Bond Funds

Bimbly · 17 October 2018 at 8:20PM

At the end of this year, I plan to start putting some of my pension contributions into bond funds and I am after some thoughts about which to choose. Everything I've read explains what the different types of bonds are, but I've found nothing about the mix of different types of bond in a portfolio.

Here's my plan. I have DB pensions which I plan to take at age 65 and my full state pension will kick in at 67. I am putting extra contributions into a work-based DC pot which I aim to take from age 60 to 65. I'll take the 25%TF then deplete the pot quickly over five years as I also want to pay off my mortgage. These DC contributions were originally destined to overpay the mortgage and I also might want to move, so paying off the mortgage is important. I have 10-and-bit years until retirement.

I'm currently all in equities in trackers to reflect whole of market. Next step is to switch my investment to bonds by 10% each year until it's quite low risk. I will do this with my contributions rather than sell and buy what's already in the pot, until my planned asset mix can't be done with new contributions alone. Towards the end, I'll be sticking a lot in cash.

This means that next year I'll be putting 40% (ish) of my contributions into bonds in order to make up 10% of the total pot. My original thought was to put it into government bonds. Blackrock All Stocks UK gilt tracker gives me a mix of those (rather than separate govt bonds/ index linked funds).

But it's not exactly diverse, especially as my pot becomes 50/60/70% bonds. I've looked at bond trackers held in multi asset funds and they tend to have a big chunk of coporate bonds and overseas bonds. High grade corporate I'm fine with, but dubious about overseas because of currency risk (I don't have an option of a hedged to sterling fund). Then there's the question of how much in each.

I only have the option of investing in a "select" group of funds in my scheme. Some funds which allow me to diversify more also have higher charges, which doesn't seem sensible in what are supposed to be low risk/low reward funds. Percentage charges in brackets; there is no platform fee.

Blackrock UK All Stocks Gilt Index (0.21)
BL 5 year index linked gilts (0.21)
BL over 15 year UK gilts (0.21)
BL over 15 year corporate bond (0.21)
BL all stocks corporate bond (0.21)
BL overseas bond tracker index (0.21)
Invesco Perpetual Corporate bond (0.71)
Kames high yield bond (0.61)
L&G PMC pre-retirement (0.28) (a mix, currently 50% global corporate, 20% global govt, 30% uk gilts)

* In addition, there are some multi asset funds like BL Consensus & Bailie Gifford Managed (0.51) that I could have gone for instead and added extra bonds as time went on. I sometimes think I should have done that. (I'm also offered a lot of funds like My Future Drawdown which just mixes the BL trackers).

My aim is to get to a pot of £200k with contributions plus growth. For this I would need an average return of 4% p.a. after charges (in monetary terms, as mortgage is big chunk of the pot and not affected by inflation... my contributions will increase a bit with inflation, which should help with the living expenses bit of the pot). I'd be more comfortable with a return of 7% but I think this is unrealistic as my equity allocation reduces (although I could get lucky). I suspect if I want more money in the pot it would be better for me to save more rather than increase risk. Having said that, if I get a return of 0% after charges (monetary terms again) I won't be any worse off than if I had just overpaid the mortgage (although I wouldn't have enough to retire at 60

)

So anyway, thoughts on bond funds. I suppose I'm looking for my bond allocation to be kinda low risk with a chance of some return. Maybe I should just be satisfied with keeping up with inflation and hope my equities do the growth bit? I know bonds have had a good run in recent years (quantative easing... yada) and I shouldn't necessarily expect this to continue.

Bimbly · 18 October 2018 at 7:20PM

I know this was a long post, but short posts are often met with requests for more info. So I tried to give a full picture up front.

Has no one had to make a decision over which bonds to have in their pension portfolio?

I have some ideas of my own, but thought I would also canvas opinions from others.

kidmugsy · 18 October 2018 at 8:07PM

I wouldn't use IL Gilts. Because UK DB pension schemes are pretty much instructed to buy them, the yields are poor: negative versus RPI inflation. So I'd look at either the US equivalent - TIPS - or an international IL portfolio (which will doubtless be at least half TIPS).

I have a memory that L&G do a fund or ETF of them. But if that sort of thing isn't offered at your DC pension ....

Come to think of it, how can we help unless you give us some idea of what choice of relevant funds is offered? Is that little list you've given us the whole choice of bond funds? Is there anything else that might be relevant e.g. property funds?

Secondly, what is the actuarial reduction on your DB pensions; is there a case for taking one or more early?

Thrugelmir · 18 October 2018 at 10:42PM

Bonds are going to be impacted by rising interest rates. Possibly not as safe as you imagine.

PS. The narrowing of bond yields started years ago. QE simply accelerated the trend. Bonds and equities are currently highly correlated.

kidmugsy · 18 October 2018 at 11:36PM

OP, it might be worth reading John Kay on the subject of investing in bonds. Unless he's changed his mind recently, he thinks it's mad.

Alexland · 19 October 2018 at 12:18AM

Fidelity today published an interesting interview with well respected M&G bond fund manager Richard Woolnough on the current state of the fixed income markets around the world.

https://m.youtube.com/watch?v=OKC2kH6lQXI

Alex

Bimbly · 20 October 2018 at 11:01AM

kidmugsy wrote: »

Come to think of it, how can we help unless you give us some idea of what choice of relevant funds is offered? Is that little list you've given us the whole choice of bond funds? Is there anything else that might be relevant e.g property funds.

Secondly, what is the actuarial reduction on your DB pensions; ?

I did give you an idea of what relevant funds are available. I went through them all and listed them above. These are the only bond-only funds.

Property funds are M&G Feeder of Property (0.93) and Legal & General PMC Global Real Estate Equity Index (0.62). I am not comfortable committing more than, say, 5% in this area as a diversifier as they are expensive and I have a feeling in my water that property is over valued.

Other funds on offer are multi asset (or just equity) as mentioned above.

Thrugelmir wrote: »

Bonds are going to be impacted by rising interest rates. Possibly not as safe as you imagine.

PS. The narrowing of bond yields started years ago. QE simply accelerated the trend. Bonds and equities are currently highly correlated.

Yeah, I read a lot about how bonds might not be such a great idea at the moment (covered in my "yada" comment), but what's the alternative? I could use cash, but I'm looking at a return of about 0.3% after charges so my money will eroded by inflation.

I figured I should ignore the noise and follow a derisking bond strategy as per the traditional wisdom, as my investment will be drip feeding over ten years and economic conditions will change over that time. Perhaps half government and half corporate, maybe with 10% overseas. But that's more hedging my bets than any reasoning behind it. Hence my post.

ADDING: acturial reduction of DB pension not attractive at 6% per year.

Thrugelmir · 20 October 2018 at 12:00PM

Bimbly wrote: »

Yeah, I read a lot about how bonds might not be such a great idea at the moment (covered in my "yada" comment), but what's the alternative? I could use cash, but I'm looking at a return of about 0.3% after charges so my money will eroded by inflation.

Been a discussion point for some considerable time. As QE and other monetary policies have resulted in a close correlation between virtually all asset classes. As investors chased yield.

While inflation is going to erode the value of money. The greater dangers may lie elsewhere. As a rule of thumb every 1% rise in interest rates is going to reduce capital value of bonds by 10%.

Bimbly · 21 October 2018 at 7:58PM

And yet people still invest in bonds in their pensions.

People who put their money, say in a VLS 80 will have 20% in bonds.

I have read a lot about bond funds, but nothing goes beyond explaining what they are. I can tell you that Monevator only likes government bonds. I know that a Vanguard multi asset fund is rather keen on overseas bonds. Others are similar, some favour more corporate bonds. I have read advice that investing in overseas bonds should be hedged back to sterling (I don't have that option). I know that my pension's low risk mixed asset funds (eg, My Future Cash Out or whatever it's called) are either 50/50 corporate/govt bond trackers or one third each cash/govt/corp.

I have tried reading a few books in this area, but they stop at suggesting strategies that are x% stocks and x% bonds. They don't discuss which bonds to include in that x%, they merely explain what the different bonds are.

As my pension contributions are via salary sacrifice, everytime I sacrifice £68 of take home pay, I get £100 in my pension. No savings account could match that, even when taking into account taxed income on withdrawl (25% is tax free then 5 x £12000 personal allowance (ish) and no NI). Putting all contributions into shares for the next 10 years would be a bit risky. Hence my question about what bond funds to use.

Is this wrong? Is there something I'm not understanding?

MK62 · 22 October 2018 at 11:19AM

To get some idea, you could have a look at some of the multi-asset passive fund series around.....Vanguard Lifestrategy, LG Multi-index, Blackrock Concensus, HSBC Global Strategy etc.

Within each series there are a range of equity/bond allocation splits.......you can compare the risk ratings and chart the historic returns through good and bad periods to see the different effects of the allocations (don't just concentrate on the last few years though, as the funds with the higher equity splits will show higher returns as equities have had a good run over that time).

HSBC's Global Strategy series, for instance, is a series of risk profiled funds....here
https://www.assetmanagement.hsbc.co.uk/en/intermediary/investment-expertise/multi-asset/hsbc-global-strategy-portfolios

They also do an asset allocation brochure here.....
https://www.assetmanagement.hsbc.co.uk/-/media/files/attachments/uk/new-pdfs-14-12/hsbc-global-strategy-portfolio-asset-allocation-brochure.pdf
which details each fund's asset split, it's risk profile and it's target volatility range.
It should give you a broad idea of what's going on......

As to which specific bonds to include, that's best left to the fund manager tbh.

There's a high level overview of bond ratings here though
https://en.wikipedia.org/wiki/Bond_credit_rating
which will give you an idea of what the various bond ratings are and what they mean. Bear in mind though that the lower the risk, the lower the return, so while it might initially sound good to pick a bond fund which invests mainly in AAA rated bonds, that might not meet your return goals......in the end it's always going to be a trade off between your goals and the risk level you are prepared to take to achieve them (within your investment timeframe).

Then have a look at some of the popular bond funds to see what split they are using compared to their risk, and you'll soon build up a picture.....many of the factsheets the fund providers use will have a credit rating breakdown of the fund in question

Here's an example of a Corporate Bond fund
https://investorhub.financialexpress.net/documents/royallondon/en-gb/GWUM/FS
(that's not a recommendation btw, just an example)

Here's one for a global government bond fund
https://investorhub.financialexpress.net/documents/royallondon/en-gb/0GDQ/FS

There are also the high yield bond funds, which tend to specialise in sub-investment grade bonds (hence the high yield)......and the strategic bond funds which can alter their allocation between bond types at the manager's discretion, depending on the state of the world etc

Bond Funds

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