Investing in different bond funds

Linton

aroominyork said:

Tondrive said:

Personally i think passive trackers are good for equities but i am not convinced the same applies to bonds.
They may need a more active approach and there are plenty of Funds and Investment Trusts where fees are not much greater than a tracker.

One of the challenges with actively managed bond funds is that fees often are much higher than a tracker. It is easy to pay 0.5%, 0.6%, even 0.7% for active bond management, and even if you succeed in beating the index a high proportion of the marginal gain is likely to be eaten by fees....

Linton said:

Tondrive said:

Personally i think passive trackers are good for equities but i am not convinced the same applies to bonds.
They may need a more active approach and there are plenty of Funds and Investment Trusts where fees are not much greater than a tracker.

I agree with this.  In my view when buying bonds you need to have a fairly precise idea of why you are buying them and then choose those bonds which match your objectives.  ISTM with long dated bond funds you are in danger of increasing volatility without sufficiently increasing returns.

... so one solution is to determine the type of bonds you want - government/corporate, duration, investment grade or high yield - and then but a low cost tracker which matches you objectives.

A low cost bond tracker is likely to have a wide range of durations.  The time to maturitry is arguably the most important characteristic of a bond and the time frame is arguably the most important part of an objective of a bond investment.  So it is likely that a bond tracker wont be ideal for any specific objective.

JohnWinder

I don’t understand. As I see it, a bond fund has one duration, calculated from the durations of the bonds in the fund. The fund itself has only a single duration, and this will be a guide to interest rate sensitivity. The fund’s duration might change, a bit, if the index changes its composition, or if the manager decides to go ‘longer’ or ‘shorter’, and as interest rates rise duration falls a bit (since more of the money you get back is in coupons and these are paid out earlier than the principal at redemption of sale.

Linton

JohnWinder said:

I don’t understand. As I see it, a bond fund has one duration, calculated from the durations of the bonds in the fund. The fund itself has only a single duration, and this will be a guide to interest rate sensitivity. The fund’s duration might change, a bit, if the index changes its composition, or if the manager decides to go ‘longer’ or ‘shorter’, and as interest rates rise duration falls a bit (since more of the money you get back is in coupons and these are paid out earlier than the principal at redemption of sale.

The point about durations is that the price of an individual bond is fixed at purchase and at maturity.  In between those dates the price can be volatile depending on what happens to interest rates.

So the average duration for a fund is pretty meaningless unless the duration is very short:

When you buy into a fund with average duration of 10 years you are probably buying a set of bonds with durations between 1 month and 50 years.  When you sell in 10 years time your fund will still have an average duration of 10 years and comprise underlying bonds with durations between 1 month and 50 years. Most of the underlying  bonds will be some way from maturity. So the price could be significantly higher or lower than that  at which you bought - you have no way of knowing.

This is very different to buying a single bond with an 10 year duration when you know for certain what your return will be in 10 years time.

ISTM that if you are going to buy bonds rather than equity the risk in the sale price of a broad bond fund can remove most of the advantages of buying bonds in the first place.  Better alterantives are:
1)  to invest a higher % of equity and hold a tranche of cash
2)  buy individual bonds with durations matching your objectives or very short duration bond funds
3) buy a managed fund where the fund manager moves between different types and durations of bond depending on economic conditions to reduce price volatility risk.

masonic

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Linton

masonic said:

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Unlike with equities, predicting the future is possible to a major extent with bonds since the position at maturity is 100% certain.  So for example prior to the recent rise in interest rates the significantly above par market price of inflation linked bonds gave rise to major risk.  One did not need the powers of Nostradamus or Old Mother Shipton to see this.  Now IL bonds are trading close to par and so have a far lower risk.

This sort of management is perfectly feasible if one is aiming for the short/medium term.  A passive fund cannot make such strategic choices whereas the Wealth Preservation funds can and do.  Perhaps the risk targetted multi-asset funds do as well, I dont know.

masonic

Linton said:

masonic said:

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Unlike with equities, predicting the future is possible to a major extent with bonds since the position at maturity is 100% certain.  So for example prior to the recent rise in interest rates the significantly above par market price of inflation linked bonds gave rise to major risk.  One did not need the powers of Nostradamus or Old Mother Shipton to see this.  Now IL bonds are trading close to par and so have a far lower risk.

This sort of management is perfectly feasible if one is aiming for the short/medium term.  A passive fund cannot make such strategic choices whereas the Wealth Preservation funds can and do.  Perhaps the risk targetted multi-asset funds do as well, I dont know.

Yes, it was easy to see the direction of travel when rates were at historic lows. However, I don't believe the same can be said today for an individual retail investor wishing to buy bonds for short-term profit. Are you sure that someone buying long dated gilts today with YTM 3.7-4.0% could expect to see a capital gain in the short term? I'm not.

Linton

masonic said:

Linton said:

masonic said:

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Unlike with equities, predicting the future is possible to a major extent with bonds since the position at maturity is 100% certain.  So for example prior to the recent rise in interest rates the significantly above par market price of inflation linked bonds gave rise to major risk.  One did not need the powers of Nostradamus or Old Mother Shipton to see this.  Now IL bonds are trading close to par and so have a far lower risk.

This sort of management is perfectly feasible if one is aiming for the short/medium term.  A passive fund cannot make such strategic choices whereas the Wealth Preservation funds can and do.  Perhaps the risk targetted multi-asset funds do as well, I dont know.

Yes, it was easy to see the direction of travel when rates were at historic lows. However, I don't believe the same can be said today for an individual retail investor wishing to trade bonds for profit. Are you sure that someone buying long dated gilts today with YTM 3.7-4.0% could expect to see a capital gain in the short term? I'm not.

I believe trading bonds for profit is best left to the professionals making £millions from large scale arbitrage.  Trading bonds by small private investors is better suited to risk management. If one was concerned about short term capital gains why look at long dated bonds?  Surely the way to get most advantage from the features of bonds is to link durations to objectives.

masonic

Linton said:

masonic said:

Linton said:

masonic said:

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Unlike with equities, predicting the future is possible to a major extent with bonds since the position at maturity is 100% certain.  So for example prior to the recent rise in interest rates the significantly above par market price of inflation linked bonds gave rise to major risk.  One did not need the powers of Nostradamus or Old Mother Shipton to see this.  Now IL bonds are trading close to par and so have a far lower risk.

This sort of management is perfectly feasible if one is aiming for the short/medium term.  A passive fund cannot make such strategic choices whereas the Wealth Preservation funds can and do.  Perhaps the risk targetted multi-asset funds do as well, I dont know.

Yes, it was easy to see the direction of travel when rates were at historic lows. However, I don't believe the same can be said today for an individual retail investor wishing to trade bonds for profit. Are you sure that someone buying long dated gilts today with YTM 3.7-4.0% could expect to see a capital gain in the short term? I'm not.

I believe trading bonds for profit is best left to the professionals making £millions from large scale arbitrage.  Trading bonds by small private investors is better suited to risk management. If one was concerned about short term capital gains why look at long dated bonds?  Surely the way to get most advantage from the features of bonds is to link durations to objectives.

I agree with you, but the thesis of the OP was that long duration bonds will be most sensitive to interest rate reductions, therefore there will be significant capital gains when interest rates fall. I don't think any strategic bond funds are positioned in this fashion, so they wouldn't be a suitable choice for someone wishing to position themselves to exploit this prediction.

Linton

masonic said:

Linton said:

masonic said:

Linton said:

masonic said:

In the context of someone wishing to trade bonds specifically to capitalise on their superior knowledge about future interest rates, a tracker is an adequate vehicle, while an active fund would be at odds with this approach. However, the doubt would be that they are in fact able to predict such favourable movements in bond prices.

Unlike with equities, predicting the future is possible to a major extent with bonds since the position at maturity is 100% certain.  So for example prior to the recent rise in interest rates the significantly above par market price of inflation linked bonds gave rise to major risk.  One did not need the powers of Nostradamus or Old Mother Shipton to see this.  Now IL bonds are trading close to par and so have a far lower risk.

This sort of management is perfectly feasible if one is aiming for the short/medium term.  A passive fund cannot make such strategic choices whereas the Wealth Preservation funds can and do.  Perhaps the risk targetted multi-asset funds do as well, I dont know.

Yes, it was easy to see the direction of travel when rates were at historic lows. However, I don't believe the same can be said today for an individual retail investor wishing to trade bonds for profit. Are you sure that someone buying long dated gilts today with YTM 3.7-4.0% could expect to see a capital gain in the short term? I'm not.

I believe trading bonds for profit is best left to the professionals making £millions from large scale arbitrage.  Trading bonds by small private investors is better suited to risk management. If one was concerned about short term capital gains why look at long dated bonds?  Surely the way to get most advantage from the features of bonds is to link durations to objectives.

I agree with you, but the thesis of the OP was that long duration bonds will be most sensitive to interest rate reductions, therefore there will be significant capital gains when interest rates fall. I don't think any strategic bond funds are positioned in this fashion, so they wouldn't be a suitable choice for someone wishing to position themselves to exploit this prediction.

I see your point.  Perhaps one should question the thesis as a basis for investing.  I see no good reason to believe that interest rates  will be lower than now at some undefined point in the future when the OP wishes to sell the investments.  As far as one can tell it's a toss of the coin gamble.

redux

masonic said:

I agree with you, but the thesis of the OP was that long duration bonds will be most sensitive to interest rate reductions, therefore there will be significant capital gains when interest rates fall. I don't think any strategic bond funds are positioned in this fashion, so they wouldn't be a suitable choice for someone wishing to position themselves to exploit this prediction.

I suspect the OP is overlooking the possibility that future assumptions - whether or not they turn out to be exactly correct - will be already priced in.

So if interest rates are expected to be at current rate for a while then fall a bit, the consensus in the market isn't presenting a chance to buy ahead at an advantageous price for this happening

Of course, sometimes unexpected things happen, but I doubt we'll get Truss again