Bonds question

OliverLacon

Prior to the Truss mini budget, I believed that bonds were a safe place to place wealth into (particularly as company pension schemes tend to rebalance in favour of bonds as retirement age approaches). I recall  that just after the infamous fiscal event, there were concerns pension funds were being wiped out by the rapid fall in bond prices.  I thought that a bond is a loan to a company or government for a fixed period with a guaranteed level of interest. I assumed that when a bond is bought by a pension scheme, its value is fixed and it cannot change price. How can falling bond prices affect pension schemes?

Marcon

Loads of stuff on the internet. Not sure how technical you want to get (and whether you are looking at DB or DC pensions) but try https://www.actuarialpost.co.uk/article/how-bond-changes-affect-pensions-and-why-you-must-not-worry-21304.htm or a more 'user friendly' https://www.thisismoney.co.uk/money/investing/article-12624185/Bond-price-crash-investments-pension-savings.html

Hoenir

What caused the LDI crisis?

https://bankunderground.co.uk/2024/07/26/what-caused-the-ldi-crisis/

MarkCarnage

Let's leave aside the specific issues around the Truss budget....which accelerated what was already happening. 

Your definition of a bond is broadly ok, but your assumptions about what happens after issue are not. 

Use a simple notional  example:

UK Government issues a 20 year bond (gilt) back in 2020 when interest rates were (artificially) low with an annual coupon (interest payment) of 1%. The bond is issued at a price of 100. This means that you will get £1 interest per year, and £100 back when the bond matures in 2040. 
However, interest rates then rise rapidly. What this means is that this bond's current value will change. Let's say in 2022, 20 year interest rates are now 5%. No one is going to pay you 100 for a bond paying 1% interest now - they can get bonds paying much higher annual coupon now, giving them cashflows of £5 per year not £1. This means that your original bond's price needs to fall to reflect the current market, and the price will fall to a level where the total cashflows (interest payments plus return of the principal amount at maturity) will be the same between the old bond and a new bond. You will still get your £100 back at maturity, but it isn't worth that if you want to sell it now. 

How falling bond prices affect pension schemes is a different subject......

OliverLacon

MarkCarnage said:

You will still get your £100 back at maturity, but it isn't worth that if you want to sell it now. 

.

My (incorrect) belief was that pension funds kept the bonds until maturity. If that had been the case, then there would have been no risk or loss to any investment. What I didn't realise was that pension funds were buying and selling pre-existing bonds. Before the events that unfolded after that mini budget ,I'm sure  most people thought that any pension savings that had been moved to bonds could not fall in value. 

Hoenir

OliverLacon said:

,I'm sure  most people thought that any pension savings that had been moved to bonds could not fall in value. 

Ultimately if they held to maturity they won't. However depending on their duration there'll be impacted in the short term by wider events. 

hotncold47

An interesting piece on Monevator yesterday on this subject.

OliverLacon

So is it a good idea for my pension fund to be automatically moving my savings from equities to bonds? Seems to me bonds are still risky (although less risky than equities). My pension is a DC one (using the default investment choice that gradually move savings from equities/funds to bonds as retirement age approaches). 

squirrelpie

OliverLacon said:

So is it a good idea for my pension fund to be automatically moving my savings from equities to bonds? Seems to me bonds are still risky (although less risky than equities). My pension is a DC one (using the default investment choice that gradually move savings from equities/funds to bonds as retirement age approaches). 

That depends on what you intend to do with it, and when. The usual view is that equities outperform bonds over the long term, but are more variable in the short term. So if you plan to use the cash value of your pension soon, for example to buy an annuity, then you may want to reduce the risk. If you plan to take flexi-drawdown over many years and/or you're a long way from retirement, then you may want to prioritise growth.

OliverLacon

The correct answer to all financial and retirement questions seems to be "it depends"

Albermarle

OliverLacon said:

So is it a good idea for my pension fund to be automatically moving my savings from equities to bonds? Seems to me bonds are still risky (although less risky than equities). My pension is a DC one (using the default investment choice that gradually move savings from equities/funds to bonds as retirement age approaches). 

The drop in bond values in 2022 was almost certainly a one off/once in a hundred years event, caused by the end of a long period of ultra low interest rates. Now interest rates are more back to normal, bond price movements should be a lot less dramatic.
So they can be used again as a way of derisking a portfolio from too much equity exposure.
The big question is more what proportion of equities to bonds suits your situation.
The traditional blend for people reaching retirement and not wanting to cash in /buy an annuity, would be around 50:50, although if you had a lot of cash savings as well, then you might want to increase the equity %.

These default DC lifestyling schemes tend to derisk too much, so a good idea to have a good look into it.