Cash fund vs Gilt Fund

Victorwelldue

I have an L&G workplace pension that is approx 75% equities / 25% gilt fund of varying durations. It was 65% / 35% at start of year but the fall in value of gilts along with my last two monthly contributions being 100% equities have altered the split.

I'm not comfortable continuing contributions at 100% equity but my fund choices are fairly limited (no short duration bond funds available to select). So my non-equity choices seem to be to either continue with medium to long duration bond/gilt funds or use a cash fund instead. With interest rates likely to continue rising I'm leaning towards a cash fund for 35% of my future contributions, for now at least. Appreciate inflation erosion and cant time the market etc but its Hobson's choice at the moment so I'm thinking cash is the lesser of two evils until such time that interest rates start to go down (whenever that will be).

Any flaws in this strategy or anything else I should consider? I have an 8 to 12 year horizon and I only plan to change future contributions (leave existing pot as is).

dunstonh

Any flaws in this strategy or anything else I should consider?

Gilt fund unit pricing (inc units) could be close to bottom as they have now unwound the post credit crunch boom.   You are pretty much back to 1995 levels.

With the lower unit prices, you get better yield.   So, you could be exiting gilts just at the time you should be considering them again.  

JohnWinder

Firstly, it sounds like you’ve got an understanding of the issues involved; but it’s not clear to me what a 8-12 year investing horizon means. Is it all turned to cash in 10 years, or do you change from accumulation to drawdown in 10 years, or whatever? If it’s the latter, you could be investing for another 20 years beyond that. And…if one is spending down over the next 20 years, then the ‘duration’ is about 10 years, not 20, since the spending is spread out over that 20 years, not occurring only at the 20 year mark.

Secondly, I don’t think there’s much you can make of people’s predictions about the future of asset prices/returns as a guide to what you should do now. They’re all guesses, unless they’re coming from the BoE’s interest rate setting committee, and even then….

Lastly, have a read of this strategy for mixing bond fund durations as a way of minimising bond fund interest rate risk; and a cash fund is pretty much a bond fund with a tiny duration I think.  Let us know if this gets at what you’re thinking. https://www.bogleheads.org/forum/viewtopic.php?t=318412

As to being comfortable investing at present, if you believe in ‘invest we must’ then it’s just about getting the risk level you’re comfortable with.

NannaH

I think it’s a complete coin toss at the moment.  Nobody knows where all this is heading,  could improve, could get far worse very quickly. 
I’ve been badly stung on my ISA,  2 Royal london UK bond heavy funds , bought last year,  down 22% currently. 

DH has the HSBC global strategy fund as his smallest pension pot,  it’s holding up ok ( about 7% down from purchase last year)  it’s US treasuries heavy so if they go a similar way as Gilts then where the hell do you go for ‘safety’ ? 

Between us in other Sipps we also have VLS 80,  Fidelity world index,  HSBC FTSE all world, Fundsmith and Vanguard TR 2025. Only the  first 3 are having regular contributions. 

Also opening a Sipp for cash shortly to build up an early retirement pot over the next 7/8 years.  

One question I have - if you buy say a 10 year Gilt/ treasury bond and hold it for the duration,  are you guaranteed NOT to lose money?   Do they pay out a fixed yearly interest rate or does it fluctuate?  

I assume you don’t /can’t reinvest the dividend in the same thing.   

JohnWinder

Be clear in your mind whether you’re talking about a gilt which is maturing in 10 years (could have been issued 5 years ago), or a new issue maturing in 10 years. Secondly, if it’s a nominal bond (not inflation linked), then at maturity you’ll get back its face value which I think is always £100 (in USA it’s $1000). Whether you gain or lose on it depends on what you pay for it now; it’s very unlikely to be exactly the £100 you will get back at maturity. Coupon payments will give you extra money, so that’s a plus. But did you have in mind ‘lose money’ in nominal terms or in inflation adjusted terms? Because making 2% gain/year for 10 years is a kind of a loss if inflation is 3%/year for ten years. Reinvesting the coupons is likely not worth the fiddle if it’s a small amount of money, but nothing stopping you buying more of the same if it’s being traded on the bond market as it was when you bought it.

ChilliBob

dunstonh said:

Any flaws in this strategy or anything else I should consider?

Gilt fund unit pricing (inc units) could be close to bottom as they have now unwound the post credit crunch boom.   You are pretty much back to 1995 levels.

With the lower unit prices, you get better yield.   So, you could be exiting gilts just at the time you should be considering them again.  

Interesting. I'm pretty much 40% equities and 60% cash at the moment. I wonder if now is the time to start position in a passive bond fund or something... When I considered bonds last I think they had negative yields and the consensus seemed to be it wasn't a time to buy!

What's the best way to compare predicted returns from bond funds vs cash at x% interest rate? Some kind of model showing predicted bond fund returns and yields by year, and something similar for interest rates inputting the best estimates for the next year and playing around with some scenarios over longer horizons... 

JohnWinder

What's the best way to compare predicted returns from bond funds vs cash at x% interest rate?

Pretty much a waste of time I think. Firstly, several different ways are used to calculate fund yields, each with different input and telling you different things suggesting none is ideal. One is to use a weighted average of the yields to maturity of all the bonds in the fund. The YTM is what it returns if held to maturity, with coupons reinvested at the same rate. Well, can you imagine those conditions being met over a period of more than one day? You can predict the returns of individual bonds because they mature and repay a known principal, but bond funds never mature. You can't predict the return from equity funds or bond funds, otherwise where would the fun be?

Victorwelldue

Thanks for the comments. By "horizon" I just meant when I hope to retire and start draw down.

Appreciate no one knows what's going to happen but my "logic" for what its worth goes like this: My crude understanding is that the value of bonds & gilts tend to go down as interest rates rise; they have an inverse correlation. It seems interest rates are likely to continue to rise over next year or so and if so the value of bonds & gilts will continue to fall, therefore not a good thing to invest in at present? Or is it possible for interest rates to keep going up but gilts/bonds stay where they are or rise? (or more specifically the value of funds containing a basket of medium to long term gilts/bonds as that's all that is available to me in my workplace pension). 

ChilliBob

JohnWinder said:

What's the best way to compare predicted returns from bond funds vs cash at x% interest rate?

Pretty much a waste of time I think. Firstly, several different ways are used to calculate fund yields, each with different input and telling you different things suggesting none is ideal. One is to use a weighted average of the yields to maturity of all the bonds in the fund. The YTM is what it returns if held to maturity, with coupons reinvested at the same rate. Well, can you imagine those conditions being met over a period of more than one day? You can predict the returns of individual bonds because they mature and repay a known principal, but bond funds never mature. You can't predict the return from equity funds or bond funds, otherwise where would the fun be?

Thanks for the reply. I guess I was just thinking you see a fair bit of estimates of returns per year for various portfolios, by say Vanguard research etc. E. G. 8% per year etc. 

I was more thinking the mechanics to compare bond fund vs cash. But, I suppose a 'bond fund'  isn't any different to an equity fund? 

I. E. You get a given % return on your £ invested and you get income (taxed as income as opposed to dividends). I suppose when comparing an actual 'bond' it's a bit more complex. 

So I guess you'd choose a massive bond fund, the equivalent of a global tracker for equities, and look at yearly returns+income in the past, give you some idea at least. 

JohnWinder

‘My crude understanding is that the value of bonds & gilts tend to go down as interest rates rise; they have an inverse correlation.’

I don’t think your understanding is crude, but the relationship between interest rates and bond prices is crude. Rates can rise and bond fund values at the same time. It depends partly on how quickly the rates rise, and how long the duration of the bond fund is. And when I say ‘rates’ I mean central bank short term rates, because the actual interest rate or yield you get from a bond must change with its price since the coupon is fixed (unless it’s a variable coupon bond which are uncommon). Have a look at these graphs for an idea of how useless it can be trying to predict bond fund returns from interest rate changes, and then add to it how hard it is to accurately predict interest rate changes. We can all have a shot at it, but it’s pointless me telling you what I think will happen and thus whether or not you should buy a bond fund now.
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=341224&p=5846789&sid=a3331907584ca8bd57448f8f93e2ec02#p5846789
https://www.bogleheads.org/forum/viewtopic.php?t=360575

JohnWinder

‘But, I suppose a 'bond fund'  isn't any different to an equity fund?

 Indeed; if it was different, and you could accurately forecast the return we could buy bond funds without worry. It would be the same as you can buy a single bond without worry, because you know exactly how much coupon it will pay each quarter or year, and exactly how much you will be repaid when the bond matures; there’s just no uncertainty if you hold to maturity. A bond fund is different since it never matures, as some of the bonds in the fund mature on a certain day, giving certainty of what you’ll get from them, the other bonds in the fund might have been tossed around by interest rate changes in the preceding days or months which has completely changed their value. How you could predict a return after a certain period of time in the future is beyond me; you could estimate it, but the estimate could be out by how much I don’t know.

‘I. E. You get a given % return on your £ invested and you get income (taxed as income as opposed to dividends). I suppose when comparing an actual 'bond' it's a bit more complex.

I wouldn’t say that. I’d say a single bond is much simpler.