Help please in selecting a bond fund?

InvesterJones

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Completely agreed - just because you /can/ hold a bond to maturity, doesn't mean you /have/ to if selling is right for you and you want to take advantage of a price rise.

OldScientist

This post attempts to expand on my point upthread that any benefit of holding individual bonds depends on what you are using them for. Sorry, it is going to be a bit long.

Axiomatic in all discussions is that individual bonds have two properties, firstly the cashflow before maturity is known and, secondly, the maturing value is also known. For nominal bonds both these quantities are defined in nominal terms (but not real terms), while with inflation linked gilts, both quantities are known in real terms (but not nominal terms).

Example methods using the known properties of bonds

In retirement

A simple method  is to buy a single, long maturity, bond and use the coupons as income (this was often used as part of a 'natural yield' approach). For example, £100 of TR63 would give an annual nominal income of about £4.50 per year (assuming today’s dirty price of about £89) until 2063 and provide £100 (plus final coupon) in October 2063 (i.e., for a shade under 40 years). A £100 purchase of TG54 (net price 95.52) would provide an annual inflation adjusted income of £1.30 and provide £100 (in real terms) in November 2054 (i.e., 30 years hence). If more income is needed, then a portion of the bond holding would have to be sold down regardless of the price ('forced sale').

A more complex method is to build a collapsing (aka non-rolling) ladder where multiple bonds are held each with different maturity dates and income is derived from both coupons and maturing bonds. Typically, these are built such inflation linked income is provided, although nominal collapsing ladders can also be constructed. The excellent tool at https://lategenxer.streamlit.app/Gilt_Ladder is useful in determining how many of which bonds to buy (IMO setting withdrawal frequency to ‘monthly’ gives a better ladder than leaving it at annual). As of today, a nominal collapsing ladder providing £10k per year (not inflation protected) for 40 years would cost £185k to construct, while an inflation linked collapsing ladder providing £10k of inflation protected income per year would cost £320k to construct. Again, if more income is required than the ladder was designed to provide, then rungs might have to be sold prematurely regardless of the price.

In accumulation

Either of the potential income methods for retirement discussed previously can be set up earlier than at the moment of retirement. For example, the rungs of a collapsing ladder can currently be built out to 2073 and the tool linked to above can be set to provide a deferred start (although, as written, the tool stores unspent coupons as cash, so this might not be inflation protected). Alternatively rungs can be added gradually, e.g., with 20 years to go before retirement, the first rung can be built to cover income in the first year of retirement, the following year the second year is added, etc. A single bond with a long maturity date could also be bought and held (and potentially added to). In each case, a decision about what to do with coupons captured before retirement will need to be made.

Example methods NOT using the known properties of bonds

Bond funds

Bond funds (whether index or actively managed) typically hold a number of bonds at a range of maturities. The NAV of the fund will change with time with a known, but variable, increase provided by the coupons of the individual bonds and a volatile component that will depend on the prices of the individual bonds. The prices vary with changes in yield with the magnitude of the changes determined by the duration of the bonds (so, approximately, the weighted or effective duration of the fund). Longer durations mean more price volatility (but typically, greater returns), while short durations mean less price volatility (but, typically, lower returns). STMMF could be considered as ultra-short duration fixed income.

During accumulation, pound cost averaging will apply to bond funds, e.g., because of the increases in yields, people currently buying bond funds will be getting the fund at a discount compared to 5 years ago. Conversely, if yields drop accumulators will be paying more for their bonds.

For retirees, pound value averaging will apply with the opposite effect since they will be spending their bond funds (i.e., with increases in yields, retirees might have to sell their bonds cheaply, if yields drop, then the price will rise). To reiterate, the magnitude of the price fluctuations depend on the duration of the fund.

Rolling bond ladder

In a rolling ladder, one or more individual bonds are held and coupons and maturing bonds are either reinvested (during accumulation) or partially reinvested (with the remainder spent) during retirement. Either way, the behaviour of the rolling ladder will be similar to that of a bond fund because it is the yield at reinvestment not the price at maturity that is critical in determining returns and that, in practical cases, either new money is being added or existing value is being removed. However, there are two important caveats. The first is tax since, where bonds are held in a general investment account, individual gilts are not subject to capital gains tax while bond funds are. The second is investment costs because while platform fees are usually(?) the same for both funds and individual bonds, investment costs may be different (it depends on the platform). Furthermore, there is some additional complexity in holding individual bonds and many pension platforms do not allow them.

itwasntme001

InvesterJones said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Completely agreed - just because you /can/ hold a bond to maturity, doesn't mean you /have/ to if selling is right for you and you want to take advantage of a price rise.

Plus holding individual gilts is more tax efficient because the capital gians are tax free.  Not for bond funds however.

I can not see any reason to hold bond funds, either seperatly or as part of a multi-asset fund.  I suppose if you are clueless about holding individual bonds it might come of use.  But bond funds are usually of fixed maturities or duration so if one needs to meet a liabiltiy, they would actively need to sell down the bond fund at an appripriate time, and the price you get can be inappropriate.  With a gilt held till maturity at the time you intend to spend it, you do not have to worry about this.

Prism

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Agreed but then you have the question of should you. It effectively changes from a strategy of buying now and getting a fixed income into the realms of active investing but with bonds.

Lets say you have a bond ladder in place and the bond prices go up. Do you stick or sell? And if you do sell then which bond do you sell? How does that change your ongoing income from the bond and how do you replace the 'gap' you now have when it matures. If you are buying bonds for guaranted income and eventual redemption, you need to think seriously about selling based on price

Its not that these things cannot be worked out but it isn't as simple as selling a bit of a fund on a regular basis for income.

OldScientist

itwasntme001 said:

InvesterJones said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Completely agreed - just because you /can/ hold a bond to maturity, doesn't mean you /have/ to if selling is right for you and you want to take advantage of a price rise.

Plus holding individual gilts is more tax efficient because the capital gians are tax free.  Not for bond funds however.

I can not see any reason to hold bond funds, either seperatly or as part of a multi-asset fund.  I suppose if you are clueless about holding individual bonds it might come of use.  But bond funds are usually of fixed maturities or duration so if one needs to meet a liabiltiy, they would actively need to sell down the bond fund at an appripriate time, and the price you get can be inappropriate.  With a gilt held till maturity at the time you intend to spend it, you do not have to worry about this.

Two possible reasons for holding funds:
1) Global bond funds offer international diversification in fixed income (useful in the unlikely event of UK default)

2) Many pension platforms do not allow individual gilts to be held.

I have a DB pension in payment that effectively consists of inflation linked gilts, so holding global bond funds (including cash accounts, my fixed income holdings have a weighted duration of less than 2 years) allows me to diversify away from the UK. I also hold individual inflation linked gilts in a collapsing ladder (to provide an element of inflation protected income to supplement a nominal life insurance payout in the event of my death before my OH gets their SP).

I note that multiple bond funds of different durations can be used to duration match a collapsing ladder (there has been a lot of discussion and modelling of this over on the bogleheads forums), although there are some limitations (e.g., with non-parallel shifts in the yield curve). Indeed, some 'lifestyle' pension funds intended for annuity purchase (rather than drawdown) use long bonds to match the duration of the annuity.

Do the gilts you hold solely form part of a liability matching portfolio?

OldScientist

Prism said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Agreed but then you have the question of should you. It effectively changes from a strategy of buying now and getting a fixed income into the realms of active investing but with bonds.

Lets say you have a bond ladder in place and the bond prices go up. Do you stick or sell? And if you do sell then which bond do you sell? How does that change your ongoing income from the bond and how do you replace the 'gap' you now have when it matures. If you are buying bonds for guaranted income and eventual redemption, you need to think seriously about selling based on price

Its not that these things cannot be worked out but it isn't as simple as selling a bit of a fund on a regular basis for income.

If you have a collapsing ladder in place that is designed to provide income (whether inflation linked or nominal) over your retirement, you spend the coupons and maturing bonds and don't touch the rest of the ladder. Where the income from the ladder (together with state pension, etc.) forms your income floor, it is with the rest of your portfolio (i.e., equities, cash, etc.) that you take market risk.

InvesterJones

itwasntme001 said:

InvesterJones said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Completely agreed - just because you /can/ hold a bond to maturity, doesn't mean you /have/ to if selling is right for you and you want to take advantage of a price rise.

I can not see any reason to hold bond funds, either seperatly or as part of a multi-asset fund.  I suppose if you are clueless about holding individual bonds it might come of use.  But bond funds are usually of fixed maturities or duration so if one needs to meet a liabiltiy, they would actively need to sell down the bond fund at an appripriate time, and the price you get can be inappropriate.  With a gilt held till maturity at the time you intend to spend it, you do not have to worry about this.

Oh I think there are still reasons you might want a bond fund (or several) - the most obvious one is availability: not all platforms offer the chance to buy bonds directly, and those that do often have limited selection (for example UK only). If you want to hold Emerging Market etc, a bond fund is pretty much the only way to go. Then there's the reason funds exist in the first place: convenience - a manager is doing/setting up the buying and selling, you only need concern yourself with entry and exit - this is especially relevant for ultra short duration bonds, or where a particular risk level is being targetted. Funds may end up with lower costs too than are possible with individual purchases. Any you can hold bond funds in tax wrappers if CGT (or income) is a tax concern.

itwasntme001

Prism said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Agreed but then you have the question of should you. It effectively changes from a strategy of buying now and getting a fixed income into the realms of active investing but with bonds.

Lets say you have a bond ladder in place and the bond prices go up. Do you stick or sell? And if you do sell then which bond do you sell? How does that change your ongoing income from the bond and how do you replace the 'gap' you now have when it matures. If you are buying bonds for guaranted income and eventual redemption, you need to think seriously about selling based on price

Its not that these things cannot be worked out but it isn't as simple as selling a bit of a fund on a regular basis for income.

I firmly believe that the bond market is just too efficient for an active manager to add value.  Bonds also are predictable in terms of payoffs (obviously yields move around in the interim) so you can work out yourself duration etc.  Plus there are the fees with bond funds.

So if one does understand bonds, one can attempt to time things to their favour, such as selling out on bond sin 2020/21 given returns were onyl going to be negative, or buying them in 2022.

But personally, I never trade bonds, I only use them for certainty in payoff for meetting future expected and unexpected liabilities.  Any money needed for more than 15 years I leave invested in equities.

itwasntme001

OldScientist said:

itwasntme001 said:

InvesterJones said:

itwasntme001 said:

Prism said:

The opposing argument is that if you only sell individual bonds at maturity then you don't benefit from prices rises that might occur along the way. One of the arguments of holding a bond fund isn't that you know exactly what you are going to get, or that its immune to losses, but that it might well give you some decent gains when you really need them.

But you can do the same with holding a bond directly.

Completely agreed - just because you /can/ hold a bond to maturity, doesn't mean you /have/ to if selling is right for you and you want to take advantage of a price rise.

Plus holding individual gilts is more tax efficient because the capital gians are tax free.  Not for bond funds however.

I can not see any reason to hold bond funds, either seperatly or as part of a multi-asset fund.  I suppose if you are clueless about holding individual bonds it might come of use.  But bond funds are usually of fixed maturities or duration so if one needs to meet a liabiltiy, they would actively need to sell down the bond fund at an appripriate time, and the price you get can be inappropriate.  With a gilt held till maturity at the time you intend to spend it, you do not have to worry about this.

Two possible reasons for holding funds:
1) Global bond funds offer international diversification in fixed income (useful in the unlikely event of UK default)

2) Many pension platforms do not allow individual gilts to be held.

I have a DB pension in payment that effectively consists of inflation linked gilts, so holding global bond funds (including cash accounts, my fixed income holdings have a weighted duration of less than 2 years) allows me to diversify away from the UK. I also hold individual inflation linked gilts in a collapsing ladder (to provide an element of inflation protected income to supplement a nominal life insurance payout in the event of my death before my OH gets their SP).

I note that multiple bond funds of different durations can be used to duration match a collapsing ladder (there has been a lot of discussion and modelling of this over on the bogleheads forums), although there are some limitations (e.g., with non-parallel shifts in the yield curve). Indeed, some 'lifestyle' pension funds intended for annuity purchase (rather than drawdown) use long bonds to match the duration of the annuity.

Do the gilts you hold solely form part of a liability matching portfolio?

Yes I solely use gilts for liability matching.  Which is also why I just stick to gilts and nothing foreign.  I believe cash/gilts should onyl be used to meet your liabilities and you need a certainty in payoff.  I invest the rest in equities that is not needed for say 15 years.

With certain exceptions (e.g. Truss 2022) I do not believe it is worth trading bonds as the market is just too efficient most of the time.

incus432

OldScientist said:

2) Many pension platforms do not allow individual gilts to be held.

Perhaps but AJ Bell do. and both they and Iweb allow them in an ISA