Which bond index funds to balance portfolio?

aroominyork

GeoffTF said:

aroominyork said:

I personally hold Vanguard's Global Bond Index which is about 60% govt, 40% corporate. It is cheaper than IGLH and I am happy to have some high quality corporate bonds as part of the mix.

VAGP and the accumulating version VAGS are the ETF versions of the Vanguard's Global Bond Index fund. They are cheaper, but hold less bonds.

I would be happy with the ETF's 7000 holdings rather than the OEIC's 15,000 - it's just that I tend to hold OEICs. The ETF charges 0.10% compared to the OEIC's 0.15% but the former has a c.0.16% buy/sell spread.

GeoffTF said:

aroominyork said:

I personally hold Vanguard's Global Bond Index which is about 60% govt, 40% corporate. It is cheaper than IGLH and I am happy to have some high quality corporate bonds as part of the mix.

Vanguard UK's head of portfolio construction recently said in an interview that their global bond funds were are good starting point and ending point for any portfolio.

What a surprise!

Prism

GeoffTF said:

Linton said:

With developed world government bonds time to maturity can be a bigger factor than country of origin.  Bond index funds generally hold bonds with a motley collection of maturity dates, typically averaging 10-15 years.  This, I believe makes them at least questionable as a major component of a balanced portfolio bought to provide protection agtainst equity falls.

The UK gilt market has an unusually long duration. VGOV (which is an aggregate gilt fund) currently has a duration of 14.2 years. VAGP (which is an aggregate global bond fund hedged into sterling) currently has duration of 7.7 years. If you want maximum protection against stock market falls, you want an investment that has the largest possible negative correlation with stock market prices. That investment is long dated government bonds. You think that they are overpriced, but the market disagrees. I bought VAGP rather than VGOV, but that may not have been the best choice.

Surely that would depend on the reason for the stock market fall. If it were due to rising interest rates then equities and long duration bonds would likely fall together.

Thrugelmir

Victorwelldue said:

I've pretty much settled on a 70% equity / 30% bond split for my workplace pension and I'm fairly happy with my equity fund choices but I'm more perplexed by which bond funds to choose.

So I'm trying to understand what are the characteristics of bond index funds that I should be looking for, for this purpose. For example:

• Stick to UK or diversify with world? (If so in which proportions?)
• Stick to Gilts & T-Notes or diversify with corporate? (If so in which proportions?)
• Inflation index linked or not?
• High yield or not?
• Maturing over 5 years? 15 years? Does this even matter when it will only be index funds anyway?
• Diversify over multiple bond index funds or just stick to one or two?
• Are bonds enough? I also have limited choice to a couple of cash & property funds - should these be considered too?

Hopefully retiring in somewhere between 8 to 12 years.
  

Why not use a managed asset fund to achieve your objectives?  It's constantly shifting sands out in the markets at the moment. You'll be behind the curve. 

Linton

GeoffTF said:

Linton said:

With developed world government bonds time to maturity can be a bigger factor than country of origin.  Bond index funds generally hold bonds with a motley collection of maturity dates, typically averaging 10-15 years.  This, I believe makes them at least questionable as a major component of a balanced portfolio bought to provide protection agtainst equity falls.

The UK gilt market has an unusually long duration. VGOV (which is an aggregate gilt fund) currently has a duration of 14.2 years. VAGP (which is an aggregate global bond fund hedged into sterling) currently has duration of 7.7 years. If you want maximum protection against stock market falls, you want an investment that has the largest possible negative correlation with stock market prices. That investment is long dated government bonds. You think that they are overpriced, but the market disagrees. I bought VAGP rather than VGOV, but that may not have been the best choice.

It isnt about market sentiment.  Safe bond prices are directly linked to interest rates.  Given one it is a relatively simple mathematical calculation to determine the other.
 
Should the equity market fall by say 50%, at current interest rates are you really expecting a significant rise in long term bond prices?  Taking the bond maturing in 2055 currently valued at £183, if long term interest rates drop to zero the price would be about £240.  Are you predicting that long term interest rates could drop to zero or below?

On the other hand if long term interest rates rise to 4.5%, which is about the value just before the 2008 crash, the 2055 bond  price would be about £95.

Are these figures compatible with a safety blanket against equity volatility?

GeoffTF

Prism said:

GeoffTF said:

Linton said:

With developed world government bonds time to maturity can be a bigger factor than country of origin.  Bond index funds generally hold bonds with a motley collection of maturity dates, typically averaging 10-15 years.  This, I believe makes them at least questionable as a major component of a balanced portfolio bought to provide protection agtainst equity falls.

The UK gilt market has an unusually long duration. VGOV (which is an aggregate gilt fund) currently has a duration of 14.2 years. VAGP (which is an aggregate global bond fund hedged into sterling) currently has duration of 7.7 years. If you want maximum protection against stock market falls, you want an investment that has the largest possible negative correlation with stock market prices. That investment is long dated government bonds. You think that they are overpriced, but the market disagrees. I bought VAGP rather than VGOV, but that may not have been the best choice.

Surely that would depend on the reason for the stock market fall. If it were due to rising interest rates then equities and long duration bonds would likely fall together.

Market crashes are not usually triggered by an interest rate rise (which usually is not a big surprise). When the market does crash, people often panic and sell equities and buy bonds for safety. Bond prices often (but not always) rise as a result. See the Monevator article linked above for a discussion of which bonds are most likely to cushion a fall.

Inflation does increase stock / bond correlation. Here is recent Vanguard paper on the topic:

https://www.vanguard.co.uk/content/dam/intl/europe/documents/en/the-stock-bond-correlation-eu-en-pro.pdf

They do not recommend dumping bonds.

GeoffTF

aroominyork said:

GeoffTF said:

aroominyork said:

I personally hold Vanguard's Global Bond Index which is about 60% govt, 40% corporate. It is cheaper than IGLH and I am happy to have some high quality corporate bonds as part of the mix.

Vanguard UK's head of portfolio construction recently said in an interview that their global bond funds were are good starting point and ending point for any portfolio.

What a surprise!

Other fund managers provide equivalent products. Vanguard provides other types of bond fund. If Vanguard sees a market success it copies it. So do the others.

Thrugelmir

GeoffTF said:

Prism said:

GeoffTF said:

Linton said:

With developed world government bonds time to maturity can be a bigger factor than country of origin.  Bond index funds generally hold bonds with a motley collection of maturity dates, typically averaging 10-15 years.  This, I believe makes them at least questionable as a major component of a balanced portfolio bought to provide protection agtainst equity falls.

The UK gilt market has an unusually long duration. VGOV (which is an aggregate gilt fund) currently has a duration of 14.2 years. VAGP (which is an aggregate global bond fund hedged into sterling) currently has duration of 7.7 years. If you want maximum protection against stock market falls, you want an investment that has the largest possible negative correlation with stock market prices. That investment is long dated government bonds. You think that they are overpriced, but the market disagrees. I bought VAGP rather than VGOV, but that may not have been the best choice.

Surely that would depend on the reason for the stock market fall. If it were due to rising interest rates then equities and long duration bonds would likely fall together.

Market crashes are not usually triggered by an interest rate rise (which usually is not a big surprise). 

Corrections reflect a change in market conditions. An rise in interest rates will result in increased costs for growth stocks that are dependent upon issuing new equity to fund their expansion. At the moment their are numerous investors who are driving flat out oblivous to the wall of fog that lies ahead. 100% equity portfolios have always carried high risk. Never going to change. 

GeoffTF

aroominyork said:

GeoffTF said:

aroominyork said:

I personally hold Vanguard's Global Bond Index which is about 60% govt, 40% corporate. It is cheaper than IGLH and I am happy to have some high quality corporate bonds as part of the mix.

VAGP and the accumulating version VAGS are the ETF versions of the Vanguard's Global Bond Index fund. They are cheaper, but hold less bonds.

I would be happy with the ETF's 7000 holdings rather than the OEIC's 15,000 - it's just that I tend to hold OEICs. The ETF charges 0.10% compared to the OEIC's 0.15% but the former has a c.0.16% buy/sell spread.

With its OEICs, Vanguard does its best to make sure that buyers and sellers pay the cost of creating and redeeming units. It does that with swing pricing:

https://www.vanguard.co.uk/content/dam/intl/europe/documents/en/guide-to-swing-pricing.pdf

Trading has costs, whether you use the OEIC or the ETF. These costs are higher than they are for a simple gilt fund like VGOV, which has a narrower spread.

bd10

GeoffTF said:

Prism said:

GeoffTF said:

Linton said:

With developed world government bonds time to maturity can be a bigger factor than country of origin.  Bond index funds generally hold bonds with a motley collection of maturity dates, typically averaging 10-15 years.  This, I believe makes them at least questionable as a major component of a balanced portfolio bought to provide protection agtainst equity falls.

The UK gilt market has an unusually long duration. VGOV (which is an aggregate gilt fund) currently has a duration of 14.2 years. VAGP (which is an aggregate global bond fund hedged into sterling) currently has duration of 7.7 years. If you want maximum protection against stock market falls, you want an investment that has the largest possible negative correlation with stock market prices. That investment is long dated government bonds. You think that they are overpriced, but the market disagrees. I bought VAGP rather than VGOV, but that may not have been the best choice.

Surely that would depend on the reason for the stock market fall. If it were due to rising interest rates then equities and long duration bonds would likely fall together.

Market crashes are not usually triggered by an interest rate rise (which usually is not a big surprise). When the market does crash, people often panic and sell equities and buy bonds for safety. Bond prices often (but not always) rise as a result. See the Monevator article linked above for a discussion of which bonds are most likely to cushion a fall.

Inflation does increase stock / bond correlation. Here is recent Vanguard paper on the topic:

https://www.vanguard.co.uk/content/dam/intl/europe/documents/en/the-stock-bond-correlation-eu-en-pro.pdf

They do not recommend dumping bonds.

I trust you mean by "increase" in the correlation coefficient a move towards zero (or even positive territory). Statistically speaking,  "increasing" correlation would bring it either closer to -1 or +1.

Right hand side on page 5 of the aforementioned Vanguard paper is the crucial bit reg inflation.

Personally I would prefer a bond fund which actively manages inflation and duration risk. Also, I would be wary of the assumption that the market still enjoys the Fed put. That would undermine their credibility right now. Should we indeed enter a phase of equity bond correlations closer to zero or even positive, this has profound impacts to asset allocation as one's 60/40 for example has a different risk profile. Add to that a dash of inflation, say 3-5% pa for a prolonged period, there will be challenges ahead.

With a CAPE around 40 and prospective returns over the next decade much suppressed, say mid-single digits (at least that's what the statistical model would suggest), a 10y note with a 2% coupon may no longer seem so unattractive by comparison. I would not suggest to rush out and hold nominal bonds, quite the contrary but higher interest rates reprice the relative attractiveness of assets.

JohnWinder

For example there is a Gilt maturing in 2055 at a price of £182.  You know with absolute certainty that the price will be £100 in 2055.  ...

Equally, if you buy a long dated bond now paying 1.25% interest it would cost you about £100.Were general interest rates to rise to 4% today its value would also halve. 

This alludes to the relationship between interest rates and bond prices: as rates rise, bond prices fall, roughly by the duration times the % rise, so a 20 year duration fund would fall 40% with a 2% interest rate rise. It's a handy way to think of this relationship, but it grossly oversimplifies and can misrepresent the reality.

Firstly, which interest rates are we talking about? If it's the central bank rate, then this has a limited and very indirect effect on longer term bond rates. Secondly, interest rates customarily don't exhibit step rises/falls of the 2% variety; central banks move their rates by fractions of a percent, and markets move longer bond rates by fractions of fractions each week/month. Thirdly, the OP is talking about bond funds, not bonds, and bond funds continually shed old (poor yielding) bonds and acquire new (higher yielding) bonds as interest rates rise thus ameliorating the effect of the interest rate change on the bonds' prices. With slow rises in interest rates you might not even be aware of the fund price falling. Fourthly, roll yield (explained at the bottom of p1 of the linked post) further ameliorates the price fall.

See it all in graphic detail here: https://www.bogleheads.org/forum/viewtopic.php?t=360575