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Weekend reading: Finally time for the big bond blow-up?

Weekend reading

Good reads from around the Web.

I first feared signs of a UK and US government bond bubble back in December 2008, writing:

With these crazy yields on government debt it’s getting too expensive to be a bear.

I believe the West can avoid deflation, and so I’m buying cheap equities, not expensive government debt.

At the time UK 10-year gilt yields had recently fallen below 3%, and short-term US treasury yields had briefly turned negative, which meant investors in them were effectively paying the government to hold their money.

I saw this pile into bonds as a sign of the extreme gloom and panic in the market, and worried that it would unwind with costly consequences. Equities looked much more attractive.

A good call? Not exactly.

As regularly readers will know, I have no problem admitting my own mistakes. But this was a case of half-right, but at least half wrong.

Equities have indeed done very well since December 2008. If you’d put your money into a UK FTSE 100 tracker and reinvested dividends at the time of my post, you’d now be more than 60% up.

I was right, too, that investors were clearly ultra-fearful (which was exactly why we had a great opportunity to profit from the stock market).

But there’s no denying I was wrong about those low bond yields being unsustainable. Money has kept piling into bonds of all shapes and durations for the past five years. The initial bond mania turned into a mass exodus from equities, driving yields ever lower.

As this graph from the Fixed Income Investor site shows, UK government bond yields approached 1.5% in late 2012.

What a downer….

It’s a small consolation that nobody reading this in the UK has never known such tiny long bond yields, and virtually nobody would have thought them even possible a decade ago.

Just another reminder of how hard it is to fathom the markets.

That was then, this is now

As we start 2013, there’s a lot of renewed chatter – and even fear – that this great bond bubble could finally be about to burst.

A sharp move up in yields last week in the wake of the US fiscal cliff resolution is being seen as a catalyst for this long-awaited unwinding.

There’s good reason to expect yields to rise, and hence bond prices fall. Ten-year gilt yields of less than 2 to 3% make little sense in an environment where inflation is running ahead of that. Unless we go into another big recession or even a depression – and hence see deflation – then sooner or later people will get fed up with the value of their bond holdings being eroded in real terms.

As a consequence, The New York Times is one of many outlets reporting that the bond craze could run its course this year:

“Mathematically, it’s next to impossible to get the kind of returns on bonds you’ve seen over the last few years,” said Kate Moore, the chief global equity strategist at Bank of America.

When the turn does ultimately come, it is likely to cause pain for at least some of the people who have been investing in bonds in recent years.

“You don’t want to be the last one out the door when the trends turn,” said Rebecca H. Patterson, the chief investment strategist at Bessemer Trust. “All good things come to an end and we want to make sure we’re in front of it.”

An article on a blog called Mutual Fund Observer puts these fears more colourfully:

We’ve been listening to REM’s It’s the End of the World (as we know it) and thinking about copyrighting some useful terms for the year ahead.

You know that Bondpocalypse and Bondmageddon are both getting programmed into the pundits’ vocabulary.

[We also suggest] Bondtastrophe and Bondaster.

It’s this kind of fear that has prompted Telegraph writer Ian Cowie to take what he says is the biggest bet of his life:

Contrary to the conventional wisdom that people should raise their exposure to supposedly low-risk bonds and reduce shareholdings as they get older, I did the opposite and sold all the bonds in my company pension to buy shares.

Now that’s an ultra-risky move, and not one that many advisers would recommend.

I don’t own any government bonds, but I’ve got 25-30 years ahead of me (touch wood!) before I’ll likely be required to live on my savings.

I could ride out another savage bear market. Could Mr Cowie?

How to deal with the bond bubble

That said, I do feel for you if you’re in your later years and you’re trying to decide what to do in the face of these extreme markets.

Anyone retiring since the mid-noughties has already had to decide whether to turn their pension pot into an incredibly low-yielding lifetime annuity.

Now the next round of retirees face the possibility of their retirement pots being cut down to size, if and when those low yields finally reverse.

However it’s important to remember a few things.

  • Firstly, most long-term pension savers would have already benefited from the rise in bond prices over the past few years. You can’t really enjoy the proceeds of a bubble and then cry foul when it bursts.
  • Secondly, even this kind of seemingly extreme bond bubble is not the same as an equity bubble. We have looked before on Monevator at the consequences of a crash (see the links below). While you wouldn’t exactly order one for yourself and a double helping for the lady, it’s very hard for a bond crash to be as catastrophic for an individual as an equity slump.
  • Finally, most Monevator readers probably only have 5-40% in government bonds. A 20% holding in bonds falling by a quarter is still a 15% holding in bonds – and it would very likely come with a stronger rise in your equity holdings. Meanwhile your bonds are protecting you from bigger downside risks, like a 60% fall in the stock market.

What am I doing? Right now I prefer cash to bonds when it comes to cushioning my portfolio. But deciding between them is not a risk you have to take.

Remember cash and bonds are not the same thing.

Perhaps the biggest risk of the bond bubble bursting is a disorderly market that sees institutions and others scrambling for the door at once. Given that Central Banks have been mighty buyers of bonds due to QE, any sudden unwinding could get very messy.

But you and I don’t have any good way of knowing how likely that is, or even what we should do about it.

Staying diversified, rebalancing as necessary, and not trying to be clever is likely to prove the best approach for most in the long-term.

More reading from Monevator on bonds and the potential burst:

Don’t panic, Mr Mainwaring!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The online lender Frodo is offering flexible short-term loans to those who’d otherwise use punitive bank overdrafts, says The Guardian. Remember that by far the best long-term solution is to restructure your finances so you never need to use debt.

Mainstream media money

Passive investing

  • Vanguard’s index changes prove no big deal – Index Universe
  • Another poor showing for active funds – Swedroe/CBS
  • No wonder ever more US investors are turning passive – WSJ

Active investing

  • Few new commodity ETFs in 2012. A contrarian signal? – Barrons

Other stuff worth reading

  • Only fools claim to know the future – FT
  • Inflation impossible to measure in a service economy – Slate
  • Let diversification do its job – New York Times
  • Women are better retirement planners – Wall Street Journal
  • How to think about risk in financial planning – Swedroe/CBS
  • HMRC publishes photos of top tax dodgers – Flickr and The Telegraph

Book of the week: Stock pickers might want to check out What’s Behind the Numbers?, a new book exposing the various ways in which companies try to fiddle their earnings. It comes highly commended by the excellent Clear Eyes Investing blog.

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{ 40 comments… add one and remember nothing here is personal advice }
  • 1 gadgetmind January 5, 2013, 5:08 pm

    I’m mostly holding corporate bonds (SLXX and ISXF) and these have softened slightly, particularly the latter as it hasn’t benefited from the falling yields of most financial bonds.

    I also use a couple of strategic bond funds, both of which only hold short duration sovereign bonds, and mainly linkers. One is even at negative duration (i.e. shorting) gilts and bunds while being long on “riskier” sovereigns.

    Alongside these, I’m directly holding some bank preference shares (LLPC and NWBD came good big time in the end!) and infrastructure funds such as HICL.

    I’m currently just watching and waiting, but I doubt my ISXF holding will survive my annual review come the next tax year.

  • 2 The Investor January 5, 2013, 5:35 pm

    @gadgetmind — Yes, NWBD and LLPC have done the business. 🙂 I’m carrying on holding the latter, as I don’t think it’s being priced much to do with interest rates yet. Indeed a world where the long rate went up to even say 4% again would probably be good for it I fancy, presuming it went along with a gathering economic recovery.

  • 3 gadgetmind January 5, 2013, 5:49 pm

    LLPC may turn out to be the gift that keeps on giving. This is because the prospectus says that if it ceases to count as regulatory capital then Lloyds have to move us to something just as good, but the new capital rules don’t allow this. The end result is that we keep holding LLPC but it becomes a mandatory coupon!

    Of course, they could tender, but I’d hold out as I don’t want the capital gains.

    I’m holding other financial capital via Invesco Perpetual Global Financial Capital. Yes, an open ended fund, and what’s more I bought at launch! Most unlike me, but I liked their plan and have greatly enjoyed the performance to date!

  • 4 Moneyman January 5, 2013, 6:16 pm

    A very pertinent post – but which private investor is holding government bonds?

    The 33% total return on my own portfolio – clearly a freak occurance – is partially fuelled by inflated values of high-yield corporate bonds. What to do, though, as these make up 50% of my portfolio! Sell and hold the cash until the ‘smart’ money runs back into high-yield equities (the other 50%)?

    The paradox for me, as an income investor, is that as the price falls, the yield rises. So I may just hold on and accept the loss (but with the continuing income that is better than what is available elsewhere). For new-ish investors in corporate bonds, though, it may be time to take a profit.

  • 5 gadgetmind January 5, 2013, 6:32 pm

    @Moneyman – Yes, these are strange times for fixed interest and it’s hard to know what’s best to do. I’ve gone for a dual strategy of over-weighting equities alongside a diverse income approach, but this isn’t for everyone

  • 6 The Investor January 5, 2013, 6:48 pm

    @Moneyman — I far prefer government bonds to corporate bonds, personally, I barely think of them as the same asset class. 🙂

    Plenty of model portfolios have a big weighting to government bonds, and very little to corporates.

    I have some posts in the archive about this (ironically because I was writing about how corporate bonds actually were attractive for once, due to the hugely inflated spread… Alas I’m replying to this on a Smartphone in a restaurant so can’t link to them! They’ll be easy to find with search though, if you’re curious).

    Obviously this doesn’t imply I like govvies now. I don’t like any bonds now, really, fwiw, which is not much. 🙂

    @gadgetmind — Interesting. Have to admit that aside from a small topslice around 110p I’ve pretty much gone to sleep on thinking about my LLPC. I have Lloyds ordinaries, too, which are providing all the drama (and potentially early news of trouble) now…

  • 7 Snowman January 6, 2013, 11:21 am

    I posted about gilts in November over on MSE. At the time you could take out a best buy 5 year fixed rate savings account then leave the maturity proceeds under a mattress for 5 years (i.e earning no interest) and still match the return on holding a 10 year benchmark gilt (that is assuming nobody steals your money from under the mattress).

    I considered then a passive portfolio made up of

    75% equity trackers and
    25% in the L and G All Stocks Gilt Index fund

    And assumed that funds are being held for the long term (i.e to maturity) as part of a fully passive strategy.

    Now about 60% of the gilt fund is invested in short or medium term gilts of 10 years outstanding term or less (and 40% in longer term gilts) because of the make up of that index.

    As mentioned those short and medium term gilts were as good as guaranteed in November to do worse than holding the same amount in savings accounts (it is not quite so crystal clear now over 10 years as you need to earn about 1%pa over the second and unknown 5 year savings account term to break even over a 10 year gilt held to maturity but the worst case downside to the savings route is pretty minimal)

    So I made the point (which was valid in November) you were guaranteed to do better by switching to a portfolio of

    75% equity trackers
    15% best buy savings accounts (0.6 x 25)
    10% long term gilts (of same average duration as the long term gilts in the original gilt fund)

    Of course if gilt yields increase and prices fall you may switch back the cash element into gilts.

    I’m not advocating holding long term gilts incidentally, just saying that holding 10% in long term gilts may be a better stategy for diversification than holding a 25% mix of gilts; an optimal strategy may or may not be to hold no gilts at all. I hold no gilts myself.

    While savings rates have come down since November and gilt yields risen slightly I think the argument above still holds.

  • 8 Passive Investor January 6, 2013, 2:04 pm

    Interesting comments. Ian Cowie’s column seemed a bit irresponsible to me. Even if the strategy of 100% equities is right for him (Almost certainly IMO it probably isn’t) it will definitely be bad advice for anyone approaching retirement and many others with different personal circumstances. Still, I have long believed that the investment parts of the broadsheet personal finance sections are really nothing more than sponsored adverts for the fund management industry. They give virtually no sensible advice about portfolio construction or costs and rely totally on ‘time the market’, ‘pick the star fund manager’ kind of tips.

    I’m in the moderate anti-bond corner. ie shorten duration where necessary, reduce bond proportion and hold more cash. Even in the current dire, for bond investors, macro-economic conditions the risk of taking a 50% hit on a 100% equity portfolio would make it difficult for me to sleep at night.

    This link from Canadian Couch Potato runs some figures on bond fund returns / duration in different scenarios. It is well worth reading in my view and gives a balanced view.

    http://canadiancouchpotato.com/wp-content/uploads/2012/07/Opportunity-Cost_Bortolotti.pdf

  • 9 Salis Grano January 6, 2013, 2:47 pm

    I hold no bonds, governmental or corporate, so I have missed out on the bubble (likewise for gold), but I am happy at the moment with 40% equities / 60% cash (the latter with an average return of 3.3%). It looks like the market has been irrational for some time with QE, but fortunately it has not affected my solvency.

    How CBs unwind their bond positions will determine what happens. I am just hoping vaguely that equities will rise over the next few years (perhaps to irrational levels) and that I can gradually sell down to keep my holding under 50%. Then, with bonds deflated, I can start buying in the 2020s, as I enter my twilight years. If, on the other hand, equities tank, then I release some cash. That’s the theory, anyway.

  • 10 Passive Investor January 6, 2013, 5:40 pm

    Hi @salis grano

    My strategy is pretty similar to yours. Although I am otherwise a passive investor like you I think the bond market is massively irrational at present.

    The main problem is that there are huge market participants who will buy bonds no matter what. First with QE, the Bank of England now own a huge proportion of the gilt market (is it 25% or is it more?) and secondly UK pension funds are forced to own gilts to cover their future liabilities. As yields fall the pension funds have to buy more gilts.
    These distortions are a matter of fact.

    A secondary problem (where there is more room for debate about it being a market distortion) is that investors are terrified of a tail risk in equities (eg a large fall due to Grexit or other macroeconomic shock). Because of the low yields in government bonds there has been a massive rush to corporate bonds.

    Once bond yields start to rise a little I will start moving more of my cash position into a mixture of Vanguard gilt fund / iShares short duration gilts.

    Interesting times……

  • 11 Salis Grano January 6, 2013, 7:07 pm

    @PI,

    Yes, good points. The legal constraint on Pension Funds has struck me as bizarre for some time now. Why, for example, should fund holders not selectively sell a small proportion of bonds in a rising market in order to maintain decent annuity rates? I can only assume it is a mix of regulation and convention.

    I should add that I aim to turn more passive in the next few years, also, by buying some ETFs, as and when I feel it is appropriate.

  • 12 The Investor January 6, 2013, 8:23 pm

    Good comments all. I’d just add that cash has several advantages for private investors/savers that aren’t available to institutions (such as far higher interest rates and deposit protection) that are worth remembering, too.

    (Nice to hear from you Salis! Will we see at least one blog update from you this year? 🙂 )

  • 13 gadgetmind January 7, 2013, 8:31 am

    The problem with cash is that it’s hard to hold efficiently within an ISA or SIPP, which makes rebalancing difficult for the former and close to impossible for the latter.

  • 14 The Investor January 7, 2013, 8:54 am

    @gadgetmind — Agree it’s tricky in an ISA (because you can’t go from a stocks and shares ISA back to cash) but why a SIPP? The impression I get is it’s easy to hold cash in a SIPP, albeit currently at rates lower than one would ideally like (but still over 2% for no-notice cash on deposit).

    I’ve never actually held cash in my SIPP though, so wondering if I’m missing something? (A quick Google suggests I’m not?)

    e.g. Close Brothers will pay you 3% on its cash-in-a-SIPP account with a two year term: http://www.closetreasury.co.uk/businesssavingsaccounts/sippdeposits/.

  • 15 gadgetmind January 7, 2013, 9:06 am

    Yes, you can hold cash in some SIPPs but most pay negative real interest. Short dated (less than 3-5 years) bonds are usually a cash-like option, but ISA rules mean you’d need to hold these via a fund and even within a SIPP getting any real return is tricky.

    I currently hold 6% cash in my SIPP and it’s earning zero. It’s ear-marked for buying some gilts when these are back to “normal” but it might be quite a wait!

  • 16 The Investor January 7, 2013, 9:55 am

    @Gadgetmind — I’m sure most SIPP providers like to rake in some profit with low interest on cash, but can’t you move the cash portion of your SIPP to a better account? Are SIIP cash deposit accounts much ‘stickier’ than ISAs/deposit accounts?

    (My SIPP is currently a very simple UK tracker with one SIPP provider affair, so I’ve a lot to learn here. 🙂 ).

    I appreciate there could be a hassle factor, of course.

  • 17 gadgetmind January 7, 2013, 11:19 am

    Were it that I was at the stage of life (and thinking) where I felt that I wanted to hold a lot of cash, then I’d hunt around for SIPPs that allowed this. However, as I’m not yet 50 (weeks away!) and intend to remain pretty much fully invested well into my dotage, I regard cash as an emergency buffer rather than a key asset class.

    As a result, most of our cash is held unwrapped in a combination of NS&I linkers and highish (3.6%) term accounts. The latter only works as my wife doesn’t, if you see what I mean!

    I guess someone could have equities in one SIPP and cash in another, but transferring between them is a hassle and partial transfers not always allowed.

    I did see one chap using short-dated gilts as his “cash” in a Harry Browne portfolio, and I’m guessing this was because of the difficulty of holding cash in a way that’s both tax efficient and gives a positive real return.

  • 18 The Investor January 7, 2013, 11:43 am

    Yes, in normal times you could expect to get at least 2-3% from 5-year gilts. Hopefully this fixed income yield squeeze issue will go away over the longer-term perspective.

  • 19 Mark Meldon January 9, 2013, 2:03 pm

    It is entirely possible to hold cash in a “proper” SIPP. By “proper”, I mean a SIPP provided by an administrator for a pounds and pence fee (should be around £500 per annum, inc VAT) with no conflict of interest about your buying, for example, funds with commission kick-back “loyalty bonuses”. There are a range of banks and building societies offering SIPP deposit accounts, such as the Leeds Building Society, to name but one example; it is true to say that the funding for lending scheme has meant a significant decrease in interest rates, although Shawbrook Bank will give you 2.40% for 1 year. Being inside a SIPP, there is no tax to pay.

    We often arrange cash deposit only SIPPs for the ultra-cautious or for those within, say, 5 years of retirement. In my experience, cash is deliberately misrepresented by the financial services industry, as it can ‘t flay you alive with extrotionate fees (unlike most funds).

    To take a simple example, the average personal pension plan, whether insured or a mutual fund based SIPP, charges on average 2% a year (Source: RSA report) to run. If you have an insured pension plan and you run for cash, you will lose money on a virtually guaranteed basis as life office cash funds are posting returns of something like 0.2% at present.

    So, £100,000 in an insured pension plan might attract “interest” of just £200 over the next 12 months. Take off the 2% charge, then you are left with £98,200 at the end of the year. That’s terrible, but there is a solution!

    After allowing for set up charges of about £1,000, and the annual fee of about £510, a “proper” SIPP, entirely invested in a cash account paying 2.40% looks rather better. £100,000 – £1,500 = £98,500. £98,500 x 2.40% = £100,864-ish at the end of the first year, an improvement over the insured scheme of £2,664.

    Things are even better in year 2. Assuming everything remains the same, the insured scheme might only be worth £96,432. The SIPP only has the £510 charge this time. So that will be worth about £103,284. You are better off with your own bespoke SIPP to the tune of about £6,852 – not to be sniffed at! And so on and so forth.

    You can’t do this with “Britain’s Biggest SIPP Provider” or the majority of other SIPP providers but, if you know where to look, there are boutique solutions out there.

    I am an IFA based in Somerset and the above is for information only and does not constitute advice, but it is quite interesting, I hope!

  • 20 gadgetmind January 9, 2013, 10:29 pm

    2% a year? I pay less than a quarter of that for both my GPP and SIPP.

    “Only” £510 per year? “Only”?

    A few people are getting rich off that pension but sadly it’s not the poor sod whose pension it is!

  • 21 Mark Meldon January 10, 2013, 9:44 am

    Hmmm.. According to the Royal Society for the Encouragement of Arts Report, the average pension arrangement (money purchase) can devour up to 40% of the fund in charges. According to a report written in 2011 for the Treasury written by Christopher Sier and David Norman, the average cost of a retail fund is 1.70% (in TER terms) and trading costs add another 1.40%, giving a total of 3.10% per annum. These, of course, are averages. I came across a bond fund a year or two ago where the effect of the PTR (portfolio turnover rate) gave an annual charge of a shade over 7%!

    Clearly, you can buy the SIPP wrapper on-line for “free”, but you then have to include the fund costs. Even with ETF’s you are looking at 0.20%-0.75% per annum. There are no free lunches.

    I don’t think a charge of £510 (inc VAT) is excessive for the administration of a SIPP. It’s only 0.51% on a £100,000 fund, reducing to a mere 0.17% on a £300,000 pot. If you only hold cash on deposit, that’s it, as the costs of cash on deposit (ignoring inflation just for the moment) are implicit, not explicit.

    Once you add in fund costs – the true costs – you are looking at around 1% a year for a “full-blown” SIPP that avoids commercial property; that’s no more than stakeholder pensions and, in my opinion, quite acceptable, especially if you receive top-notch administration and service.

    If you can tell me where, exactly, you can buy both a GPP and a SIPP for a true expense deduction of less than 0.50%, with all costs included, I’d love to know because I think that would be an exceptional bargain!

    I was merely trying to point out that it is entirely possible to hold “real” cash deposit accounts in an unfettered SIPP (by unfettered, I mean with true “whole of market” accesss to all qualifying investments, unlike the majority of so-called SIPP propositions before the public today) with the “wrapper” charges being explicit and in pounds and pence rather than in (invariably increasing) percentage fees. Right now, 1.80-2.00% is the best you can get for “immediate access” money; that’s a whole lot better than “zero” (again, ignoring inflation)!

  • 22 gadgetmind January 10, 2013, 10:14 am

    > If you can tell me where, exactly, you can buy both a GPP and a SIPP for a true expense deduction of less than 0.50%, with all costs included, I’d love to know because I think that would be an exceptional bargain!

    Group Personal Pension with Friends Life. All internal funds are 0.5%. I’m assured that with these funds the AMC is the same as the TER, and I know that even TER isn’t the whole picture but I mainly use Blackrock Class D trackers there anyway.

    My SIPP with BestInvest, £120 pa to access Vanguard trackers and whatever active satellite Investment Trusts and equities I want on the side. Total weighted TER according to my spreadsheet is currently a little over 0.4%.

    I know there are no free lunches, but I bought the financial services industry enough expensive lunches, gold watches, and Lamborghinis during the 80s and 90s to know that they need to be both kept at arms length and watched like hawks.

    I suspect that your idea of reasonable charges and mine (and I suspect that of most others here) differs so significantly that there is little chance of us meeting in the middle. Sorry.

    Thanks for the info regards cash in SIPPs, but I very much doubt it’s something I’ll ever do.

  • 23 Mark Meldon January 10, 2013, 11:08 am

    Thanks for having the courtesy to reply. It is true that the Friends Life/BlackRock GPP offering is broadly competitive for an insurance-company based arrangement. Mind you, I would not like to be a life office actuary today, as there are something like 2m low-cost endowments (and I have not sold those for 20 years) maturing this year – we are 25 years on from the “endowment boom” triggered by the disasterous “double MIRAS” withdrawal and nearly 30 from the deregulation of financial services (and look where that has got us), innumerable “guaranteed annuity rate” S226 pension policies “maturing” (many with frankly astonishing annuity rates), an increase in the number of death and critical illness insurance claims as the pioneering cohort of early adopters perish and/or get sick – where will all the money come from?

    The BestInvest SIPP is also great for those sophisticated enough (and I’m not trying to patronise anyone here!) to chose their own investments from the 2,000-odd available, as this is an execution-only offering like the HL Vantage one. It’s undeniably quite cheap, but it isn’t, in my humble opinion, a real SIPP; it’s more like whet the FSA calls a “packaged retail investment product”, but only sold on an “execution-only” basis, thus allowing the continuation of trail commission in the post-RDR world (so that’s where the “loyalty bonuses” come from; they give you back your own money!).

    With a real SIPP, you merely purchase the “wrapper”, normally from an independent actuarial/pension administration company. They charge what I think are modest fees to administer the SIPP, liaise with HMRC, act as professional trustee, etc, etc. Once the wrapper is bought, away you go! We quite often open dealing accounts with Stocktrade (the discount arm of Brewin Dolphin) and that’s quite a cost-effective arrangement, for those wanting to purchase “real assets” either through their choice or with advice for a fee.

    As an aside, why is it that most advisers, who continue to purport to be independent post-RDR, still wish to continue to charge clients percentages? I think, for what it is worth, an hourly rate is much fairer and offers transparency.

    However, in my experience (24-years) as an IFA, when you are, say, within 5 years or so of wanting to take your pension fund benefits, whether via draw down or (for the majority, still) by purchasing an annuity, staying in risk-based assets is a high-stakes gamble that has a significant probabilty of not paying off.

    That’s when you need to run for the “safe harbour” of cash deposits, despite the pernicious effect of inflation. I do know that the deposit account options available from HL are very limited and I can’t find much reference, if any, to cash as an asset on the BestInvest website (I wonder why?), so I’m not sure what they offer.

    The SIPP we normally use has the Bath Building Society as the “bank” account provider (all “proper” SIPPs need a bank account into which funds like dividends, etc. are paid ). This “holding” account offers interest of, currently, 0.85%. From there, over recent months, we have opened accounts (all within the £85,000 FSCS limit, of course) for clients with the Leeds Building Society, Julian Hodge Bank, the Buckinghamshire Building Society, Scottish Widows Bank, Arbuthnot Latham, Britannia International, and several others – the choice being driven by interest rates. Some clients locked-in to 3.50% for a year, but that isn’t possible today, thanks to Funding for Lending.

    What we do, after advising the client appropriately, is instruct the SIPP administrator to open the relevant account – it’s quite a simple and painless excercise. These genuine cash deposit accounts are a much better choice, in my opinion, to “unitised” money market funds, they don’t have charges, as such, its implicit in the interest rate.

    By the way, I have never wished to own a sports car or gold watch, nor have I ever been in the position to afford one; it sounds soppy, but after my family, clients come first!

  • 24 gadgetmind January 10, 2013, 11:26 am

    Yes, SIPP is a much-abused term. I used to have a “real” SIPP with Skandia/SIPPdeal but ditched it was the fees were too high.

    As for remaining invested post-retirement, I fully intend to retire at age 55 and have solid and achievable plans in place to ensure this is very likely to happen. No way can I fund that length of retirement without using a decent slug of equities but I’ve back-tested my approach using firecalc and other tools and the probability of it paying off is very close to 100% over every 35 year starting point since 1871.

    Throw in going easy on my equities during slumps by using my NS&I linkers, bonds, etc., and also some belt-tightening, and I’m confident that I’ll be sleeping soundly.

    When you say “has a significant probabilty of not paying off”, what do you mean by significant?

  • 25 Mark Meldon January 10, 2013, 12:20 pm

    Firstly, I’m sure you are entirely comfortable with your personal assumptions about asset allocation, risk, and costs; that’s great!

    It’s a bit different when you have a fiduciary duty to someone else in that, if advice offered and acted upon goes horribly wrong, the buck stops with me. That’s fair enough. Unlike you – and I guess, most others who comment on this site – the overwhelming majority of the population don’t understand percentages, let alone all of the options available to those with “pensions” today, such as the misunderstood, but very useful, phased income withdrawal, as an example. That, perhaps, is why I continue to make a modest living!

    To attempt an answer to your question, I have to say that I’m (sort of) with Bill Gross of PIMCO on this (and, yes, I know he has built a fortune out of selling overpriced bond funds in the States). In his August 2012 “Investment Outlook”, he described the 6.6% real return on stocks since 1912 as a ponzi scheme. As he said:-

    “If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, labourers and government)?”

    He went on:-

    “Common sense would argue that appropriately priced stocks should return more than bonds. Their dividends are variable, their cash flows less certain and therefore an equity risk premium should exist which compensates stockholders for their junior position in the capital structure.”

    “The ligitimate question that market analysts, government forecasters and pension consultants should answer is how that 6.6% real return can possibly be duplicated in the future given today’s intial conditions which historically have never been more favourable for corporate profits?”

    “The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned”.

    I also happen to agree with Gross when he says:-

    “Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.”

    Even if we do see 6.6% real return, skim off costs of, say, 3%, we are down to 3.6%, not much more than cash. In the interests of full disclosure, I have a small SIPP fund that holds 25% in cash, 25% in a trio of investment trusts, and 50% in index-linked gilts, but I’m very cautious, as are most of our clients, regardless of their net worth.

    My bottom line is that I attempt, in my own small way, to emulate the philosophy expounded by the (really rather wonderful) Personal Assets Trust plc to “preserve and increase the value of clients investments – in that order”.

  • 26 gadgetmind January 10, 2013, 12:33 pm

    “skim off costs of, say, 3%” – errr, no, let’s not!

    As it happens, PNL is my wife’s single largest unwrapped holding by quite a large margin and it’s hard to foresee a time when we’d sell. However, like Ruffer, I fully expect them to have “tractor on the motorway” moments, perhaps moments that last for many years or even decades.

    Regards equities, the last IFA who warned me against them did so while sliding a form across the desk for me to confirm my HNWI status, and he then outlined his proposal for moving my SIPP over to him so that it could be used for mezzanine loans to commercial property developers.

    This was five minutes into out first meeting!

  • 27 The Investor January 10, 2013, 12:58 pm

    Just a quick note to say I’m enjoying this conversation, and it’s excellent that it’s all being done in the usual respectful tone we like around here. I know it can be a fiery topic, so cheers chaps.

  • 28 Mark Meldon January 10, 2013, 1:05 pm

    Mezzanine finance – blimey! Barge poles spring to mind; mind you, I recall 20% commissions on these deals a few years ago, not that we ever did anything other than throw the glossy brochures in the bin. We have just won substantial compensation for a Birmingham-based client via the FSCS who ended up with dodgy Moroccan Hotel investment that is now worthless flogged by some goon from Warwickshire – 25% commission on these schemes, I am given to understand!

    I personally own just a few shares in Personal Assets and in the Ruffer investment trust, as do several clients, via their “proper” SIPPs.

    I am not warning anyone against equities, per se, but many of our clients are approching or are already in the “decumlation” phase of life; matters can be rather different then.

    For those in the “accumulation” phase, dependent of capacity for loss and attitude to risk, equities can be fine things.

    I do, however, believe that future returns will be lower than the baby boomers have experienced, a view reinforced by several clients who are much brighter then me, but of course, it’s just a hunch.

    If I’m right, however, clients will need to adjust their portfolios – pension or otherwise – accordingly. The only reliable measurement that can be a guide to the future are costs, and costs, clearly, are a major determinant of future returns.

    To give a simple example, if I may.

    Yesterday I received an email from a client who wanted to add some exposure to US Smaller Company Stocks in his SIPP (that’s up to him – he’s an economist, amongst many other interesting things). The (always dangerous) “mate of his” had admitted to a holding in the generally well-respected Schroder US Smaller Companies Fund. So, I printed off the KIID (“Key Investor Information Document”). The new, post-RDR, class A accumulation units have a published TER of 1.67%, but that figure, apparently, does not include any allowance for PTR (“Portfolio Turnover Rate”), which, at best, might add a further 0.45% to the annual cost. That comes to an approximate running cost of 2.12%, about 0.50%-0.65% of which goes back to the likes of BestInvest and HL (hence the “loyalty bonus” fund). This unit trust is benchmarked to the Russell 2000.

    As an “advice only” IFA, by the way, we do not receive these fee kickbacks anymore, unlike the “execution-only” shops.

    A better choice might be the Deutsche Bank db x-trackers Russell 2000 ETF (assuming client able to sign off “sophisticated investor” form and happy with counterparty risks). TER 0.45%, no performance fee, PTR going to be low – say 0.15% – gives ownership cost of 0.60%. No commission or “fund rebates”, to my knowledge.

    Everything else being equal, buying the index is the better choice, in nearly every case.

    I’m sure you will agree.

  • 29 gadgetmind January 10, 2013, 1:07 pm

    Why, thank you, TI.

    I rarely get heated on these subjects because we have a choice regards how we invest (and even whether we invest) and it’s when discussing those areas where our options are limited by government policy, silly rules, of inefficient markets, that I tend to gently simmer.

    That and my mother brought me up to disagree without being disagreeable, and I try and make the effort.

  • 30 gadgetmind January 10, 2013, 1:22 pm

    @Mike Meldon – yes, barge pole deployed and it cost me no more than an hour of my time and an unpleasantly strong cup of coffee. (My PA is a fair judge of character but I must have a word with her some time!)

    You’re not going to get much (any?) disagreement regards buying the index around here, though small cap and EM are areas where EMH is perhaps starting to get onto shaky ground. As a result, I have a fair holding in the Vanguard Global Small Cap tracker, but also some Asian smaller company ITs that I bought on fat discounts.

    Regards kickbacks and “loyalty bonuses”, the likes of HL and BestInvest don’t seem to admire my liking for trackers, ITs, ETFs and equities, so my annual loyalty bonus wouldn’t cover a Full English at the local greasy spoon.

  • 31 Mark Meldon January 10, 2013, 1:39 pm

    You are, Sir, quite correct about the “SIPP shops” disliking the investments that we should mainly employ; they can’t make any money out of them, after all. I rather like ETF’s and investment trusts (and, I hope, my clients do, too!) and have used them for years.

    I also then to think that nowadays the “EMH” is strarting to look rather insecure; this is something that has often given me a particular dilemma when advising clients over the last year or two. I agree with you about “inefficient” (Read: “dodgy”) markets, such as developing nations. Mind, you, I’m rather glad we avoided the terribly expensive Fidelity/Bolton China investment trust thingy a few years ago.

    Mainly stick to trackers as your core, with a few “interesting” investment trusts like, perhaps, Aberforth Smaller Companies or Monks, on decent discounts, as “satellites”, methinks.

    Then chose your “tax wrapper”, be it a SIPP, the (preferable in the right circumstances) SSAS, ISA, etc. Unless you have special circumstances, ignore life office investments, as they are terribly expensive and grossly oversold (still!).

    Mind you, you would be astonished as to how few understand the purpose of investment. This, I think, is to produce an income, either now or in the future, period.

    It’s Mark, by the way, and I am, to reiterate, not offering any advice here!

  • 32 gadgetmind January 10, 2013, 1:50 pm

    Ah, sorry, Mark. And yes, the complete lack of advice is noted and understood.

    I see all my investments as generators of future income streams. My projection spreadsheets look at each pot and see what income stream it can generate (or what HMG will allow us to take!), what the tax situation is on that stream, and how it all adds up in today’s terms.

    If someone can just tell me what to put in my “Investment Real Return” cell than I can tell you to the penny what my annual income will be in 2018!

    > Unless you have special circumstances, ignore life office investments, as they are terribly expensive and grossly oversold (still!).

    Confession 1: I don’t know what life office investments are.
    Confession 2: Even after using google, I still don’t know what life office investments are!

  • 33 Mark Meldon January 10, 2013, 2:08 pm

    IRR = 3%?! Maybe too gloomy, but best err on the side of caution.

    Life office investments = “investment bonds”. These are single premium lump sum investments “wrapped” under life assurance legislation. They can be useful for trusts, minors, and higher-rate taxpayers as they do offer tax deferral (note: “deferral”). Most have been flogged, by IFA’s and the banks, to little old ladies – commission of up to 8% inital would have had absolutely nothing to do with that, of course. Three years ago, I dealt with a case where £16,800 commission had been extracted by a well-known bank for ½ an hours work. All of the clients money had been swiped out of deposit accounts – the poor soul was 96!

    As an aside, and without wanting to be at all rude, have you considered the position your SIPP/Wife/Partner might face were you to unfortunately to have the sheer bad timing to die prior to running out of money? Hopefully, academic, but consideration needs to be given to this. We recently dealt with a new widow ( very decent amount of life cover, thankfully) who was minded to “cash-in” her late husbands draw-down plan. When we pointed out 55% tax recovery charge, she agreed with me that a continuing pension was a far beter idea. Even had she taken the lump-sum, where would she have put it to match the income return from the pension?

    One assumes, Sir, that you have written your SIPP into an appropriate “spousal by-pass trust” or something similar in order to cater for what be a rather diappointing turn of events?

    You would be amazed as to how few people attend to “I’ll do it another day” administrative matters as far as their investments are concerned!

    Anyway, I’m off to munch on a sandwich (yes, I do have home-made sandwiches for lunch, not steak!).

    Speak again, maybe?

  • 34 gadgetmind January 10, 2013, 2:30 pm

    My absolute growth is currently set at 4% so a real 1% on a good day. Gloomy is good, but I will admit that I do enjoy occasionally changing it to 5% for a minute or so.

    Ah yes, I do know about Investment Bonds. My view is that they are pretty handy in some circumstances, just not any that apply to me or are likely to. However, some people do seem to want to charge huge fees for what is in effect a fairly simple wrapper, which is one of those things I find annoying.

    Regards me having an argument with the number 28 bus (which I do share a road with as I cycle to work!) my life insurance is pretty good and my affairs fairly simple as nothing will be crystalised for at least five years.

    Additionally, as my wife doesn’t work, she is actually a rich lady in her own regard whereas I am something of a pauper.

    I will however do some reading regards ““spousal by-pass trust”.

  • 35 Mark Meldon January 10, 2013, 2:52 pm

    Bypass Trusts are normally established with a nominal amount of £10 which should be paid by the trustees into something like a building society account to create the intial trust fund.

    They are (or should be) commonly used with pension schemes, both private and employer-funded. They are for people who want their spouses/civil partners and children to benefit from any death lump sum without it forming part of their inheritance tax (IHT) estate.

    It’s really important to check that when a bypass trust is being alongside any pension scheme that a review of the scheme rules will be essential before proceeding as they must allow the trustees to transfer death benefits to another trust.

    In brief generic terms, the Settlor (you) establishes the bypass trust with a nominal sum, as noted above. He (or she) then submits a revised death benefit nomination form (and you would be amazed as to how many people don’t complete these) to the pension scheme administrators or trustees requesting that on death they pay the death in service lump sum to the trustees of the bypass trust who will hold these monies for the benefit of the settlor’s spouse, etc. The lump sum death benefits are accessible to the member’s family as discretionary beneficiaries but do not form part of any individual beneficiary’s estate for IHT purposes, thereby saving IHT on second death.

    Unfortunately, I have seen these trusts in action several times, and they do work and are, often, very inexpensive to set up (you don’t need a lawyer).

    That might be helpful, I hope.

  • 36 gadgetmind January 10, 2013, 2:56 pm

    Yes, I’d done some reading, but that is a useful summary. My SIPP, GPP and life insurance is all in trust but I guess I need to consider a bypass trust to hoover up the lot.

  • 37 Mark Meldon January 10, 2013, 3:29 pm

    You are on the right track!

    As an aside, why is it that so many folks have the “wrong” type of life insurance? Something like 98% of term life insurance policies arranged in the UK are of the lump sum variety. 3% become claims. That’s OK for covering specific liabilities such as mortgages and loans and it’s true to say some capital offers flexibility.

    In my opinion, however, nearly all life insurance arranged for other purposes (protecting the husband/wife/partner and kids, for instance or “alimony insurance” – there’s a thing!) should be “family income benefit”. I have to admit that this is a particular bug-bear of mine.

    FIB’s pay a pre-selected income, which can (and should) be index-linked, from the date of death (or critical illness diagnosis, where included) to the expiry of the chosen term. For instance, you have a policy that was agreed to run for 20 years and die after 15, then 5 years “income” will be paid. I say, “income”, as HMRC treat these payments (monthly or quarterly) as return of capital; they are thus tax-free.

    They are, effectively, riskless in payment and no investment descisions need be made.

    Because the sum at risk diminishes each month that passes, these are a form of decreasing term insurance, and thus a lot less expensive than lump sum cover.

    One client of mine lost her husband quite some years ago – that little policy has just finished, but it paid for her daughter’s education, right up to her PhD. It cost £6.60 a month, if I remember rightly.

    A really useful product that is dismissed by most salesmen as the commission is so low! Hey, ho!

    Don’t even get me started on the woeful uptake of disability insurance!

  • 38 gadgetmind January 10, 2013, 3:52 pm

    We might be drifting off topic unless TI is considering articles on trusts and insurance!

    But yes, I do have life insurance, critical illness insurance, and inability to work (dunno right name!) income cover. What’s nice is that my employer provides all of these.

    They all pay out lump sums but TBH I’d rather my wife have the money than a promise.

  • 39 Mark Meldon January 10, 2013, 4:10 pm

    Hmmm… are we off topic (well, yes, we are, and it’s all my fault)?

    Surely FIB is very akin to a, wait for it, bond!

    As far as your comment “..a promise” is concerned, I fear, Sir, you are being overly cynical. Most UK life offices are both inexpensive and heavily re-insured where protection insurance is concerned.

    I think I’m right in saying that the last time an annuity failed to be paid was when Henry VIII was king. They were offered by Monks (not the investment trust), you see.

    I am unaware of any occurence where death benefits haven’t been paid in the last 100+ years, excepting cases on non-disclosure and/or fraud.

    Anyway, have fun with your PRIP SIPP!

  • 40 gadgetmind January 10, 2013, 4:36 pm

    I wasn’t born cynical, the world made me this way!

    However, most of my distrust is aimed at HMG who seem to delight in making arbitrary changes to taxation for no better reason than political point scoring.

    For this very reason, I will be grabbing my PCLS from every pot on the very day on which they deign to permit this. And yes, I do understand the IHT and tax implications.

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