Your browser isn't supported
It looks like you're using an old web browser. To get the most out of the site and to ensure guides display correctly, we suggest upgrading your browser now. Download the latest:

Welcome to the MSE Forums

We're home to a fantastic community of MoneySavers but anyone can post. Please exercise caution & report spam, illegal, offensive or libellous posts/messages: click "report" or email forumteam@. Skimlinks & other affiliated links are turned on

Search
  • FIRST POST
    • chucknorris
    • By chucknorris 5th Nov 19, 5:04 PM
    • 10,244Posts
    • 15,137Thanks
    chucknorris
    Bond funds
    • #1
    • 5th Nov 19, 5:04 PM
    Bond funds 5th Nov 19 at 5:04 PM
    I would like to test my logic (or lack of it) with regard to bond funds. I understand of course that bond funds prices will suffer if (when) interest rates start creeping back up eventually. But the bond fund that I am interested in:

    https://www.ishares.com/uk/individual/en/products/253488/ishares-global-high-yield-corp-bond-gbp-hedged-ucits-etf?switchLocale=y&siteEntryPassthrough=true

    has a weighted average to maturity of bonds of only 3.51 years. Is it reasonable to assume as the years roll on and the bond fund invests in new corporate bonds which reflect the newer rates of interest environment, that the bond fund will start to recover from an interest rate rise correction? Obviously I appreciate that rising interest rates might end up being an ongoing situation, and the fund might end up playing catch up for some time.
    Last edited by chucknorris; 05-11-2019 at 5:15 PM. Reason: Link didn't work
    Chuck Norris can kill two stones with one bird
    The only time Chuck Norris was wrong was when he thought he had made a mistake
    Chuck Norris puts the "laughter" in "manslaughter".
    I've started running again, after several injuries had forced me to stop
Page 1
    • went galumphing back
    • By went galumphing back 5th Nov 19, 6:24 PM
    • 1 Posts
    • 3 Thanks
    went galumphing back
    • #2
    • 5th Nov 19, 6:24 PM
    • #2
    • 5th Nov 19, 6:24 PM
    I think you're about there. It's a bit like putting your money in a fixed-rate account for 3.5 years (on average some of it is fixed for shorter times, some for longer). When the fixed rate period ends, the fund will reinvest it in whatever fixed rates are then available.

    And just like a fixed-rate account with a bank or building society, if prevailing interest rates rise while you're locked into a fixed rate, you may be kicking yourself. But that doesn't mean you actually lose money: hold on till the fixed rate ends, and you'll get back exactly what you originally expected (unless the bond issuers default a real risk with high-yield bonds, unlike with FSCS-protected or NS&I accounts). But because you're locked in, you won't get the higher rates which became available later on: it's an opportunity cost. With a fixed-rate bank account, you don't see this as a capital loss, because there is no market where you can sell your fixed-rate account part way through the term. With corporate bonds, or funds investing in them, there is, so you do.

    However, note that part of the yield (of 5.1%) on this fund is effectively eating your own capital. The YTM of the fund is 4.1% that is the projected return on the bonds it holds, allowing for the fixed interest they pay and the capital loss at maturity (because they are currently, on average, trading at above their maturity value). Deduct the fund's OCF of 0.55%, offset by securities lending return of 0.05%, from the YTM, and you have a projected return of 3.6%. Which suggests that c. 1.5% of the yield you're apparently getting is really depleting your own capital.

    Those figures do not allow for changes in interest rates, losses from defaults, gains from bonds being upgraded to investment-grade, etc. So actual returns will probably be completely different. It's just something to start from.

    As a comparison, iShares Corp Bond 0-5 Years ETF (IS15) is an investment-grade bond fund (though sterling-only, not global) which has a similar average maturity (2.7 years), and a projected return, calculated the same way, of 1.6% (YTM) minus 0.2% (OCF) = 1.4%. So you're getting c. 2.2% extra for taking the risks of high-yield bonds.

    Is that enough for the extra risks? I'm more inclined to stick to investment-grade corporate bond funds, but try to boost returns by adding a few individual bonds that yield a bit more (but not too much more!). E.g. there were some useful issues from housing associations (some of them under the Retail Charity Bonds label), but there haven't been any new issues for a while, and the old ones are trading well above face value.
    • Linton
    • By Linton 5th Nov 19, 6:31 PM
    • 11,533 Posts
    • 11,946 Thanks
    Linton
    • #3
    • 5th Nov 19, 6:31 PM
    • #3
    • 5th Nov 19, 6:31 PM
    ..... Is it reasonable to assume as the years roll on and the bond fund invests in new corporate bonds which reflect the newer rates of interest environment, that the bond fund will start to recover from an interest rate rise correction? Obviously I appreciate that rising interest rates might end up being an ongoing situation, and the fund might end up playing catch up for some time.
    Originally posted by chucknorris

    In my understanding...

    If interest rates remain constant new bonds replacing old bonds should have little effect on bond fund pricing. Using calculated figures but a simplistic approach*** to demonstrate a principle, if interest rates were at 1%, a 100 5% old bond maturing in 10 years time could be worth 136 now as that gives a 10% total return (100+5X10= 150 =approx 1.1x136) over 10 years. This is what would be provided by a new 10-year bond priced at 100 but only returning 1%. In both cases if you bought 10000 worth of bonds now you would get ethe same benefit. Yes you would get more new bonds for your money, but they would only provide the same return as the smaller number of old bonds. So new bonds being issued makes no difference.



    Prices would only change significantly if interest rates changed. If rates rose to 5% then all the old bonds held in the fund would be worth less as their effective, in this case, 1% annual return would make then less valuable than new 100 bonds paying 5%.


    *** this example of pricing is too simplistic in practice, because the higher rate old bond would provide more of its return earlier in the form of interest compared with the new bond returning the full cost price at maturity. Money paid out sooner is worth more than money paid out later.
    • chucknorris
    • By chucknorris 6th Nov 19, 5:56 AM
    • 10,244 Posts
    • 15,137 Thanks
    chucknorris
    • #4
    • 6th Nov 19, 5:56 AM
    • #4
    • 6th Nov 19, 5:56 AM
    However, note that part of the yield (of 5.1%) on this fund is effectively eating your own capital. The YTM of the fund is 4.1% — that is the projected return on the bonds it holds, allowing for the fixed interest they pay and the capital loss at maturity (because they are currently, on average, trading at above their maturity value). Deduct the fund's OCF of 0.55%, offset by securities lending return of 0.05%, from the YTM, and you have a projected return of 3.6%. Which suggests that c. 1.5% of the yield you're apparently getting is really depleting your own capital.
    Originally posted by went galumphing back
    Thanks that was very helpful, although I realised that with individual bonds, I had overlooked the above with (this) bond fund. Now that you have stated it, I can see that I missed something quite obvious, I had incorrectly assumed that the bond fund had been acquiring bonds newly issued, rather than picking up existing bonds above the 1 issue cost.

    I'm going to have a bit of a rethink about bonds, although that projected return of 3.6% doesn't actually lose money after tax and inflation it only gives me a return of about 0.5%, and as you say that could be reduced by the risks of defaults and interest rate rises. It might not put me off entirely but it isn't as good as I thought that it was.

    My situation is that I have sold and I'm currently still trying to sell another investment property (lifestyle not financial choice) and I have to find somewhere to invest the equity. I already have a significant investment in equities and I was hoping to find a reasonable return and have some portfolio diversity with bonds. This may result in me taking that unsold property off the market, it hasn't exactly flown off the shelf in the first month of marketing. I dropped the price last week and have had quite a few bookings booked, so I will be in a better position to assess the situation by next week. But the return from the equity is actually earning 7.3%! So I may just have to decide that although I would like to sell, now is not the time to sell.
    Last edited by chucknorris; 06-11-2019 at 6:07 AM.
    Chuck Norris can kill two stones with one bird
    The only time Chuck Norris was wrong was when he thought he had made a mistake
    Chuck Norris puts the "laughter" in "manslaughter".
    I've started running again, after several injuries had forced me to stop
    • masonic
    • By masonic 6th Nov 19, 6:39 AM
    • 12,633 Posts
    • 10,134 Thanks
    masonic
    • #5
    • 6th Nov 19, 6:39 AM
    • #5
    • 6th Nov 19, 6:39 AM
    I had incorrectly assumed that the bond fund had been acquiring bonds newly issued, rather than picking up existing bonds above the 1 issue cost.
    Originally posted by chucknorris
    This may not be an incorrect assumption. An ETF is going to acquire bonds soon after issue and it is likely the coupon would have been set at an appropriate level for the economic situation at that time. The underlying bonds can give rise to capital gains while they are being held by the ETF and when you buy the ETF you are buying all of the underlying assets at their current valuation. If you hold the fund long enough, these effects become insignificant.
    • chucknorris
    • By chucknorris 6th Nov 19, 7:11 AM
    • 10,244 Posts
    • 15,137 Thanks
    chucknorris
    • #6
    • 6th Nov 19, 7:11 AM
    • #6
    • 6th Nov 19, 7:11 AM
    This may not be an incorrect assumption. An ETF is going to acquire bonds soon after issue and it is likely the coupon would have been set at an appropriate level for the economic situation at that time. The underlying bonds can give rise to capital gains while they are being held by the ETF and when you buy the ETF you are buying all of the underlying assets at their current valuation. If you hold the fund long enough, these effects become insignificant.
    Originally posted by masonic
    Ahh yes, thanks for that, I (think I get) what you are saying, that if I stay invested for long enough, I will be eventually be investing in bonds at 1. Whereas on my initial investment I have invested (on average) above 1. I am actually intending to invest for the long term, so the outlook looks rosier than I thought above.

    Presumably this is why the bond fund price has been rising as time passes (because the bond's values have risen above the 1 initial price). So does this mean if you stay invested in the fund long enough, the 5.1% yield is approximately achievable? Because although the bonds fall in value on maturity, if you were invested long enough they only fall back to the 1 that you originally invested in.

    What I am unsure about now is whether the OCF charge of 0.55% is already taken into account in the 5.1% yield. Initially I thought not, and others have seemed to confirm this. But when you express the yield as dividends paid divided by the price of the fund, it seems that the 5.1% yield is after the OCF of 0.55% has been deducted. Am I missing something there too??
    Chuck Norris can kill two stones with one bird
    The only time Chuck Norris was wrong was when he thought he had made a mistake
    Chuck Norris puts the "laughter" in "manslaughter".
    I've started running again, after several injuries had forced me to stop
    • EdGasketTheSecond
    • By EdGasketTheSecond 6th Nov 19, 8:31 AM
    • 1,418 Posts
    • 741 Thanks
    EdGasketTheSecond
    • #7
    • 6th Nov 19, 8:31 AM
    • #7
    • 6th Nov 19, 8:31 AM
    This may not be an incorrect assumption. An ETF is going to acquire bonds soon after issue and it is likely the coupon would have been set at an appropriate level for the economic situation at that time. The underlying bonds can give rise to capital gains while they are being held by the ETF and when you buy the ETF you are buying all of the underlying assets at their current valuation. If you hold the fund long enough, these effects become insignificant.
    Originally posted by masonic

    But that can't be true for a short-dated bond fund; they can only buy more short-dated bonds in the market because bonds are not normally issued with a short lifespan.
    • chucknorris
    • By chucknorris 6th Nov 19, 4:29 PM
    • 10,244 Posts
    • 15,137 Thanks
    chucknorris
    • #8
    • 6th Nov 19, 4:29 PM
    • #8
    • 6th Nov 19, 4:29 PM
    But that can't be true for a short-dated bond fund; they can only buy more short-dated bonds in the market because bonds are not normally issued with a short lifespan.
    Originally posted by EdGasketTheSecond
    I'm not sure what you are saying Ed, are you saying that the ethos of this etf is to buy short dated bonds? I thought that it was simply to try and follow the index, or are you saying that is the aim of the index, is to buy short dated bonds?

    Or were you simply making a general point that wasn't necessarily applicable to GYHS?
    Last edited by chucknorris; 06-11-2019 at 4:32 PM.
    Chuck Norris can kill two stones with one bird
    The only time Chuck Norris was wrong was when he thought he had made a mistake
    Chuck Norris puts the "laughter" in "manslaughter".
    I've started running again, after several injuries had forced me to stop
    • masonic
    • By masonic 6th Nov 19, 5:45 PM
    • 12,633 Posts
    • 10,134 Thanks
    masonic
    • #9
    • 6th Nov 19, 5:45 PM
    • #9
    • 6th Nov 19, 5:45 PM
    But that can't be true for a short-dated bond fund; they can only buy more short-dated bonds in the market because bonds are not normally issued with a short lifespan.
    Originally posted by EdGasketTheSecond
    You're correct about short dated bond funds and bond funds with a target duration. They must buy when the bond is some arbitrary date from maturity and/or sell when it is at another arbitrary date from maturity. The fund mentioned in the OP is not such a fund (and I wouldn't advocate investing in a fund of that type).
    • masonic
    • By masonic 6th Nov 19, 6:02 PM
    • 12,633 Posts
    • 10,134 Thanks
    masonic
    Presumably this is why the bond fund price has been rising as time passes (because the bond's values have risen above the 1 initial price). So does this mean if you stay invested in the fund long enough, the 5.1% yield is approximately achievable? Because although the bonds fall in value on maturity, if you were invested long enough they only fall back to the 1 that you originally invested in.
    Originally posted by chucknorris
    Essentially at the start and end of its life, the bond has a fixed yield and is valued at par. While it's trading on the secondary market its capital value fluctuates, tending back to par as it approaches maturity. If you are invested throughout, you'll be benefiting from capital gains that offset the reduction in running yield and vice versa. It's only at the start of your investment, where you are buying the current basket of bonds at their present valuation, that you suffer the reduction in yield without benefiting from the capital gain. Of course the yield of the bond fund can fluctuate over time, so the historic yield only gives you a rough guide to what you might expect in the future and is best viewed relative to other similar funds.

    What I am unsure about now is whether the OCF charge of 0.55% is already taken into account in the 5.1% yield. Initially I thought not, and others have seemed to confirm this. But when you express the yield as dividends paid divided by the price of the fund, it seems that the 5.1% yield is after the OCF of 0.55% has been deducted. Am I missing something there too??
    It's more common for fees to be deducted from capital rather than income (sometimes it is a combination of both). This information can usually be found in the fund prospectus.
    • cup and lip
    • By cup and lip 6th Nov 19, 6:09 PM
    • 1 Posts
    • 2 Thanks
    cup and lip
    Whether you buy bonds at face value or above isn't crucial for what return you can expect (before tax though it does affect tax due), it's all about the YTM. When buying a bond fund, that means, initially, the average YTM of the bonds it currently holds; and later on, the YTMs (at the point it buys them) of the bonds it buys to replace maturing bonds.

    Now, if the YTMs of the current portfolio average 3.6% (that figure was calculated after allowing for the fund's charges), what should we expect the YTM of bonds bought at the moment, to replace maturing bonds, to be? Probably, a bit more than 3.6%, because the fund will typically be buying a relatively long-term bond (as the bonds held by this fund go), and longer bonds generally yield more than shorter bonds. I'm not sure how much more. (But there's no specific reason why it should be 5.1%.)

    GHYS happens to hold fairly short-term bonds, not because its benchmark index is restricted to short-term bonds, but because it holds high-yield bonds, and these are typically shorter-term than investment-grade, because people are reluctant to give longer-term loans to higher-risk borrowers.

    One way to push for more return is to go for high-yield bonds taking on more credit risk. Another way is to go for longer-term bonds taking on more duration risk (i.e. the risk of interest rates rising). Since you're keen to push for more return from your bonds, perhaps you should consider doing a bit of both, to diversify the risks you're taking? E.g. combine GHYS (high-yield, but pretty short-term bonds) with something holding longer-term bonds but with less credit risk (i.e. investment-grade corporates or even gilts).
    • EdGasketTheSecond
    • By EdGasketTheSecond 6th Nov 19, 6:17 PM
    • 1,418 Posts
    • 741 Thanks
    EdGasketTheSecond
    I'm not sure what you are saying Ed,
    Originally posted by chucknorris

    In your original post you said:


    "has a weighted average to maturity of bonds of only 3.51 years."


    so I assumed you were going for short-dated bonds which would mitigate the capital loss should interest rates rise.
Welcome to our new Forum!

Our aim is to save you money quickly and easily. We hope you like it!

Forum Team Contact us

Live Stats

166Posts Today

1,825Users online

Martin's Twitter