Bond funds question

JohnWinder

Which I guess is where strategic bond funds come into their own, rather than just buying a passive bond fund that tracks an index, as this allows the manager to focus on specific areas they think are most attractive in terms of risk and reward.

I think we know where this is heading…..Which strategic bond funds have done a better job than a tracker fund, given similar ‘risk’ characteristics like duration and credit risk? And let’s restrict it to ‘done better’ over a period of at least 5 years as that’s perhaps a minimum period relevant for such investing - better still 30 years since many of us will hold bond funds for 30 years. And when we know which funds those are, how did we know they would outperform when we chose them, and not choose the ones that underperformed? Or did all such funds outperform, and if so, as we’re making our choices now is it still the case for the next 5-30 years?  I just can’t see a way through all that to be confident that any particular fund is going to ‘come into its own’.

Linton

JohnWinder said:

You could be right. In which case now that linker yields are positive we should hear of people taking them up, or at least being offered them - watch this space. 

In which case #2, linker yields were positive for many years previously, but we didn’t hear anyone saying ‘I’m sorry that strategy has come to an end after 15 golden years, what do we do now?’.

And in which case #3, should we assume the advisors have been offering the strategy despite the negative linker yields recently, and the clients have been rejecting it? Or don’t they have that autonomy, it’s simply not been offered?

When I retired in 2005 restrictions made drawdown irrelevant for most people and relatively high annuity rates made it unnecessary, online investing was in its infancy, and personal investing outside an employer’s pension was a niche activity for the seriously rich or as just a hobby. So there was no need for anyone outside the seriously rich to buy bonds and little reason for advisors to use them other than for derisking prior to buying an annuity. In any case only a minority of people knew what an IFA was and even fewer would have any requirements to use one.

It is only in the past year with the increase in interest rates that all the conditions have been right for a more sophisticated use of bonds to become of interest for any but a small minority of the population.  I am unaware of much guidance from the the gurus.  So we have to work out for ourselves how best to use them.

Pat38493

Thanks all - this brings to mind that on another thread when the topic was raised of bridging income from early retirement until the start of a DB and SP pensions, someone suggested using a "bond ladder" and I had no idea what they were on about.  I'm getting a better idea now but also thinking that it's a pretty niche thing and even an IFA might not suggest it, for whatever reason.  I've also read that normally you want your bonds to be in your home currency or fully hedged?  

From the replies here I got the impression that even in a full SIPP I can't buy actual bonds or is that wrong?  NedS seemed to think it's possible?

Also - I read in a link this morning something that maybe I skimmed over or wasn't mentioned in the Tim Hale book - it said that normally you can't purchase individual bonds direclty from the governmanet or organisation - normally they are sold via auction conducted by banks, so even at the point of purchase, to a retail investor like me,  the price is not fixed at the original issuing price?

Linton

Pat38493 said:

Thanks all - this brings to mind that on another thread when the topic was raised of bridging income from early retirement until the start of a DB and SP pensions, someone suggested using a "bond ladder" and I had no idea what they were on about.  I'm getting a better idea now but also thinking that it's a pretty niche thing and even an IFA might not suggest it, for whatever reason.  I've also read that normally you want your bonds to be in your home currency or fully hedged?  

From the replies here I got the impression that even in a full SIPP I can't buy actual bonds or is that wrong?  NedS seemed to think it's possible?

Also - I read in a link this morning something that maybe I skimmed over or wasn't mentioned in the Tim Hale book - it said that normally you can't purchase individual bonds direclty from the governmanet or organisation - normally they are sold via auction conducted by banks, so even at the point of purchase, to a retail investor like me,  the price is not fixed at the original issuing price?

Some platforms sell bonds directly. The only ones I know that do this are HL and II. But even those only sell a limited range. For II you can only get ones not on the list by telephone at a much higher cost. Plus for HL there is a 1% bid/offer spread. I have no idea of how to buy foreign bonds.

Now all gilts are sold by auction even at launch. You can buy from the government, I think the Debt Management Office, if you are registered with them. But I have no idea what that might involve.

Pat38493

Linton said:

Now all gilts are sold by auction even at launch. You can buy from the government, I think the Debt Management Office, if you are registered with them. But I have no idea what that might involve.

LOL - hoist by you rown petard! 

JohnWinder

‘I've also read that normally you want your bonds to be in your home currency or fully hedged?  ‘

Bonds don’t change in value as dramatically as stocks usually, hence their attraction. But the value of the pound against the dollar or euro can change quite a lot in a short time. For the Scotsman holding US dollar denominated bonds, that currency movement can make those bonds more volatile in price. Hence, bond currency hedging is very common, but unnecessary or meaningless if the Scot holds UK bonds.

Also - I read in a link this morning something that maybe I skimmed over or wasn't mentioned in the Tim Hale book - it said that normally you can't purchase individual bonds direclty from the governmanet or organisation - normally they are sold via auction conducted by banks, so even at the point of purchase, to a retail investor like me,  the price is not fixed at the original issuing price?

The Treasury issues its bonds by auction I think; they get the best price that way, and also get an idea of how popular such financial instruments are by how much the auction is over or under subscribed. I suspect that you can bid at an auction, but the anti-money laundering paperwork alone would put you off, long before you’d be put off by not having a clue how much to bid at the auction (risking overpaying, or completely wasting your time). Pricing bonds involves heavy duty maths.
So you buy them from a broker or a bank. Price fixed at issuance? No. The bond’s coupon is fixed, say it’s 2% for a 5 year bond. The moment before the auction closes every buyer decides how much the interest rate on a 5 year bond should be at that moment. If they think the interest rate should be 2.5%, then the bid for a £100 bond will be less than £100, so that a 2% interest payment is worth 2.5% of the price they bid. The following day, now that they own the bond, that bond buyer looks at all the latest economic information and decides the interest on bonds maturing in 4 years and 364 days should be 2.49%, so the price they offer the bond for becomes different from the price they paid for it yesterday. And so it goes on; have a look at the prices the same bond trades for on any day, and you’ll see it’s changing all the time; just like stocks. The latest market relevant information is incorporated into everyone’s thinking of what the true value is, and the prices move around accordingly. By the way, that makes it a bit meaningless to say ‘bonds are overpriced today’, because they’re priced by everyone with any interest in bonds and all the information available to evaluate their price.

Pat38493

JohnWinder said:

Price fixed at issuance? No. The bond’s coupon is fixed, say it’s 2% for a 5 year bond. The moment before the auction closes every buyer decides how much the interest rate on a 5 year bond should be at that moment. If they think the interest rate should be 2.5%, then the bid for a £100 bond will be less than £100, so that a 2% interest payment is worth 2.5% of the price they bid. The following day, now that they own the bond, that bond buyer looks at all the latest economic information and decides the interest on bonds maturing in 4 years and 364 days should be 2.49%, so the price they offer the bond for becomes different from the price they paid for it yesterday. And so it goes on

Thanks actually that's a really good explanation of it

Linton

Pat38493 said:

Linton said:

Now all gilts are sold by auction even at launch. You can buy from the government, I think the Debt Management Office, if you are registered with them. But I have no idea what that might involve.

LOL - hoist by you rown petard! 

Not at all.  The "Now" in the sentance is correct - though the sentance would be better expressed as "Gilts are sold by auction at launch".  Many years ago they  weren't.  The point being that even the institutions have to to buy at a market price at launch rather than par. I notice that the BoE has also being selling some of its QE bonds by auction.

Linton

JohnWinder said:

‘I've also read that normally you want your bonds to be in your home currency or fully hedged?  ‘

Bonds don’t change in value as dramatically as stocks usually, hence their attraction. But the value of the pound against the dollar or euro can change quite a lot in a short time. For the Scotsman holding US dollar denominated bonds, that currency movement can make those bonds more volatile in price. Hence, bond currency hedging is very common, but unnecessary or meaningless if the Scot holds UK bonds.

Also - I read in a link this morning something that maybe I skimmed over or wasn't mentioned in the Tim Hale book - it said that normally you can't purchase individual bonds direclty from the governmanet or organisation - normally they are sold via auction conducted by banks, so even at the point of purchase, to a retail investor like me,  the price is not fixed at the original issuing price?

The Treasury issues its bonds by auction I think; they get the best price that way, and also get an idea of how popular such financial instruments are by how much the auction is over or under subscribed. I suspect that you can bid at an auction, but the anti-money laundering paperwork alone would put you off, long before you’d be put off by not having a clue how much to bid at the auction (risking overpaying, or completely wasting your time). Pricing bonds involves heavy duty maths.
So you buy them from a broker or a bank. Price fixed at issuance? No. The bond’s coupon is fixed, say it’s 2% for a 5 year bond. The moment before the auction closes every buyer decides how much the interest rate on a 5 year bond should be at that moment. If they think the interest rate should be 2.5%, then the bid for a £100 bond will be less than £100, so that a 2% interest payment is worth 2.5% of the price they bid. The following day, now that they own the bond, that bond buyer looks at all the latest economic information and decides the interest on bonds maturing in 4 years and 364 days should be 2.49%, so the price they offer the bond for becomes different from the price they paid for it yesterday. And so it goes on; have a look at the prices the same bond trades for on any day, and you’ll see it’s changing all the time; just like stocks. The latest market relevant information is incorporated into everyone’s thinking of what the true value is, and the prices move around accordingly. By the way, that makes it a bit meaningless to say ‘bonds are overpriced today’, because they’re priced by everyone with any interest in bonds and all the information available to evaluate their price.

Yes, but they can certainly be overpriced for the purposes for which you and any other private investor may wish to buy them.  Institutions and private investors are likely to have different reasons for buying bonds and it's the institutions that determine the market price. Private investors are pretty much irrelevent.

Ciprico

You can certainly buy Gilts on Interactive Investor, I have several maturing over the next few years (home made ladder).

I would like to buy Linkers but don't understand enough about them...

Gilts are relatively simple - below for HL, you pick the maturity, and price/coupon for your requirements... 

So you buy the second one for £99.30, and get £100 back in Sept 23, with the final coupon of £2.50, no selling charges.

So guaranteed a loss with inflation factored in - but better than cash is a SIPP...

It is also interesting for non tax protected savings  - ie 31/Jan/2025 Gilt (last one), the coupon is peanuts, but but over two years what you buy for 94p returns 100p (about 3%pa), but you don't pay capital gains on gilts...