A good time to buy bonds?

Aged

It seems we're entering a new era with regard to bonds after their 'boom and bust' years. For anyone contemplating buying into bonds now to play a safe, balancing role in their 60/40 portfolio, what type of bonds/bonds funds should they be looking at? 

biscan25

Bonds are only safe if you hold them to maturity, otherwise you are exposed to changes in interest rates. You are also exposed to defaults depending on which ones you buy.

The 'safest' are gilts, or UK government bonds. These come in two flavours, nominal and index-linked. Index-linked coupons and redemption payment increase in line with inflation. Nominal do not. They also vary in coupon (the interest paid every year), and duration (time to maturity). The coupon rate matters if you are not holding the gilts in a tax-efficient wrapper, e.g. an ISA or SIPP.

The other types are corporate bonds. These are almost always nominal, and the yield available varies with the creditworthiness or the issuer. E.g. Microsoft are AAA rated, so there's next to no risk of default, but a low yield. a B rated bond or below would be higher yielding to compensate for the higher chance of default.

Basically, you should buy bonds which match your liability (e.g. your spending). If saving for retirement, you'll want much longer dated bonds than say if you were saving for a remortgage in 5 years time. Also, you'll probably want bonds denominated in sterling if that's what you will be spending in.

A bond fund would be best placed to give you the diversification you want want to avoid any concentration risk.

Linton

I agree with biscan25 with two caveats. 
1) As said the best bonds to hold are those with dates that match your need for the money.  However with a bond fund you will normally get a broad range of times to maturity and so close matching with needs is not possible.
2) If you have a long timeframe for investing, longer dated bonds should normally give the best return.  However they can be more volatile as we have seen recently.  So their "safe balancing" role which is your main reason for buying them may not always be met.

However if you do not wish to become a bond nerd, have a long timescale and are not prepared to accept the volatility of a 100% equity fund then a simple, mainly gilt, bond fund could well be appropriate.

Aged

Linton said:

... if you do not wish to become a bond nerd, have a long timescale and are not prepared to accept the volatility of a 100% equity fund then a simple, mainly gilt, bond fund could well be appropriate.

My pension provider does not facilitate the purchase of individual bonds and I'm loathe to change providers, so a bond fund sounds like the ideal solution.

JohnWinder

If we ignore individual bonds, for your reason, a suitable bond fund depends on your time horizon and to some extent what you’ll spend the money on when you cash in the fund. Bear with me and I’ll get to the second one.

Recent months has shown what interest rate risk means with bond funds, some falling in value more than others as interest rates rose; longer dated bonds (or funds with long dated bonds) fall more than short dated ones. ‘Duration’ is the jargon for how long or short dated they are. In theory (and when markets work ‘perfectly’) you’re best served by a fund with a duration which matches your spending ‘duration’ or horizon. This is because the longer the duration of the fund, the better the returns should be, but the bigger the interest rate risk it carries. You minimise the interest rate risk, and get the best return, with a fund, or a bond, whose duration matches your ‘cashing in’ timeframe. 

Problem with bond funds is their duration stays the same, but your ‘cashing in’ timeframe gets shorter as you get older; this is why Linton says ‘close matching is not possible’. This ‘truth’ hides a mountain of detail. Firstly, if the bond fund duration is 2 years (they don’t exist in UK), then it’s only mismatching your spending by a maximum of 2 years, so that’s pretty close. Secondly, you can get a very close match if you hold 2 bond funds, one long and one short duration, in the relative proportions to give a combined duration to match your needs. For example, a quarter of your bond money in a 20 year duration fund (‘5’), and three quarters in a 5 year duration fund (‘3.75’) would give a duration of 8.75 years (I think). You will find your own local constraints to this lovely theory.

Secondly, if your future spending needs are nominal (not inflation adjusted), such a repay a mortgage of £100 pounds in 10 years, then nominal bonds/funds can do it for you. But if your spending in future is subject to inflation between now and ‘in future’ then you can be let down by unexpected inflation, which is where linkers are your friend. So, do you need a linkers bond fund? I can’t see why most people don’t if unexpected inflation can occur.

Equities are risky enough, with returns you hope will compensate you for taking that risk, so why would choose risky bonds like low grade commercial bonds when you can have government backed bonds? You wouldn’t; if you want more risk and return, get more equities.

bostonerimus

Absent the ability or desire to create your own bond ladder so you can control the payment of interest and return of principal directly I'd keep the average bond maturity of any funds you buy to less than 10 years. A short term bond fund will be more "cash like" and if you can reinvest and and not make withdrawals from the medium term fund then you should get the benefit of the increased interest rates. You also won't be taking on the large effect of interest rate variations on something like a 30 year bond. I'd also stick to Government (both UK and international) and high quality corporate bonds.

Shocking_Blue

Dear all,
I'm just looking at Capital Gearing Trust, which I hold, and a large % of its UK bonds seem to have a maturation date of 22/3/24, if I'm reading this correctly. Based on what's been said above, would these (and the fund as a whole) be less affected by the current interest rate/bond concerns than longer dated bonds?
Thanks

JohnWinder

Bonds have two risks: interest rate risk and credit risk (default). Inflation risk as well if they’re nominal bonds. So ‘yes’ to your question, if we ignore credit risk (I have no idea of the ‘quality’ of your bonds). I think that covers it.

Linton

Shocking_Blue said:

Dear all,
I'm just looking at Capital Gearing Trust, which I hold, and a large % of its UK bonds seem to have a maturation date of 22/3/24, if I'm reading this correctly. Based on what's been said above, would these (and the fund as a whole) be less affected by the current interest rate/bond concerns than longer dated bonds?
Thanks

Yes, that is an example of active management achieving the objective of the fund in a way that would not be possible with an index fund.  Also you should find that CGT is highly invested in US bonds rather than gilts which as well as performing better are also benefitting from the fall in the £.

Prism

I generally only use bond funds, as my platform also does not allow individual bonds. If I want a specific holding period I will use a fixed term savings account/bond up to 3 years

Government bonds only for protection. Gilt funds would be fine, except that the choice seems very limited and many of them are pretty high duration which makes them volatile. Therefore I tend to look at global hedged bond funds which usually have a duration less than 10 years. Most of the decent ones seem to be ETFs which means the platform needs to support that - one of mine does, the other does not.

Specifically, I have an amount invested in

IGLH - global government bonds 
GISG - global index linked government bonds

There are a bunch of other options but I am most happy for the moment with these

Shocking_Blue

Linton said:

Shocking_Blue said:

Dear all,
I'm just looking at Capital Gearing Trust, which I hold, and a large % of its UK bonds seem to have a maturation date of 22/3/24, if I'm reading this correctly. Based on what's been said above, would these (and the fund as a whole) be less affected by the current interest rate/bond concerns than longer dated bonds?
Thanks

Yes, that is an example of active management achieving the objective of the fund in a way that would not be possible with an index fund.  Also you should find that CGT is highly invested in US bonds rather than gilts which as well as performing better are also benefitting from the fall in the £.

Thanks, Linton.
So you'd expect some re-jigging of the CGT holdings etc this week (in response to BoE comments on bonds)?