what is the point of bonds?

luckylizard

hi everyone, i'm a newbie so please don't bite. i have been building a diversified portfolio of funds/shares/cash over the past year and keep reading that I should have a proportion of it in corporate bonds and gilts. but looking at their rates of return, and given the fact that corporate bonds carry risk, I can't see their advantage over simple cash savings (i've got fixes at 6.5% plus and I'm a non tax-payer).

is there some advantage to holding bonds/gilts that I'm missing?

Aegis

Gilts and bonds can be traded for amounts that differ from the face value, and during market downturns they tend to become more sought-after as safe places for money without withdrawing from the investment side of things altogether. As such, during times when the rest of your portfolio devalues, you will often see a marked increase in the value of your bonds/gilts.

To be honest, I don't have much of a holding of these either. My entire exposure to bonds is through my investment in Jupiter's High Income fund.

dunstonh

If you look at the recent performance of fixed interest funds you could be forgiven for asking that question. However, as any experienced investor knows, short term performance either up or down occurs for a reason.

The poor performance, keeping it very basic and simple, was that it wasnt the right time in the cycle of fixed interest funds to be too heavy in them. There is a very rough cycle to fixed interest funds and then they are influenced by interest rates which can impact on that cycle.

Being a cycle, where shall i start.... Ok, lets take a fund that has a yield currently of 8.52% That is quite atrractive currently and people are likely to buy it. Unit price is likely to rise. As the unit price rises, the running yield will drop. Over time the yield drops to a level that it is no longer attractive and can be beaten by cash. So people start to sell up. The unit price then starts to fall and the yield starts to increase again. Over time the yield will increase until it appears attractive and then we are back at the start of the cycle.

Now you have influences on that. Such as interest rates. a 5% yield isnt attractive if cash can give you 6%. However it is if cash can only give you 3%. You also have outside influence of the other asset classes, such as property and stockmarket. It stockmarket sentiment is not great, then money may move to fixed interest, property or cash. You also have the type of bond and sentiment towards that.

Its similar to the reason that property funds have gone down so much recently. If you look at property fund performance upto June last year you had 16 years of near continuous double digit returns. The problem was that the rental yields were getting lower and lower and now that the potential for growth on the property value no longer appeared to exist, the money left the funds.

I personally think that now could be a very good time to be investing in fixed interest funds. The unit prices have been dropping to a level that has allowed the yield to pick up and you can get 8.5% on some funds now. Interest rates are going down which will make cash look less attractive.

If you look at past performance, then you have to look at why something didnt do well. Equally, you need to look at the top peformers and realise that you may have missed the boat. Indeed, a very good strategy is often to look at the bottom performers and some of my best investments have come from investing in the areas that have gone down the most and now look like value.

I think fixed interest funds look like good value at this time.

luckylizard

thanks for those replies, very informative. i'll give some serious consideration to adding some bonds to my portfolio. the fund i keep seeing recommended is Artemis Strategic Bond so maybe i'll go with that.

EdInvestor

luckylizard wrote: »

is there some advantage to holding bonds/gilts that I'm missing?

The key difference is that with cash the capital is fixed but the interest income fluctuates, while with bonds the interest income is fixed but the capital value fluctuates.

So which one you choose depends on whether you want certainty of capital or of income.

Debt_Free_Chick

Traditionally, bonds were used where you needed a specific amount of income e.g. in retirement, you need £xxx to fund your bills. You would invest £yyy in order to provide the income you needed.

Capital growth tended to be "not an issue". It was the income that was important.

Pension schemes still use bonds for this purpose, as they need to be sure they can pay out all the pensions due to be paid in the next 1, 5, 10 or whatever years.