Gilts Fund

Victorwelldue

I know I know, its a repetitive theme at the moment!

So after months of research here & elsewhere back in January I finally decided to dump my workplace pension's default fund for something with a bit more risk. I opted for 50% world ex-UK, 7.5% UK, 7.5% emerging and a 35% UK Gilt fund with various durations.

The gilt fund was meant to be the non-risky bit for when equities went down but due to rising interest rates & inflation, like everyone else my pot has taken a bit of a nose dive over past 6 months, 13% overall but the gilt bit is down 16% (the default fund I left doing slightly better at the moment).

So the question is what to do? Especially as I'm about to sacrifice a £20K bonus into my pension pot. I'm not really concerned about the equities as I wont be accessing the money for another 8-12 years, but should I have the same relaxed attitude towards the gilts or should I change something and if so for what? I guess I don't want tinker with what's already invested as I would just realise the loss? But I'm uncertain what to do about the lump sum I'm about to put in and contributions going forward. Should I just stick to same allocation and ride it out?

My only options seem to be more equities, various bond funds, or one sustainable property fund that's done well recently and over past few years but I think would make me quite nervous as its mostly UK and I think includes retail/commercial (and its relatively expensive at 1.16%)

masonic

Gilts will continue to fall until interest rate expectations level off. We may be very close to that point, as there is a limit to how high they could go without causing serious economic pain. UK government debt tends to be weighted towards longer duration, which is more sensitive to changes in interest rates, so typical gilts funds have performed worse than global government bond funds. The 10 year gilt is now yielding 2.5%, up from about 0.8% at the start of the year, so you do have that income coming in, but you won't see a recovery in price unless interest rates are dropped to historic lows again, which seems unlikely.

If you want protection against further drops, then going for a short-dated bond fund would be a short-term option. Once rates stabilise you wouldn't want to remain in such a fund due to the low returns. Perhaps 8-12 years is a bit short to go 100% equities for the recovery and drip feed back into the gilt fund to build it back up over time.

Property is going to come under pressure due to rising interest rates. You'd kick yourself if you sold out of gilts, bought a property fund only to see that drop 30% as they tended to do in the last property crash.

dunstonh

The gilt fund was meant to be the non-risky bit for when equities went down but due to rising interest rates & inflation, like everyone else my pot has taken a bit of a nose dive over past 6 months, 13% overall but the gilt bit is down 16% (the default fund I left doing slightly better at the moment).

The gilt fund has lower volatility 90% of the time than equities.  Unfortuantly, you went through a period when it was 10% of the time.

So the question is what to do? 

Why do you need to do anything?

 Especially as I'm about to sacrifice a £20K bonus into my pension pot.

Whilst the drop was unfortunate on the gilts, the timing for this top up couldn't be better.

 but should I have the same relaxed attitude towards the gilts or should I change something and if so for what?

A gilts crash is 5%.  An equities crash is 20%.   Be wary of increasing you equity content, if you start feeling that way, as you could end up chasing an equity crash just after suffering a gilt crash.

In the vast majority of cases, sticking with strategy is best and just close your eyes and come out the other side.

JohnWinder

My views are aligned with those above, with some variation.
You made a sensible asset allocation in January; even not knowing your circumstances it’s a justifiable choice for almost anyone. Plenty of other choices should turn out better in 10 or 20 years time, but we don’t know which ones (or even if it’s yours) it will be. That’s a reason to stick with it.
Bonds and stocks often move in the same direction, much as we’d like them not to, and rarely bonds fall further. But that period of ‘further’ has been for months not years (try early 1994), so your 6 months is not at a throat cutting stage yet.
It seems you have one fund which limits ‘tweaking’ opportunities, but there’s a lot of merit in the simplicity of one fund so I don’t suggest you up end it.
But here’s one issue. Long term bonds usually yield more than shorter term ones - good. But they’re more prone to price swings with interest rate changes - bad if you’re close to drawing down for retirement, but not bad (just nerve wracking) when that’s 10 years away. The second, related relevant issue is that everyone here feels UK gilt funds have long duration because of the way treasury issues bonds. This means your gilt fund (while it should reward you better in the long run) would have bigger swings than you like now and could be troublesome if it’s swinging low in 15 years time when you’re withdrawing.
A lot of people, rightly, wouldn’t worry about that, and just follow a ‘4%’ rule or similar with confidence they won’t run out of money, and feel thankful they got higher returns from their long bonds during that long accumulation period.
So, long bonds are fine when spending them is a long way off, but maybe less so otherwise. A solution is to also own a very short term bond fund, and vary the proportions those two funds represent according to how far you are from spending. Plenty in the long fund and not much in the short fund when you’re 10 years from spending, then move to plenty in the short fund and little in the long fund when spending is close.
It’s too fiddly, and not for everyone, and you can sort of emulate it by holding cash instead of the short bond fund. Indeed, it’s widely recommended that retirees hold a bunch of cash to avoid drawing on assets which have dropped in value a lot; and that’s kind of what it’s about - duration matching your spending timeframe with your investments timeframe. Not suggesting you hold your £20k in cash now.
You can’t easily undertake this fiddly strategy as your bond fund it tied to your equities, because buying a big chunk of short term bond fund would move you to holding less equities; and you can’t spend your bond fund without spending your equity fund. And if you really wanted to execute this strategy, you’d probably use funds with linkers since your future spending needs are inflation affected not nominal; nominal bond funds would be more suitable to a nominal spending need like paying a fixed mortgage repayment.
If it makes you more comfortable, your bond fund is holding more and more higher paying bonds as this new rising interest rate period continues, which will reward you handsomely in future. You get nothing in capital gain from bonds (unless interest rates fall), so bond holders should like high interest rates since that’s where bond profits come from. Put another way, a bond fund's value keeps increasing if the interest is reinvested (as will be happening with your fund), and the increase is steeper when it holds higher yielding bonds - that’s the compensation for the ‘brief!’ fall in price when interest rates rise. Better the interest rates rise now, 10 years from you needing to spend, than just as you need to spend.

Victorwelldue

Thanks for the responses everyone, all very interesting & educational as usual for this board.

I'm inclined not to tinker too much but I may have a look at some of the bond funds available for my contributions going forwards, along the lines of some of the possible strategies mentioned above. More research on my part needed first though.

In the mean-time two hopefully simple & possibly related questions:

1. Do bond/gilt funds tend to recover over time in the same way that equity funds tend to recover over time?

2. Does "buy the dip" apply to bonds/gilts in the same way it does to equities? You often hear that equities are on sale when markets are down but I'm not sure I've ever heard/read the same being said about bonds/gilts? 

masonic

Victorwelldue said:

1. Do bond/gilt funds tend to recover over time in the same way that equity funds tend to recover over time?

No, bonds and gilts mature at a fixed price, so if they trade above this price due to interest rates falling to unprecedented lows (as has happened in the last decade), when they come back down in price that could be considered a recovery in their yield (causing their price to fall), and we might never see another period like it in the future.

2. Does "buy the dip" apply to bonds/gilts in the same way it does to equities? You often hear that equities are on sale when markets are down but I'm not sure I've ever heard/read the same being said about bonds/gilts? 

When you buy bonds/gilts, you are purchasing an income stream and (partial) return of capital at some period in the future. You can now buy a better income stream and greater return of capital because of the fall in price / rise in yield. It is analogous to buying the dip, but without the same potential for price recovery. You get the income stream for a better price, and no longer face so much of a capital loss (if any) when holding to maturity, which is something.

JohnWinder

Do bond/gilt funds tend to recover over time in the same way that equity funds tend to recover over time?

Yes and no, depends.
Here’s a 70 year chart of a bond fund’s value increasing, and falling back, over time. In case the link doesn’t work, the chart is overwhelmingly up. For the first 25 years interest rates rose from 4% to 15%/year, and for the next 45 years they fell back to 2%. Looking at the bond chart you’d struggle to see which way interest rates were moving. So, ‘yes’.
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=341224&p=5846789&sid=a3331907584ca8bd57448f8f93e2ec02#p5846789
The recovery for a bond fund is due to more of its bonds becoming higher interest bonds as old bonds in the fund mature to be replaced by newly issued ones. If your ‘over time’ is a lot shorter than the times to maturity of the bonds, then there won’t be time for recovery. So, ‘no’.
Ignoring inflation, there are two risks with bonds: credit risk and interest rate risk.
Bond funds holding poor credit risk bonds will lose money if those bonds are defaulted on, and if the bond issuer never repays the bond holder then recovery is impossible. So, ‘no’.

‘Does "buy the dip" apply to bonds/gilts in the same way it does to equities?’

Yes and no, depends.
An investment you buy cheaper today than last week should give you a better return, so ‘yes’. Except that perhaps the price fell because investors this week think it will have a worse return in absolute terms than it promised last week, so ‘no’.
Lastly, ‘buy the dip’ is ill-defined as other posts have suggested by their examples: how far does it have to dip to be a dip; how much further might it dip; has the dip finished etc? It’s not a strategy you can easily execute for investing; rather it’s just a gap filler when there’s nothing more useful to say like ‘invest for long periods to benefit from the compounding of dividends and interest’ or ‘keep costs down’ or ‘diversify to reduce idiosyncratic risk’ or ‘match your investments to your risk tolerance’ or ‘understand how bonds work if they’re to be a source of worry for you’.

Linton

Victorwelldue said:

Thanks for the responses everyone, all very interesting & educational as usual for this board.

I'm inclined not to tinker too much but I may have a look at some of the bond funds available for my contributions going forwards, along the lines of some of the possible strategies mentioned above. More research on my part needed first though.

In the mean-time two hopefully simple & possibly related questions:

1. Do bond/gilt funds tend to recover over time in the same way that equity funds tend to recover over time?

2. Does "buy the dip" apply to bonds/gilts in the same way it does to equities? You often hear that equities are on sale when markets are down but I'm not sure I've ever heard/read the same being said about bonds/gilts? 

Just considering gilts and other major developed country government bonds....

Bond funds will recover over time but for different reasons than equity funds.

Look at a single bond.  To take an example: it is created at £100, pays £4 every year interest and is redeemed for £100 at maturity 20 years later.  So it is very simple.  The complications come with the value in the period between creation and maturity.  If for example iterest rates on new £100 bonds rise to 5% the value of the 4% bond must fall below £100 so that the returns on the two bonds are equivalent.  Howevery by the time it matures the value of the 4% bond must have returned to £100.

So individual bonds vary in value over time dependent on the current interest rates.  But interest rates generally dont change quickly.  Although day traders operating in margins of a fraction of a % will add noise, you dont get anything like the day to day volatility in bonds as you find with shares.  

This leads onto the second main difference.  With equities different people may come to different conclusions as to the fair value of a share.  Bonds on the other hand can be valued accurately  - once the interest rates and the maturity date are known the value of the bonds is fairly straightforward mathematics.   Anyone in the market can make this calculation, so there is no such thing as a buying opportunity for amateur bond investors.

Bond funds are more complex since the fund will normally hold a wide range of different bonds with different interest rates and different maturity dates.  When you buy the fund very few of the bonds will be newly created or close to maturity so you are getting them at the current market price.

For the past 40 years interest rates have been going down and so bond prics have risen after creation, falling back again as they approach maturity.  Anyone buying a bond fund has been on a continuously rising escalator created by the long dated underlying bonds.  If you sell the fund those bonds will have risen in capital value.

Now that interest rates are rising those long dated bonds are falling in value.  If you sell the fund you will probably be selling them at a capital loss.  However they will eventually drop out of the portfolio to be replaced by new bonds.  Also there is the
 continuous re-investment of interest.  So over the long term you would expect the capital value of bond funds tro recover.

At some point interest rates will fall again and capital values increase, but I think we are some way off that barring emergency measures from the Central Banks.

Victorwelldue

So there are no short duration bond funds available via my workplace pension, all are medium to long term much in line with the gilt fund I'm already in. I think I'm just going to leave existing investments and future contributions as they are, however I am toying with the idea of putting upcoming £20K bonus all into equities. Current pot value is £150K, aiming to be putting in max £40K per year until retirement which could be anything from 8-12 years away depending on how things go. I have sufficient carry forward for the bonus.

Obviously it all comes down to personal choice and my own attitude to risk but just wondered what people here think in general about the idea of putting £20K lump sum in as all equities? Would probably be along lines of 70% developed world, 15% UK, 15% emerging (just for the £20K bonus then back to my normal contributions including gilt fund).

Audaxer

Victorwelldue said:

Obviously it all comes down to personal choice and my own attitude to risk but just wondered what people here think in general about the idea of putting £20K lump sum in as all equities? Would probably be along lines of 70% developed world, 15% UK, 15% emerging (just for the £20K bonus then back to my normal contributions including gilt fund).

If you going to continue the gilt fund in normal contributions, not sure why you wouldn't include it in the bonus contribution as well.

I think If it was me I would also be considering other types of funds/ITs, like infrastructure, property, wealth preservation funds etc. if I wanted more diversification away from 100% equities.

JohnWinder

It's good to toss ideas around and get opinions, but you might want to be worried that you still lack the confidence to properly manage your investments. One's decisions don't have to be 'right' by every other person, but they need to be well based and suited to your circumstances. I don't think it's a hard state to get to for a lot of people, and it might be worth it to keep working on it. Or are some of us just over-confident?

I'd have no objection to your equities dump, and the geographical mix looks OK. But your end game starts in 8-12 years. Who on earth pretends they know what's going to turn out best in another 10 years? That's the first reason it hardly matters, and the second is that with a decade of contributions ahead of you there will be plenty of opportunities to get the most suitable portfolio if you can figure out what it should be. And who knows, someone might be offering a shorter term bond fund by then. Stay widely diversified, probably index tracking, and keep costs down.