Bonds – what are you doing?

GeoffTF

Prism said:

GeoffTF said:

Alexland said:

GeoffTF said:

The UK stock market fell to about a quarter of its value and took nine years to recover in real terms.

Just imagine how powerful the dividend reinvestment and regular contributions would be buying more shares at such low prices...

It took nine years (actually ten in the table) to recover WITH reinvestment of dividends:

http://wpfau.blogspot.com/2014/01/greatest-hits.html?m=1

Regular contributions would certainly have helped, but regular withdrawals would have been disastrous. The traditional way funding retirement was to use pound cost averaging to accumulate a large sum, and then buy an annuity. That way, you benefited from pound cost averaging on the way up, but avoided the opposite after retirement.

If you hold safe investments, in addition to equities, you can live off the safe investments when the stock market is bombed out, and avoid your capital bleeding away.

Regular withdrawals have been back tested through this period and would have been fine assuming a mix of equities and bonds (even though both dropped at this time) and a moderate withdrawal rate of around 3.5%. There was no need to specifically have a safe investment buffer or pot. Regular rebalancing was enough.

The bond allocation is the safe investment buffer or pot. If you use cash flow rebalancing, you sell whichever asset is over-weighted. That will be bonds if the equities have crashed.

masonic

It wouldn't make sense to currency hedge an inflation linked bond fund because local currency inflation is intrinsically linked to exchange rate movements. Hedging would reduce the effectiveness of the index linking of non-sterling assets.

GeoffTF

masonic said:

It wouldn't make sense to currency hedge an inflation linked bond fund because local currency inflation is intrinsically linked to exchange rate movements. Hedging would reduce the effectiveness of the index linking of non-sterling assets.

I agree that buying the hedged version makes little sense. The unhedged version reflects the cost of an international basket of goods, weighted by the capitalisations of the various index linked bond markets. The unhedged version has a capitalisation of about £250 million, whereas the hedged version has a capitalisation of about 25 million. The size of the hedged version does not look viable unless it grows. The unhedged version does not look very healthy either, particularly since there do not appear to be many brokers offering it (or the unhedged version). That is unfortunate. We could do with more competition.

aroominyork

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

masonic

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund, then a hedged fund would give effective inflation protection (subject of course to the negative YTM of such assets). However, if inflation in the UK became persistently higher than the US and elsewhere, then the inflation linking would be inadequate. However, another effect of the differential inflation would be a weakening of GBP. Unhedged foreign assets would rise in value in GBP terms and make up for that missing inflation linking, whereas the hedging would destroy that part of the inflation linking. This places inflation linked bonds in a similar position as equities as far as hedging is concerned. Hedging of nominal bonds is more justifiable as it is not intended that they respond to inflation, and what's desired is a stable nominal GBP return.

There are good reasons to think the US will be more successful in battling inflation than the UK and Europe over the coming years.

GeoffTF

masonic said:

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund, then a hedged fund would give effective inflation protection (subject of course to the negative YTM of such assets). However, if inflation in the UK became persistently higher than the US and elsewhere, then the inflation linking would be inadequate. However, another effect of the differential inflation would be a weakening of GBP. Unhedged foreign assets would rise in value in GBP terms and make up for that missing inflation linking, whereas the hedging would destroy that part of the inflation linking. This places inflation linked bonds in a similar position as equities as far as hedging is concerned. Hedging of nominal bonds is more justifiable as it is not intended that they respond to inflation, and what's desired is a stable nominal GBP return.

There are good reasons to think the US will be more successful in battling inflation than the UK and Europe over the coming years.

If there is inflation in the UK and none in the US, the pound will probably fall (but not 1 : 1 with CPI) and GIST will be fine. If there is inflation in the US, but not the UK, the dollar will probably fall, and we will not be fully compensated for US inflation. We may not be worse off than we would have been if we had a conventional US bond hedged into sterling, however.

Clearly GIST is more volatile. I would not want it is a core bond holding, but as a thinking man's gold, to be held in moderation, perhaps. There were withholding tax issues with Luxembourg based funds. Their tax treaties were not as good as those in Ireland and the UK. I do not know whether that has been fixed.

Thrugelmir

masonic said:

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund,

Inflation is rarely local. As inflation itself is driven in part by currency exchange movements. With the bulk of the world's commodities priced in US $ (currently but seemingly under threat). The US itself has no such concerns other than the actual price. What the US has done is to have a very loose fiscal policy for some time, well before the pandemic in fact. The printing presses have been churning out $ bills to the extent that the currency itself is now under threat as the global reserve currency. Not helped by the fact that the US is having trade spates as well. 

aroominyork

masonic said:

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund, then a hedged fund would give effective inflation protection (subject of course to the negative YTM of such assets). However, if inflation in the UK became persistently higher than the US and elsewhere, then the inflation linking would be inadequate. However, another effect of the differential inflation would be a weakening of GBP. Unhedged foreign assets would rise in value in GBP terms and make up for that missing inflation linking, whereas the hedging would destroy that part of the inflation linking. This places inflation linked bonds in a similar position as equities as far as hedging is concerned. Hedging of nominal bonds is more justifiable as it is not intended that they respond to inflation, and what's desired is a stable nominal GBP return.

There are good reasons to think the US will be more successful in battling inflation than the UK and Europe over the coming years.

So are you saying that if a country's inflation and currency move in lockstep, then a UK index linked bond fund and a global index linked bond fund would track each other, and hence the difference between the two (my 8.24pm post) reflects where countries' currencies do not reflect rises/falls in their rates of inflation? (I'm fully expecting the answer to be No, that's not it...)

masonic

Thrugelmir said:

masonic said:

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund,

Inflation is rarely local. As inflation itself is driven in part by currency exchange movements. With the bulk of the world's commodities priced in US $ (currently but seemingly under threat). The US itself has no such concerns other than the actual price. What the US has done is to have a very loose fiscal policy for some time, well before the pandemic in fact. The printing presses have been churning out $ bills to the extent that the currency itself is now under threat as the global reserve currency. Not helped by the fact that the US is having trade spates as well.

Probably best summed up with a chart.

We were discussing earlier in the thread a risk of returning to conditions akin to the 1970s. While UK and US inflation have tracked reasonably well recently, there have been periods where UK inflation has run ahead of US inflation, and a couple of periods where the converse is true. It would make sense for a UK based investor who intends to stay in the UK to protect themselves from UK inflation. In terms of an insurance policy against rampant UK inflation, global inflation linked bonds hedged to sterling do leave some inflation risk on the table.

Some more recent data from the ONS shows US inflation running ahead of elsewhere, but may well have peaked now, while the UK and Europe are quickly catching up in part due to the Ukraine situation.

GeoffTF

aroominyork said:

masonic said:

aroominyork said:

The Royal London OIEC has performed similarly to the hedged version since the latter was launched last year so, to get a longer term perspective, I am showing the RL fund here together with the unhedged GIST ETF. Can I ask how you would choose one of the other for different conditions? I would instinctively choose the hedged version solely for the lower volatility and without a deep understanding of the underlying economic drivers of their performance.

If the inflation is global in nature and about the same across the countries represented in the fund, then a hedged fund would give effective inflation protection (subject of course to the negative YTM of such assets). However, if inflation in the UK became persistently higher than the US and elsewhere, then the inflation linking would be inadequate. However, another effect of the differential inflation would be a weakening of GBP. Unhedged foreign assets would rise in value in GBP terms and make up for that missing inflation linking, whereas the hedging would destroy that part of the inflation linking. This places inflation linked bonds in a similar position as equities as far as hedging is concerned. Hedging of nominal bonds is more justifiable as it is not intended that they respond to inflation, and what's desired is a stable nominal GBP return.

There are good reasons to think the US will be more successful in battling inflation than the UK and Europe over the coming years.

So are you saying that if a country's inflation and currency move in lockstep, then a UK index linked bond fund and a global index linked bond fund would track each other, and hence the difference between the two (my 8.24pm post) reflects where countries' currencies do not reflect rises/falls in their rates of inflation? (I'm fully expecting the answer to be No, that's not it...)

That is garbled. What are you asking?