Have short duration bonds had their day in the sun?
aroominyork
Forumite 2.4K Posts
Short duration has been a good place to be during the last year (although, of course, no bonds was better). It is where most of my bond holdings were when interest rates are ultra low since the only way was up and it seemed a matter of when and not if - I did not buy the 'new normal' thesis that rates would stay low. They still have a place for people wanting low bond volatility, but for most portfolios it seems like mid-duration is now a better risk/reward option. What do others think?
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For that reason I would not recommend bond funds with a broad spread of maturity dates to anyone. Compared with individual bonds, such bond funds in my view add risk without sufficient compensating reward.
Two exceptions, there may be others..
- Novice or passive investors for whom there is no obvious alternative way of diversifying from 100% equity.
- specialist active funds where bonds off different types and durations are used tactically.
2) The whole point of using bonds as opposed to equity is risk reduction when times are not normal. Though are times ever normal? Perhaps not except abnormally.
3) As a principle I advocate keeping the relationship between objectives and investments simple. If you want an investment for risk mitigation aiming for higher performance could be a distraction. If you want high performance leave the risk mitigation to those investments designed to provide it.
4) Investing for the medium term is more difficult than for the short or long term and, I would say, only appropriate if you have medium term liabilities. Under those circumstances it may be possible to plan specifically for those liabilities, moving into cash well in advance. You can then keep to 100% equity for longer.
Personally I rely on Wealth Preservation funds to do the complex management of bonds that is required. Buying individual bonds could be an option but I have not fully investigated what that would involve. However one thing it certainly would involve is significantly more management effort.
People who held bonds directly should not have got their fingers burnt. When they bought them they knew with 100% certtainty how much interest would be paid and the lump sum they would get returned at maturity. What happened to prices in the meantime should have been irrelevent as they would not be planning to sell.
I disagree with you on 3 particular counts..
1) It is not practical for many people with large investments to make great use of savings accounts. In any case savings accounts are generally for a maximum of 5 years. Bond investments can be fixed for decades. The situations are different.
2) Chasing maximum returns is not necessarily the best choice for many people if it leads to them panicking in crashes or just having a disturbed night's sleep.
3) What billionaire investors do is totally irrelevent to small private investors. Billionaire investors would tend to be active shareholders able to influence or control the way in which the companies they invest in are managed. That is how they become billionaires.
Once they become billionaires perhaps their concern could be more wealth preservation than excess growth.
I see bonds as multiple sub-asset classes that can work together to get decent returns while minimising the risk of selling an asset at a loss. When I rebalance at the turn of the tax year I expect to divide my bonds into three groups: a corporate bond fund (replacing a short dated one), bonds held within wealth preservation funds, shortish dated individual gilts. What is the objective? To have a portfolio, with retirement not too many years away, where I get decent returns and minimise the chance of selling an asset on a downturn.
I have been looking at bonds for a little while now and have come to the conclusion (possibly wrongly) that individual bonds/gilts are the way to go.
Adding a bond fund to add stability to my portfolio doesn't make sense to me when the funds can drop as they have recently, at least with individual bonds/gilts held to maturity you know exactly what you are getting.
The consensus a few months ago was that central banks needed to hike quite a lot to bring down inflation but late in 2023 we would start to see them cutting rates again. Whether the high rates would trigger a recession or not was less clear and clearly country specific. But for the US much stronger employment numbers at the start of Feb saw those expectations change with the market pricing higher rates and staying high for longer (no cuts in 2023). Europe and the UK followed that direction, notably the UK 10yr Gilt yield moved from around 3.0% to over 3.8% now which is a big move in a month.
If inflation stays higher for longer than people expect and the 'real economy' (jobs, consumer spending) stays strong in spite of higher rates, or if central banks abandon their 2% inflation targets and change them to 3% then there is risk that yields go higher from here in the medium term and bond funds will fall in value again. If we see data starting to weaken, job losses and lower house prices then yields could go back down and medium term bonds will perform well as people price in rate cuts again.
Short term bonds (<2yr) are just an alternative to fixed cash savings really, ideally you hold to maturity, you know exactly what the payout/interest rate will be. I've bought a few individual (govt) bonds recently because yields were better than I was able to get elsewhere. Medium term bond funds (2-10yr average duration) you are taking risk on the direction of interest rates, but the closer you come to retirement/spending the money the more it makes sense to lock in cash at predictable outcomes.