Bond element of pension portfolio

BobR64

I posted here last year as I was trying to work out some sort of strategy for my SIPP in retirement. One of my questions was about the extent to which I needed to follow the common guidelines like a 60/40 equity/bond split, given that we will also have a reasonable DB component coming in. In the responses, there seemed to be a consensus for some sort of caution and this was reinforced by some further learning about sequence of returns risks in the years either side of retirement. I hadn't come to any firm conclusions about what sort of split to go for, but the US political situation early in the year was spooking me and I took the decision to sell a proportion of my equities, retaining about 60%.

From the proceeds, I used a proportion of it (about 10% of total portfolio value) to buy a gilt ladder that will cover all of the income that is needed from the SIPP between retirement and SPA about 7 years later. The rest of our income in that period will come from our DB pensions and another gilt ladder in a GIA that effectively gives us our joint state pension income 7 years early.

The rest of the proceeds from the sale of equities, about 30% of the portfolio, is currently in a MMF. It is this that I am unsure about. My general plan was to find a "bond fund" to put it into. But, whereas with equities there are sensible "set and forget" options like global index funds, I can't seem to get my head around exactly what I am looking for with bond funds. And then there are apparently well-respected people such as the chap on the Pensioncraft videos, who pretty much seems to be advising against bond funds in favour of holding gilts directly. 

Which leads me to my questions. I'd like to get some feel for what people are actually doing when it comes to holding bonds in their pension. Are you investing in one or more bond funds? If so which ones? (I am sensible enough not to take anything here as financial advice but at the same I would appreciate some concrete ideas that I can look into.) Or are you tending to hold gilts directly? I feel as though I can understand this better than funds but on the downside there is more ongoing maintenance.

Linton

BobR64 said:

I posted here last year as I was trying to work out some sort of strategy for my SIPP in retirement. One of my questions was about the extent to which I needed to follow the common guidelines like a 60/40 equity/bond split, given that we will also have a reasonable DB component coming in. In the responses, there seemed to be a consensus for some sort of caution and this was reinforced by some further learning about sequence of returns risks in the years either side of retirement. I hadn't come to any firm conclusions about what sort of split to go for, but the US political situation early in the year was spooking me and I took the decision to sell a proportion of my equities, retaining about 60%.

From the proceeds, I used a proportion of it (about 10% of total portfolio value) to buy a gilt ladder that will cover all of the income that is needed from the SIPP between retirement and SPA about 7 years later. The rest of our income in that period will come from our DB pensions and another gilt ladder in a GIA that effectively gives us our joint state pension income 7 years early.

The rest of the proceeds from the sale of equities, about 30% of the portfolio, is currently in a MMF. It is this that I am unsure about. My general plan was to find a "bond fund" to put it into. But, whereas with equities there are sensible "set and forget" options like global index funds, I can't seem to get my head around exactly what I am looking for with bond funds. And then there are apparently well-respected people such as the chap on the Pensioncraft videos, who pretty much seems to be advising against bond funds in favour of holding gilts directly. 

Which leads me to my questions. I'd like to get some feel for what people are actually doing when it comes to holding bonds in their pension. Are you investing in one or more bond funds? If so which ones? (I am sensible enough not to take anything here as financial advice but at the same I would appreciate some concrete ideas that I can look into.) Or are you tending to hold gilts directly? I feel as though I can understand this better than funds but on the downside there is more ongoing maintenance.

Any investment you make much match your specific objectives.  I invest in high risk/high yield bond funds because I want income.  I do not hold gilts, either in funds or individually, at all because their interest is lower than can be achieved elsewhere and I have no need to restrain the volatility of 100% equities for long term growth, that being the usually stated reason.

The reason why individual gilts seem to be preferred over gilt funds is because when you buy a gilt   you know the interest you are going to get you as it is fixed, you know the price at which you buy, you know the price at maturity and you accept that between the fixed points the price can vary significantly.  

When you buy or sell a medium or long dated gilt fund the majority of the underlying gilts will be far from maturity so you lose the certainties of both price and interest that individual gilts provide. TBH I find it difficult to identify any objectives for which the optimal answer is a gilt fund.

What objectives do you have that suggest gilts, or other bonds, may be right for you?

AlanP_2

Personally I would avoid the issue by using a multi-asset fund at the appropriate split that incorporates bonds and let the manager worry about it.

I can't get my head around direct bond investing but it sounds like you have so well done.

From what I can gleam the main difference between a "direct" bond and a fund is that you control the duration with the former and, if held until maturity, you know exactly what your return will be.

With the latter, say it is a fund that holds 10-12 year bonds. Next week it will sell some and replace them as the duration will have gone outside their remit. The price they will sell for is dependent on the market so anybody's guess really.

DT2001

I am about 85% in equities and the rest is in ultra short bond ETF. It is, as my latest thread proves, too risky for some as like you I need a very low drawdown.

When researching I looked at twoetfs.com ‘The two ETF portfolio: simple is often best’ article and YouTube videos by James Shack and Ben Felix. Bonds soften the decline but depending on your specific income requirements, IHT considerations and attitude to risk I would look at part annuitisation or part income portfolio to achieve the same end. A regular contributor, Linton, has a 3 pot system (cash pot, income/wealth preservation feeding into cash and growth fund) that I much admire (but my willingness to adopt a flexible expenditure has lead me to a simpler but much more volatile approach)

leosayer

The basic retirement spending needs of my wife and I will be met by guaranteed income from DB, Gilt ladder and eventually, state pensions so our investments are for discretionary spending. 

Our investments are 65% global equities with the remainder being a 'low risk allocation' split pretty evenly between MM, Gilt ladder and a short-term gilt fund (ticker IGL5).

Our purpose for this low risk allocation is not to generate a return or for negative corrolation with equities. It is simply to ensure that any equity market corrections won't meaningfully curtail our retirement spending plans whilst we are relatively young, fit and healthy. We have some expensive plans over the next 5-10 years and beyond that can possibly comfortably live off DB and State Pensions so our low risk portion only has to cover this period.

Hoenir

BobR64 said:
 One of my questions was about the extent to which I needed to follow the common guidelines like a 60/40 equity/bond split, 

Both equities and bonds can take many forms. Your portfolio needs to be risk adjusted to reflect your own personal objectives. There's not a one size fits all. 60/40 is born out of the concept of minimising volatality. That bonds will smooth the periods of weaker equity performance.  Taking high levels of risk doesn't neccessarily equate to far superior investment returns that is often assumed. Depending upon the actual starting point. Currently the equity risk premium is at a 20 year low. A fair weather indicatator that returns are going to be somewhat subdued compared to the post GFC free money era. 

OldScientist

BobR64 said:

I posted here last year as I was trying to work out some sort of strategy for my SIPP in retirement. One of my questions was about the extent to which I needed to follow the common guidelines like a 60/40 equity/bond split, given that we will also have a reasonable DB component coming in. In the responses, there seemed to be a consensus for some sort of caution and this was reinforced by some further learning about sequence of returns risks in the years either side of retirement. I hadn't come to any firm conclusions about what sort of split to go for, but the US political situation early in the year was spooking me and I took the decision to sell a proportion of my equities, retaining about 60%.

From the proceeds, I used a proportion of it (about 10% of total portfolio value) to buy a gilt ladder that will cover all of the income that is needed from the SIPP between retirement and SPA about 7 years later. The rest of our income in that period will come from our DB pensions and another gilt ladder in a GIA that effectively gives us our joint state pension income 7 years early.

The rest of the proceeds from the sale of equities, about 30% of the portfolio, is currently in a MMF. It is this that I am unsure about. My general plan was to find a "bond fund" to put it into. But, whereas with equities there are sensible "set and forget" options like global index funds, I can't seem to get my head around exactly what I am looking for with bond funds. And then there are apparently well-respected people such as the chap on the Pensioncraft videos, who pretty much seems to be advising against bond funds in favour of holding gilts directly. 

Which leads me to my questions. I'd like to get some feel for what people are actually doing when it comes to holding bonds in their pension. Are you investing in one or more bond funds? If so which ones? (I am sensible enough not to take anything here as financial advice but at the same I would appreciate some concrete ideas that I can look into.) Or are you tending to hold gilts directly? I feel as though I can understand this better than funds but on the downside there is more ongoing maintenance.

Holding individual gilts can take two forms:
1) a collapsing ladder of the type you have already constructed (i.e. where coupons and maturing bonds are taken as income)
2) a rolling ladder where some or all of the maturing bonds and coupons are reinvested in bonds with higher maturities.

Functionally, there is little difference between a rolling gilt ladder and a gilt fund with the same maturity range and similar duration.

Duration is the key element of fixed income funds - typically longer durations will provide higher returns (that was certainly true from the 1980s to 2022 but was not true from the 1940s to 1980) but with greater volatility, whereas shorter durations (including very short durations such as 3-month bills and 'cash') will provide lower returns (but not always) with lower volatility. 'Intermediate' duration funds will provide returns and volatility somewhere between the two extremes.

FWIW, we have 3 elements of fixed income: 'cash' in two 1-year fixed rate accounts set to mature 6 months apart (corresponding to our withdrawal frequency and typically benefiting from enhanced yields compared to bills or gilts), a short duration global bond fund, and a longer duration global bond fund (the two offered by Vanguard, but funds tracking the same index are available elsewhere). These are combined to give a weighted duration of between 1 and 2 years (closer to the low end if I think rates are going to rise and the high end if I think rates are going to fall - fixed income is the only active investing I do, getting it wrong will make little difference, but scratches an itch!).

We also have a short inflation linked gilt ladder (to provide an element of income before my OHs SP kicks in) and an individual gilt that, on maturity, will be used to cover a nominal liability (it was convenient and had about the same rate, after tax, as the equivalent fixed rate cash account).

BobR64

Linton said:

What objectives do you have that suggest gilts, or other bonds, may be right for you?

I am not sure that it is driven by my objectives so much as it simply being my impression that having an equities + bonds mix is by far the most common and commonly recommended approach. There is also an element of wanting to keep things reasonably simple even if it ends up not being the most optimal thing I could have done.

In terms of the objectives I do have:

• The main thing is to provide an income, but I think we are going to be reasonably comfortable on quite a low drawdown rate from the SIPP.
• Although I am happy to accept some volatility, and, relating to the previous point, we will be quite resilient to volatility, I will probably sleep easier if it can be reduced to some extent, and it is my understanding that bonds can help in this regard.
• Although not a primary goal, it would be nice, if it ends up that we have more than we absolutely need, to be able to take out extras from time to time, perhaps to help family, and also to have a decent amount left to be inherited (though obviously things are changing here). There is therefore an element of wanting to preserve capital and avoid erosion by inflation.

BobR64

AlanP_2 said:

Personally I would avoid the issue by using a multi-asset fund at the appropriate split that incorporates bonds and let the manager worry about it.

I can't get my head around direct bond investing but it sounds like you have so well done.

From what I can gleam the main difference between a "direct" bond and a fund is that you control the duration with the former and, if held until maturity, you know exactly what your return will be.

With the latter, say it is a fund that holds 10-12 year bonds. Next week it will sell some and replace them as the duration will have gone outside their remit. The price they will sell for is dependent on the market so anybody's guess really.

While this does seem to be the most straightforward approach, the multi-asset funds that I am aware of are OEICs and these are expensive with HL. I have moved everything into ETFs and a few individual ITs and shares in recent years. Of course, I don't need to stay with HL in the long term, but it's where my work pension is and my wife has her own account, so I would probably prefer to stay for the time being at least. 

The other thing is that I did see someone recommend keeping bonds and equities separate so that you retain the flexibility to sell in different proportions.

What you say about funds vs individual gilts pretty much sums up the issue I have in that you lose the predictability you get from holding to maturity. Funds will end up selling at fixed times without any consideration of the price at that time.

BobR64

DT2001 said:

I am about 85% in equities and the rest is in ultra short bond ETF. It is, as my latest thread proves, too risky for some as like you I need a very low drawdown.

When researching I looked at twoetfs.com ‘The two ETF portfolio: simple is often best’ article and YouTube videos by James Shack and Ben Felix. Bonds soften the decline but depending on your specific income requirements, IHT considerations and attitude to risk I would look at part annuitisation or part income portfolio to achieve the same end. A regular contributor, Linton, has a 3 pot system (cash pot, income/wealth preservation feeding into cash and growth fund) that I much admire (but my willingness to adopt a flexible expenditure has lead me to a simpler but much more volatile approach)

It sounds like we are in a reasonably similar position but maybe I am feeling slightly more cautious than you.

I have watched some of the James Shack videos and will seek out Ben Felix. The problem I often have when I watch these videos is that it all makes perfect sense at the time but then I watch something else or read someone saying something slightly different and I am paralysed into inaction.

Thank you for the "Two ETF" article suggestion. I see that that one actually does mention some concrete fund names, which is something that is often missing from the YouTube videos.

Regarding part annuitisation, this is something I have considered. I know that there are some people on this forum who strongly recommend annuities at the moment and that the rates are very good compared with what they had been until recently. However, even at these better rates, they still don't seem too attractive to me once I start to build in the things I would want such as some index linking and a second life.

I'd be interested to read more about Linton's system. Is there a particular post you (or Linton if you are reading this) could highlight? No worries if not, I'll have a hunt around. I suspect it will be too complicated for me anyway, but I would still like to learn about it.

Linton

BobR64 said:

DT2001 said:

I am about 85% in equities and the rest is in ultra short bond ETF. It is, as my latest thread proves, too risky for some as like you I need a very low drawdown.

When researching I looked at twoetfs.com ‘The two ETF portfolio: simple is often best’ article and YouTube videos by James Shack and Ben Felix. Bonds soften the decline but depending on your specific income requirements, IHT considerations and attitude to risk I would look at part annuitisation or part income portfolio to achieve the same end. A regular contributor, Linton, has a 3 pot system (cash pot, income/wealth preservation feeding into cash and growth fund) that I much admire (but my willingness to adopt a flexible expenditure has lead me to a simpler but much more volatile approach)

It sounds like we are in a reasonably similar position but maybe I am feeling slightly more cautious than you.

I have watched some of the James Shack videos and will seek out Ben Felix. The problem I often have when I watch these videos is that it all makes perfect sense at the time but then I watch something else or read someone saying something slightly different and I am paralysed into inaction.

Thank you for the "Two ETF" article suggestion. I see that that one actually does mention some concrete fund names, which is something that is often missing from the YouTube videos.

Regarding part annuitisation, this is something I have considered. I know that there are some people on this forum who strongly recommend annuities at the moment and that the rates are very good compared with what they had been until recently. However, even at these better rates, they still don't seem too attractive to me once I start to build in the things I would want such as some index linking and a second life.

I'd be interested to read more about Linton's system. Is there a particular post you (or Linton if you are reading this) could highlight? No worries if not, I'll have a hunt around. I suspect it will be too complicated for me anyway, but I would still like to learn about it.

The starting point of my investment approach is that the requirements of retirement financing are too complex to be satisfactorily met by a single portfolio. It is much easier to implement separate portfolios each focused on a particular subset of the requirements rather than have one portfolio that does everything.

My requirements are:
1) Sufficient steady income to provide a stable long term standard of living.  One should never be in the position of being forced to cut back on one's standard of living by short/medium term economic circumstances.
2) Inflation matching of all on-going income as required to maintain an acceptable standard of living,
3) Sufficient flexibility to make large one-off expenditures at short notice.
4) Minimal ongoing management.  No ongoing management decisions. Changes to one's portfolios should only be implemented for strategic reasons, and then only rarely.
5) One should be able to enjoy a good night's sleep without worrying about one's finances

These requirements lead to 3 separate and quite different portfolios
1) Near to cash.  All income is moved into this portfolio and all expenditure taken from it.  As one's long term income should not exceed one's long term expenditure this portfolio should naturally increase over time, being reduced only by significant one-off expenditures or by strategic transfer into the Growth portfolio.
2) Income. This portfolio generates income which is automatically paid into my current account which is regarded as part of the Near to Cash Portfolio.  The income includes both interest and dividends and is generated by a set of globally diversified investments.  The target yield is 6% of asset purchase price.   Diversified income is far more stable than asset prices.
3) Growth. The primary role of the Growth portfolio is to increase the size of  the income portfolio to provide inflation protection. It is 100% equity, configured to maximise diversification with respect to country, sector, style and company size. If appropriate it can be topped up with excess cash from the Near to Cash portfolio.  

An important aspect iof the 3 portfolio approach is that investments are never sold for short/medium term cash,  only to buy different investments.  Therefore one is not faced with the problem of selling equity when prices are low.