Bonds – what are you doing?

masonic

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...)

I don't think I'm saying that (if I've deciphered correctly). Other factors affect bond prices in different countries, such as interest rates and movements thereof, yield curves, perceived default risk, attractiveness of other asset classes to investors, composition of the relative bond markets etc. If you start from the premise that you want to hold something that will have a fixed series of cash flows defined in today's money, then add on the risk if getting this exposure through a fund that trades such securities for capital gains/losses, then add assets denominated in foreign currencies that have different return profiles, and finally attempt to hedge these back to sterling in order to prevent them from fluctuating in nominal value but thereby locking the inflation protection to that of the foreign currency, you end up quite far removed from the characteristics of the initial asset.

In the chart in my previous post, that spike in UK relative to US inflation in the 1970s was associated with a drop in sterling from a peak of ~$2.60 down to $1.60. It subsequently recovered and then fell to current levels during the early 1980s. Hedging would certainly have smoothed the nominal pricing of a global inflation linked bond fund during that period, but such a fund would have delivered significantly less of the inflation protection of a UK index linked gilt during the mid-late '70s.

CheekyMikey

Can I throw my own bond question in here too? My portfolio has a fixed interest component chosen by my ifa years ago consisting of Dimensional Short Dated Bond and Vanguard Short Dated Bond Index. It constitutes about 25% of my portfolio with the rest in diversified equity funds. The performance of both, but especially the Dimensional fund, has been sketchy to say the least and have barely grown if at all over 5 years. The best years they’ve barely done 2% at most. I know why the ifa insists they must be there, but given the way things are, would I not be just as well off selling them and putting the money into 5 year fixed interest deposit accounts generating 2.4% with no fees. I should add that most of the money in these two funds are in ISA’s so I’d lose that I guess, but given there’s no growth anyway does that really matter? Is there any other bond fund which might be better which I could transfer too within the ISA?

masonic

That's not an unexpected level of performance for short dated bonds. Selling the bond funds and then transferring the realised cash to a separate cash ISA is an option, the fixed term ISA rates generally lag normal fixed savers, but you could still achieve a guaranteed 1.71% for a 2 year fix and the prospect that interest rates will continue to rise (hence a 5 year fix for just 0.2% more does not look so attractive).

CheekyMikey

masonic said:

That's not an unexpected level of performance for short dated bonds. Selling the bond funds and then transferring the realised cash to a separate cash ISA is an option, the fixed term ISA rates generally lag normal fixed savers, but you could still achieve a guaranteed 1.71% for a 2 year fix and the prospect that interest rates will continue to rise (hence a 5 year fix for just 0.2% more does not look so attractive).

Thanks…perhaps by the time I get round to it there could even be a 2% cash isa. Should I do it though? A pertinent fact I forgot to mention is that I have just received a pension lump sum so have £140k of cash reserves which I intend keeping accessible at best available rates from which to top up regular pension income….should last me 6 or 7 years. Given that cash buffer, perhaps I could be slightly bolder and put the realised bond cash into something like Troy Trojan and CG Absolute Returns, so I’ve still got a decent defensive component in my portfolio? I’m itching to dump the short dated bonds but I know my ifa won’t be keen…

eskbanker

CheekyMikey said:

masonic said:

That's not an unexpected level of performance for short dated bonds. Selling the bond funds and then transferring the realised cash to a separate cash ISA is an option, the fixed term ISA rates generally lag normal fixed savers, but you could still achieve a guaranteed 1.71% for a 2 year fix and the prospect that interest rates will continue to rise (hence a 5 year fix for just 0.2% more does not look so attractive).

Thanks…perhaps by the time I get round to it there could even be a 2% cash isa. Should I do it though? A pertinent fact I forgot to mention is that I have just received a pension lump sum so have £140k of cash reserves which I intend keeping accessible at best available rates from which to top up regular pension income….should last me 6 or 7 years. Given that cash buffer, perhaps I could be slightly bolder and put the realised bond cash into something like Troy Trojan and CG Absolute Returns, so I’ve still got a decent defensive component in my portfolio? I’m itching to dump the short dated bonds but I know my ifa won’t be keen…

Why would you pay an IFA but then seek guidance from random internet strangers?

masonic

CheekyMikey said:

masonic said:

That's not an unexpected level of performance for short dated bonds. Selling the bond funds and then transferring the realised cash to a separate cash ISA is an option, the fixed term ISA rates generally lag normal fixed savers, but you could still achieve a guaranteed 1.71% for a 2 year fix and the prospect that interest rates will continue to rise (hence a 5 year fix for just 0.2% more does not look so attractive).

Thanks…perhaps by the time I get round to it there could even be a 2% cash isa. Should I do it though? A pertinent fact I forgot to mention is that I have just received a pension lump sum so have £140k of cash reserves which I intend keeping accessible at best available rates from which to top up regular pension income….should last me 6 or 7 years. Given that cash buffer, perhaps I could be slightly bolder and put the realised bond cash into something like Troy Trojan and CG Absolute Returns, so I’ve still got a decent defensive component in my portfolio? I’m itching to dump the short dated bonds but I know my ifa won’t be keen…

I've personally removed all direct exposure to bonds, and now only have bond exposure through the investment trust equivalents of the wealth preservation funds you mention (and one other). Their bond exposure is almost entirely in inflation linked bonds, and they are generally positioned for inflation protection. The adviser might be holding short dated bonds temporarily with a view to switching to longer dated bonds once interest rates and yields are higher. This would avoid some of the inevitable capital losses from long dated bonds as interest rates rise. I am effectively doing likewise, but am using cash rather than short dated bonds. It is worth a discussion with your adviser.