing all dancing asset that does everything. Some promote 'wealth protection' funds as such an animal, but we've debunked that. Not all parts of ones portfolio will be a standout winner at the same time. We might as well live with the reality: work longer, spend less, take more risk.

MarkCarnage

There isn't an all singing all dancing asset that does everything. Some promote 'wealth protection' funds as such an animal, but we've debunked that. 

I don't think that such funds claim to do everything. The better ones have done a decent job at what they say on their tin, namely protect real wealth. Yes, there are individual years when they don't but over sensible time periods they have done that, albeit in an environment that has for much of the time been quite benign  for that goal. 

I use them, but in conjunction with active global equity funds, and some satellite specialist holdings. 

What I think you are saying is that diversification is important. Which it is. Unfortunately, many investors think they're diversified when they're not. 

Thrugelmir

theblueflash said:

Yes - thank you. So if inflation is the big worry, then actually 100% Government Bonds - if you’re going to hold any Bonds at all, are actually less risky as a bigger proportion of default risk is removed with GOV bonds? 

With corporate bonds you may also be exposed to equity capital loss as well if the company concerned is forced to default in some manner. 

[Deleted User]

On the balance of probability yields are more likely to rise than to fall.  And if they were to fall, the floor isn’t very far of the current levels (albeit further than in Jan 2021).  And inflation is likely to outstrip the coupon.  This means that bonds are likely to lose money in real terms.  Long duration bonds are impacted more when yields jump.  Basically, bonds carry more risk and less reward than in the recent past.

There are several ways to mitigate this risk, including:
- shorten duration 
- use cash for fixed income
- change from 60/40 to 70/30, etc
- buy higher yield and higher risk bonds 
- use annuities for your FI

Audaxer

JohnWinder said:

MK62 said:

.....but, with UK inflation linked bonds at least, do you actually get any "real" protection at the moment, at current valuations? 

 We might as well live with the reality: work longer, spend less, take more risk.

I would think that if you work longer and spend less, you should end up with a bigger pot and be therefore able to take less risk with your portfolio.