Bond Volatility

JohnWinder

Quite right, I had considered only the interest rate rises of the last year or so when I set out to explain how interest rate changes affected bond prices. The whole picture should not ignore the effect many prior years of falling interest rates had on enhancing bond prices. Sorry for not including that important element.

In addition to your ‘probably paid more than £100 in past years’ example, even if you paid £100 10 years ago, for a bond maturing 2 years from now, when the interest rate was 8%/year, then that bond would be worth more than £100 now (since it pays 8%, whereas new 2 year bonds pay a lot less), so holding it for another 2 years would see its price fall to £100. Hope that’s right.

Linton

JohnWinder said:

Quite right, I had considered only the interest rate rises of the last year or so when I set out to explain how interest rate changes affected bond prices. The whole picture should not ignore the effect many prior years of falling interest rates had on enhancing bond prices. Sorry for not including that important element.

In addition to your ‘probably paid more than £100 in past years’ example, even if you paid £100 10 years ago, for a bond maturing 2 years from now, when the interest rate was 8%/year, then that bond would be worth more than £100 now (since it pays 8%, whereas new 2 year bonds pay a lot less), so holding it for another 2 years would see its price fall to £100. Hope that’s right.

Yes. Say in your example a bond 1 year from maturity paying 8% when current rates are 4% would be worth approximately £104 now so that the total return over the final year would be the same. All other things being equal you cannot gain from selling one bond to buy another one at a different interest rate. The market would quickly see to that.

hallmark

My amateurish view is that the Fed is the joker in the pack here.  By which I mean this:  historically the appeal of a stocks and bonds portfolio was the non-correlation.  Bullish macro effects for one tended to be bearish for the other (this is a huge simplification but I think it's a reasonable statement).

But currently, what the Fed does blows all other considerations out of the water, and what they do is either very bullish for both stocks and bonds (low IRs and QE) or very bearish for both (rising IRs and QT).

Everybody is bought into the "don't fight the Fed" mantra and it's distorting markets.  Fundamentals that might once upon a time have been the main factors dictating share or bond performance are shrugged aside as everybody fixates on the Fed.

GazzaBloom

Deleted_User said:

GazzaBloom said:

For anyone that doesn't hold bonds yet, but is thinking about buying some bonds funds, would you suggest it may be prudent to wait for the interest rates pivot by governments once inflation gets under control before buying in? Further interest rate hikes are going be more pain for the existing bonds held in funds aren't they?

No. Bonds don't fall when the current bank base rate rises (and rise when base rate falls), they fall when expectations for the trajectory of base rate over the remaining lifetime of the bonds rises (and rise when the expected trajectory falls).

E.g. the BoE's base rate is still expected to rise further, but not as high as markets were expecting it to a month ago, and Vanguard Long Duration Gilt fund is now (well, yesterday) up 31% since its low on 12 October.

Of course, there's no guarantee that the expected trajectory won't start rising again. But it is not always a case of "further pain" until rates top out.

Ah OK, got it.

Redlander

JohnWinder said:

Bogle’s book is good, and free; Hale’s very good and likely in a library near you. Edwards’ book is well spoken of. 

Do you have a particular purpose for this £400k you are referring to here, for use in about 5 years? We don’t need to know the purpose, just that you need it to be cash? So really specific advice might be possible.

What are the titles of those books, please?

No particular purpose, at least for the most of it. Might need to dig into it to replace a gas boier or get roof repairs. In truth I'm really nervous about managing big sums like this  I find it hard to focus on what the basic objectives are. That's why I'm contempalting putting it all in a passive fund and leaving it be. I need to get a grip on myslef and clarify my objectives.

Thanks to everyone who's posted so far

Linton

Deleted_User said:

GazzaBloom said:

For anyone that doesn't hold bonds yet, but is thinking about buying some bonds funds, would you suggest it may be prudent to wait for the interest rates pivot by governments once inflation gets under control before buying in? Further interest rate hikes are going be more pain for the existing bonds held in funds aren't they?

No. Bonds don't fall when the current bank base rate rises (and rise when base rate falls), they fall when expectations for the trajectory of base rate over the remaining lifetime of the bonds rises (and rise when the expected trajectory falls).

E.g. the BoE's base rate is still expected to rise further, but not as high as markets were expecting it to a month ago, and Vanguard Long Duration Gilt fund is now (well, yesterday) up 31% since its low on 12 October.

Of course, there's no guarantee that the expected trajectory won't start rising again. But it is not always a case of "further pain" until rates top out.

Agreed, bond prices are not linked directly to base rate which only applies in the short term. Any description of how bonds behave for someone who knows little about the topic must of necessity skate over important details.

There are in fact different current market interest rates depending on the time to maturity of the bond. Interest rates for the far future are less volatile than those for smaller time periods. So it is not like equity prices which can crash or boom after 1 year’s results. It needs something major to affect the market’s estimate of average interest rates over the next say 30 years.

The reason why long dated bonds are particularly volatile is that a small change in assumed interest rates over decades can have a major effect on total return and thus on current prices.
 

JohnWinder

My amateurish view is that the Fed is the joker in the pack here.  By which I mean this:  historically the appeal of a stocks and bonds portfolio was the non-correlation.  Bullish macro effects for one tended to be bearish for the other (this is a huge simplification but I think it's a reasonable statement).

You draw interesting conclusions, but be careful of the premises.
Yes, I earlier quoted a correlation of 0.12 for USA, essentially non-correlation. You can’t then go on to say macro effects bullish for one are bearish for another, as that would be a bit or a lot of negative correlation, which it wasn’t for the period in question. You might be right if you looked at particular periods when the correlation was negative, but you’d have to look at them.

GazzaBloom

The more I learn about bonds and bonds funds, the more I realise that there is a much larger amount of stuff I don't know about the bond market and find it less appealing to invest in.

Linton

GazzaBloom said:

The more I learn about bonds and bonds funds, the more I realise that there is a much larger amount of stuff I don't know about the bond market and find it less appealing to invest in.

A fair comment. Bonds are superficially simple but their behaviour can be complex.  The problem is that no-one has come up with anything else uncorrelated with equity to provide non-trivial returns and can be flexibly held in a tax protected environment.

JohnWinder

Redlander said:

What are the titles of those books, please?

No particular purpose, at least for the most of it. Might need to dig into it to replace a gas boier or get roof repairs. In truth I'm really nervous about managing big sums like this  I find it hard to focus on what the basic objectives are. That's why I'm contempalting putting it all in a passive fund and leaving it be. I need to get a grip on myslef and clarify my objectives.

So, you don't need anything like £400k of cash in 5 years? If like others here, you need most of that £400k dribbled out to you over 25 years of retirement and then perhaps leave some for your heirs. Those two situations, so different, are best served by two very different investing strategies. By reading up how to manage your own investments you will not only learn most of the answers you need, but also discover the questions you need to ask yourself; you're not the first person who seems not to realise that investing for retirement doesn't end as retirement starts, you're just hitting your straps by then.
The Little Book of Common Sense Investing is Bogle's. You'll get an old edition as a free pdf but it's worth every penny and more.
Hale's is Smarter Investing. I don't know Edwards'.
If You Can is a free pdf by W Bernstein, short and sweet.
The Bogleheads' Guide to Investing, by Larimore et al is a 7.2MB pdf. I think it's here: https://ia803405.us.archive.org/23/items/the-bogleheads-guide-to-investing/The Bogleheads' Guide to Investing.pdf
Expected Returns An Investors' Guide to Market Returns by Ilmanen is not such an easy read, but a free 23MB pdf.
The Basics of Investing Basics  A primer for the young retirement investor by A. Dad, is a free pdf written by a father for his daughters, not published as a book I think, but good enough at 40pp.
Investment Strategies for the 21st Century by Frank Armstrong is a 160pp pdf.
The Future of Life-Cycle Saving and Investing by Bodie et al is a 200pp pdf free from the Research Foundation of the CFA Institute. Sensible, but not a first read.
Serious Money, Straight talking about retirement investing, by Richard Ferri is a free 200pp pdf
Unveiling the retirement myth, by Jim Otar is 400pp free pdf written in the clearest well-structured way as an engineer would, but there's a lot of detail for when it comes time to decide how you can live of your investments based on a lot of financial history.