Time to reconfigure bond holdings?

aroominyork

The bond world has been turned upside down with recent events globally and even more so in the UK. We have exited the bond bull run which was coupled with historically low interest rates, a combination which seems paradoxical but is explained in this article on Occam Investing which explains how returns were due to funds holding long dated, high yielding (pre-GFC) bonds.

Turning Occam’s thesis/explanation on its head, does that mean bond index funds are stuffed full of low yielding bonds and will only gradually replace them with new, higher yielding ones? If that is the case, is there any reason to continue holding them? Vanguard says its global bond index was yielding 1.5% on 31 August.

Losses made by bond fund holders over recent months are dead money. dunstonh on this forum gave warning this was an unwinding of the events of previous years. It seems to me the only reason to continue holding such funds is if you think there will be a flight to the safety of high quality bonds that will provide a large capital gain. Otherwise, isn’t it better to take your losses and buy into gilts which are now returning 4-5%? And if you think yields will improve further, to keep the money in cash rather than in bond funds which will fall further when the yields you are waiting for materialise?

MarkCarnage

Bond funds will all be reflecting mark to market falls in bond prices in their fund pricing, so it's in the price. Spreads over gilts have widened too as concerns over recession have grown. 
There was a strong argument to hold cash a year or two ago, as I articulated a couple of times in various threads on drawdown strategies etc. but less so now given the rise in yields and spreads. 
You would only switch from credit into gilts after the spread widening if you think spreads are going to widen further, or default risk worsen considerably. If you hold a bond to maturity and it doesn't default the spread widening becomes immaterial anyway. 

Linton

I do not believe that taking the losses in older gilts and buying new gilts of the same maturity date  achieves anything.  The effect of the fall in prices in old bonds is to increase their Yield To Maturity to that comparable with new.  So if you sold your old bonds and used the money to buy new bonds the total return would be the same.  The only difference would be whether the return came from interest or changes in the capital value. 

I think active investors need to go back to first principles and ask themselves precisely what their objectives are for buying bonds or bond funds in the first place.

If one bought a bond in the past to return say £1/year interest and repay £100 in 10 years time nothing has changed.  Although that bond may have dropped in value now, nevertheless it will continue to return the original  £1 and £100 at the maturity date. So the fall is irrelevent.   If one wanted capital growth diversified from pure equity there may be better ways of doing it.  There is no point in complaining that investments  bought for one purpose are not achieving another. 

aroominyork

I understand that price falls reflect interest rate rises, in theory 1% inverse to each year's duration for each 1% change in interest rates, so selling one bond to buy another with the same maturity is a zero-sum game. (And I saw yesterday that spreads now seem to be c.0.4% on short dated gilts.) But I am thinking more of replacing global bonds with gilts. Since mid-August, global bonds have fallen c.5% while gilts have fallen c.15%. Isn't there a case for swapping a global bond fund for a gilt to hold to maturity?

ChilliBob

There's a new article on Monevator about just this, well, kind of. The comments section is pretty interesting too.

I don't hold any bonds or bond funds at the moment, and for now I'll probably keep it that way. A passive entry for me would probably be the Monevator suggested global government bond fund.

Im not sure I'd put all my eggs in the UK basket in this case either

MarkCarnage

aroominyork said:

I understand that price falls reflect interest rate rises, in theory 1% inverse to each year's duration for each 1% change in interest rates, so selling one bond to buy another with the same maturity is a zero-sum game. (And I saw yesterday that spreads now seem to be c.0.4% on short dated gilts.) But I am thinking more of replacing global bonds with gilts. Since mid-August, global bonds have fallen c.5% while gilts have fallen c.15%. Isn't there a case for swapping a global bond fund for a gilt to hold to maturity?

If your liabilities are all in sterling, and you're not worried about UK inflation relative to US,Eurozone etc. then carry on. History may not support you. 

aroominyork

I'm not especially interested in comparative inflation rates. Instead, it feels like the last fortnight has offered an opportunity to lock in good enough future yields and take risk out of the picture by holding nominal bonds to maturity. With the gilts sector down 25% YTD, this week I sold my global aggregate bond index fund (down 14% YTD) and short duration corporate bond fund (down 11%) and bought short dated gilts (TN25) with YTMs around 4.3%. While yields on the global index fund may rise I am not confident they will provide the return I have locked in, and I would have thought there is at least as much chance of further capital loss as there is of capital gain.

Frequentlyhere

Of note that UK gilts appear to be sinking back down to almost the levels seen when BOE first intervened.

I'm just looking at VGOV as a proxy and the price has sunk near 5% this week. I wonder if we'll see a sharp uptick again as the BOE pump up the price once more, or if won't work like that?

curious_squirrel

I'm too nervous about making the wrong move and worsening the situation so I am leaving my bond funds as they are.... And hoping this isn't a terrible strategy. I am wondering what the multi-asset type funds (Vanguard, L&G, etc) are doing? Are they rebalancing back into bonds?

aroominyork

Frequentlyhere said:

Of note that UK gilts appear to be sinking back down to almost the levels seen when BOE first intervened.

I'm just looking at VGOV as a proxy and the price has sunk near 5% this week. I wonder if we'll see a sharp uptick again as the BOE pump up the price once more, or if won't work like that?

I don't think they are trying to pump the price back up - only to stop it collapsing. The news coming through about how pension funds were on the verge of failing is truly frightening.

However perhaps the Bank can play a useful political role. It is in the Bank's interest to derail Truss's (I refuse to pin the blame on her Chancellor) inflationary tax cuts and the cost of new issues to fund them will, at these higher yields, surely be more than the govt can stomach. So it is in the Bank's interest not to see yields fall too much.

Frequentlyhere

aroominyork said:

 So it is in the Bank's interest not to see yields fall too much.

I think you're right, and also the BoE essentially wants to let the market do it's thing whilst intervening as little as possible as a matter of principle.

I can't recall the exact stats, but it was far more the threat of the size of their intervention than what they've actually bought so far, which I believe is relatively little  (something like £4bn out of £65bn was it?)

However - as we approach the same levels that necessitated their intervention, we are presumably also approaching their threshold for stopping things collapsing again?  Perhaps having been given a little bit of time for pension funds to shuffle things around that will allow a new lower bond price/higher yield environment to actually be sustainable though.

But it is dropping quite fast again, a sudden bounce up wouldn't surprise me.