Which bond index funds to balance portfolio?

JohnWinder

I agree you are unlikely to see a major step change in interest rates, though they could vary a lot over a small number of years.

... When interest rates rise those new bonds will lose a significant amount of value to ensure that the effective bond interest rate matches the then current market rate.

For example on 22nd September 2021 a 0.875% gilt maturing in 2033 was issued at very close to £100.  Thanks to the small rise in interest rates in the 4 months since then it is now worth £96.3. ...  Such figures lead me to believe that some-one wanting protection from equity falls would be better advised to use cash.

 And some real life bond fund data:

"This is in no sense a prediction, but we can look at what actually happened to four typical intermediate-term "core" bond funds from June 2004 through July 2006 when the Fed raises rates from 1% to 5.25%, a rise of more than 4% in just over two years.



As you can see, despite the Fed "raising rates," over the two years when the Fed Funds rate was rising not a single bond fund lost money."

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=366528&newpost=6448253

Thrugelmir

JohnWinder said:

I agree you are unlikely to see a major step change in interest rates, though they could vary a lot over a small number of years.

... When interest rates rise those new bonds will lose a significant amount of value to ensure that the effective bond interest rate matches the then current market rate.

For example on 22nd September 2021 a 0.875% gilt maturing in 2033 was issued at very close to £100.  Thanks to the small rise in interest rates in the 4 months since then it is now worth £96.3. ...  Such figures lead me to believe that some-one wanting protection from equity falls would be better advised to use cash.

 And some real life bond fund data:

"This is in no sense a prediction, but we can look at what actually happened to four typical intermediate-term "core" bond funds from June 2004 through July 2006 when the Fed raises rates from 1% to 5.25%, a rise of more than 4% in just over two years.



As you can see, despite the Fed "raising rates," over the two years when the Fed Funds rate was rising not a single bond fund lost money."

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=366528&newpost=6448253

And this predicts the future? 

aroominyork

Thrugelmir said:

JohnWinder said:

I agree you are unlikely to see a major step change in interest rates, though they could vary a lot over a small number of years.

... When interest rates rise those new bonds will lose a significant amount of value to ensure that the effective bond interest rate matches the then current market rate.

For example on 22nd September 2021 a 0.875% gilt maturing in 2033 was issued at very close to £100.  Thanks to the small rise in interest rates in the 4 months since then it is now worth £96.3. ...  Such figures lead me to believe that some-one wanting protection from equity falls would be better advised to use cash.

 And some real life bond fund data:

"This is in no sense a prediction, but we can look at what actually happened to four typical intermediate-term "core" bond funds from June 2004 through July 2006 when the Fed raises rates from 1% to 5.25%, a rise of more than 4% in just over two years.



As you can see, despite the Fed "raising rates," over the two years when the Fed Funds rate was rising not a single bond fund lost money."

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=366528&newpost=6448253

And this predicts the future? 

JohnWinder began his post by answering your question when he said "This is in no sense a prediction" but I think it's a useful post given what is being said left, right and centre that interest rates are likely to rise and bond (at least IG ones) are likely to fall or, at best, offer sub-inflation returns. Of course that might be true and we live in a different world from 2004-2006, but I think it's helpful to caution people who are stampeding for the bond exit doors that, as ever, there are no one-way bets.

Linton

JohnWinder said:

I agree you are unlikely to see a major step change in interest rates, though they could vary a lot over a small number of years.

... When interest rates rise those new bonds will lose a significant amount of value to ensure that the effective bond interest rate matches the then current market rate.

For example on 22nd September 2021 a 0.875% gilt maturing in 2033 was issued at very close to £100.  Thanks to the small rise in interest rates in the 4 months since then it is now worth £96.3. ...  Such figures lead me to believe that some-one wanting protection from equity falls would be better advised to use cash.

 And some real life bond fund data:

"This is in no sense a prediction, but we can look at what actually happened to four typical intermediate-term "core" bond funds from June 2004 through July 2006 when the Fed raises rates from 1% to 5.25%, a rise of more than 4% in just over two years.



As you can see, despite the Fed "raising rates," over the two years when the Fed Funds rate was rising not a single bond fund lost money."

https://www.bogleheads.org/forum/viewtopic.php?f=10&t=366528&newpost=6448253

If you want to understand bond funds you need to look at longer term rates - UK gilt index funds average at 10-15 years.  Normally changes in the short term rates have only a small immediate effect on the longer term ones,  



From https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart  you will see that even the 2008 crash is barely distinguishable from the long term trend.  Also you will see that the 40 year long term trend has about reached the end of the road.

At the detail you provide, you can see also the 10 year rate in June 2004 was about 4.8% and that in July 2006 was 5.05%.  Since the bonds then were paying interest at about 4-5% your performance graph looks pretty much as expected, given that the vertical axis is unlabelled.  Currently the US 10 year interest rate is about 1.8%.

Compare with the current UK situation.  The current 10 year gilt figure is 1.14%.  Even the 20 year rate is only 1.34%. So we have the double whammy of a low yield, well below inflation,  and the end of the decreasing interest/increasing capital value era.

If you are going to invest in bond index funds as a balance against equity you should be using shorter duration ones.  Unfortunately this option does not seem to be available to UK investors.

GeoffTF

Linton said:
If you are going to invest in bond index funds as a balance against equity you should be using shorter duration ones.  Unfortunately this option does not seem to be available to UK investors.

The are lots of short dated gilt funds, if that is what you want:

https://monevator.com/low-cost-index-trackers/

Linton

GeoffTF said:

Linton said:
If you are going to invest in bond index funds as a balance against equity you should be using shorter duration ones.  Unfortunately this option does not seem to be available to UK investors.

The are lots of short dated gilt funds, if that is what you want:

https://monevator.com/low-cost-index-trackers/

Thanks, yes 3 ETFs.  Though at 0-5 years they really are very close to cash with effectively zero return but without superior diversification value.  Perhaps 5-10 years would be more useful.

In the ideal world one arguably would choose bond maturities that matched ones investment timescales.

GeoffTF

Linton said:

GeoffTF said:

Linton said:
If you are going to invest in bond index funds as a balance against equity you should be using shorter duration ones.  Unfortunately this option does not seem to be available to UK investors.

The are lots of short dated gilt funds, if that is what you want:

https://monevator.com/low-cost-index-trackers/

Thanks, yes 3 ETFs.  Though at 0-5 years they really are very close to cash with effectively zero return but without superior diversification value.  Perhaps 5-10 years would be more useful.

In the ideal world one arguably would choose bond maturities that matched ones investment timescales.

For iShares UK Gilts 0-5yr UCITS ETF the weighted YTM is 0.7%, which is not zero. If you want 5-10 years, you can use VAGP or its accumulating version VAGS, which are Vanguard global aggregate bond ETFs hedged in to sterling with an average duration of 7.7 years.

Linton

GeoffTF said:

Linton said:

GeoffTF said:

Linton said:
If you are going to invest in bond index funds as a balance against equity you should be using shorter duration ones.  Unfortunately this option does not seem to be available to UK investors.

The are lots of short dated gilt funds, if that is what you want:

https://monevator.com/low-cost-index-trackers/

Thanks, yes 3 ETFs.  Though at 0-5 years they really are very close to cash with effectively zero return but without superior diversification value.  Perhaps 5-10 years would be more useful.

In the ideal world one arguably would choose bond maturities that matched ones investment timescales.

For iShares UK Gilts 0-5yr UCITS ETF the weighted YTM is 0.7%, which is not zero. If you want 5-10 years, you can use VAGP or its accumulating version VAGS, which are Vanguard global aggregate bond ETFs hedged in to sterling with an average duration of 7.7 years.

Yes there may be a case for using safe government bonds other than gilts.  I think US bonds are at lower prices and interest rates are higher.

It is significant that if you look at funds which can choose how they invest their non-equity I think you will find that they are unusually low in Gilts.

GeoffTF

Deleted_User said:

After a decade of the 10 year rate hugging the 2% or 1% line, it can only go up, right? ...

The market is saying "no". It believes that the 10 year rate is as likely to go down as it is to go up.