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Image of suit armour as symbol of Section 75 protection

This piece on Section 75 is by The Treasurer from Team Monevator. Check back every Monday for more fresh perspectives on personal finance and investing from the Team.

I was once scared of credit cards. I believed saving up for things I wanted to buy was always the right thing to do. Credit cards were the work of the devil. They were designed to trap you in debt at hideous interest rates.

I still believe those things to some extent. If I want something, I’ll save up for it. I only ever splash out if I have a real need, or if I consider it excellent value for money.

And I still think some credit cards – such as those with eye-watering interest rates pushing 40% – are awful. Especially those that target sections of society who can least afford it.

Yet as time has gone on I have also grown to understand that credit cards are essentially tools. Albeit tools with a dangerous edge.

Think of a credit card as like a very sharp knife. Extremely useful in the hands of a Michelin star chef. Less so – and potentially dangerous – when wielded by an amateur cook.

In other words, use credit cards in the right way (often contrarily to the goals of the card provider) and you can benefit, at no cost to you.

Get it wrong and you could find yourself servicing interest for years. That will leave your dreams of early retirement in ruins.

Cashback is a quick credit card win

An obvious way to use a credit card to your ‘advantage’ is cashback.

With a cashback credit card, you earn small amounts of money every time you spend on it. You’ll profit on everything you buy, so long as you pay off the balance in full every single month. That way you avoid paying interest.

I put ‘advantage’ in quotation marks above, because card providers still benefit when you use their card. Retailers must pay the card provider a small fee for each transaction. So using a cashback credit card as I’ve described won’t make your card provider lose sleep.

Of course your card provider won’t mind if you miss a payment and owe them a nice bit of interest, either. So unless you enjoy contributing to a banking giant’s annual Christmas party, set up a monthly direct debit to regularly clear your debt.

What is Section 75?

Now onto another way you can make credit cards work for you – to use one solely to benefit from Section 75 legislation.

Section 75 is part of the Consumer Credit Act. (Section 75 of it, shockingly enough).

This legislation dates back to 1974. The legal eagles who wrote it thought it would be unfair to have someone borrow to pay for something on a credit card, only to not receive the item, or to suffer issues down the line. Especially if they were still in the process of paying for it!

Today, almost 50 years later, Section 75 remains a powerful consumer tool:

  • Pay for something on a credit card that costs between £100 – £30,000 and Section 75 will automatically apply to your purchase. (As long as the thing you’ve purchased is for you).
  • Section 75 means the card provider which you buy from is equally liable for your purchase. So if anything goes wrong, you can knock at their door for a refund.

Importantly, you don’t have to pay for the whole item on a credit card for Section 75 to apply.

Pay just £1 or 25p –or any other humorously low figure – on a credit card, and your whole purchase is protected. Up to £30,000.

So if you’re buying a new car, then agreeing with the dealer to pay £100 on a credit card will give you protection on the whole purchase price.

You may find this a bit silly. But some retailers may put restrictions on the amount they’ll accept on a credit card, due to the processing costs involved.

(Since 2018 retailers can no longer charge a fee to use a credit card. However they can refuse to accept them).

Section 75: What are the main benefits?

Section 75 is particularly good for dealing with cases whereby a retailer has gone into liquidation.

For instance, you order a sofa and the supplier goes bust between the time it takes your payment and the delivery date – which can often be months away. Section 75 protection means the card provider can refund your cash. This sure beats making your case to an appointed administrator. There you’d probably have to settle for pennies in the pound, at best.

Section 75 doesn’t apply only when a retailer has gone bust. Say you want a refund for a defective or missing item and you’ve had no luck convincing the retailer to give you your money back. Section 75 enables you to seek a refund from your credit card provider instead.

A Section 75 claim doesn’t mean you’ll definitely be refunded – the card provider may not agree with your claim. But it’s fair to say that a banking giant is far more likely to pay up than a struggling retail provider keen to keep your cash. Financial companies usually have deeper pockets.

Even if your Section 75 claim is turned down, that’s not the end of the story. When you’ve paid on a credit card, you have the added option of taking your case to the free Financial Ombudsman service. It will then make a ruling on the behaviour of your card provider.

Remember, Section 75 makes both the retailer and card provider equally liable. So you don’t have to take your refund case to the retailer first. You can go straight to the card provider if you wish.

Section 75: What should I look out for?

There are no real drawbacks of Section 75. However there are some things to watch out for should you wish to rely on the protection.

Firstly, if you’re paying for something with Section 75 protection in mind, ensure it’s for your own personal use as the cardholder.

While the law isn’t set in stone, you may suffer some pushback if you make a claim via Section 75 for an item or service that wasn’t intended for your own use. (That said, one popular consumer website suggests that group bookings should be covered.)

Secondly, for Section 75 to apply make sure the thing you’re buying is actually over £100.

Annoyingly, if you buy two single flight tickets costing under £100 each – with a combined cost over £100 – you probably won’t have any luck with a Section 75 claim. However, a return ticket costing more than £100 means the cover will apply. It’s considered a ‘single item’ in the eyes of the Consumer Credit Act.

Thirdly, there may be an issue with relying on Section 75 protection if you buy via a third-party intermediary. More on that below.

Finally, if you’re buying something costing less than £100, don’t assume that you haven’t got any protection at all.

Lesser ‘chargeback’ protection applies for all purchases made on either a credit or debit card. This protection doesn’t have a legal basis. Rather it is part of rules associated with the major card processors (Visa, Mastercard, and Amex).

With chargeback you can ask your card provider for a refund. However unlike Section 75, under chargeback your card provider will seek a refund from the retailer you purchased from, rather than reimbursing you directly.

While it’s much less powerful than Section 75 protection, chargeback is still a consumer tool worth remembering.

My own personal horror stories

Knowing I’m a personal finance wonk, friends and family members often come to me for unofficial guidance. Despite this I’ve found convincing them to sign up for a credit card – solely for Section 75 protection – a tough sell.

That’s ironic, given that in my personal life I’ve seen the importance of paying for big purchases on a credit card.

A few years back, a former flatmate contacted me for help. She had paid upfront for a teeth whitening service. The provider went into liquidation when she was only a quarter of the way through her treatment. I was horrified to learn she’d put the £3,000 treatment on a debit card.

Unfortunately my efforts to convince her to use a credit card for all big purchases in future couldn’t bring back her lost cash. And I’m sorry to report that her chargeback claim was unsuccessful.

Similarly, but fortunately not so devastating, a family member recently purchased a large camping item from a retailer based in continental Europe. The value was just shy of £1,000.

The first I’d heard about this purchase was when I was contacted to ask for help when the item didn’t arrive. I asked what was used to purchase the item. Yes, you guessed it, a debit card.

A package did eventually turn up, albeit in a very damaged box. It was the wrong item! The cost to send it back was over £80. Other than explaining to my family member how easy it would have been to claim back the cost from a credit card provider, there was nothing I could do.

The same family member also experienced difficulty in claiming a refund for a long haul flight last year that was later cancelled due to Covid-19.

While Virgin Atlantic eventually gave way and refunded the money many months later, this was another instance where Section 75 would probably have come up trumps.

Third-party complications

If you want to rely on Section 75, try not to use a third-party service if you can.

There have been a few stories of people missing out on Section 75 protection due to a requirement that there must be a direct link between the customer, the credit card company, and the supplier or retailer.

Using a third-party website, such as a travel agent, may therefore mean you won’t be able to make a claim under Section 75. That’s because the travel agent may be seen as ‘breaking the link’ between parties.

I say ‘may’ as the rules on this are pretty blurred, and there’s conflicting information across the web.

To play it safe, always book direct if you can. So if booking a flight over £100, for instance, it’s probably best to go directly to the airline’s website rather than going through a travel agent, if you want to maximize your Section 75 protection.

Section 75: The takeaway

I’m wary of calling anything a ‘no-brainer’. We should always consider the drawbacks of any particular product.

Yet, as long as you don’t use a credit card to recklessly borrow, signing up for a credit card and using it to pay for anything over £100 really is a no-brainer, due to the free Section 75 protection you get.

But don’t just take my word for it – let’s hear from some readers. Have you ever gone to your card provider to make a Section 75 claim? What was your experience? Let us know in the comments below.

You can see all The Treasurer’s articles in a dedicated archive.

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Weekend reading: Turning on the triple-lock

Weekend reading logo

What caught my eye this week.

I was a big fan of real-time strategy computer games in my frugal but otherwise misspent youth.

You know – those games in which you’d martial digital resources and deploy armies to expand your burgeoning industrial-military complex (or gold based goblin empire).

At their best, real-time strategy games gave you a glimpse of what it was like to be Napoleon or Marcus Aurelius – commanding legions!

At their worst, they were invariably broken by glitches that threw the whole illusion out of whack.

For example, weapon combinations whose lethality escaped the game’s bug testers and made your troops invincible.

Or technology tree choices that exponentially repaid whatever you put into them, giving your faction near-infinite riches while your computer opponent was still rubbing two sticks together.

Triple-lock turns the screw on UK finances

I thought of these glitches when considering the fuss over the triple-lock for pensions. As Simon Lambert noted in ThisIsMoney (my bold below):

The government made a deal in its manifesto to stick with the triple lock, which raises the state pension by whichever is the highest of consumer prices inflation, average annual wage growth, or 2.5 per cent.

It uses September’s inflation figure but July’s average earnings number, and this week the UK’s public finances watchdog, the Office for Budget Responsibility, warned that the latter could trigger a shock £3billion bill.

This would come from pensioners getting a bumper rise due to a quirk from the coronavirus crisis.

Average earnings figures are temporarily being distorted by furlough, lockdown job losses and a comparison to pay cuts in the depths of the crash a year ago, meaning that average wage growth is currently coming in at a high level and rising.

Annual wage growth climbed to 5.6 per cent in the three months to April, according to the latest official figures, and the crucial three months to July figure could hit 8 per cent.

That’s a very nice uplift for doing nothing different if you can get it. But the triple-lock wasn’t meant to occasionally throw up three melons on the slot machine of financial life like this.

An 8% rise after everything we’ve been through looks like a classic glitch.

Still, it’s worth remembering the triple-lock has otherwise delivered roughly what it was meant to.

The State pension has increased ahead of average earnings since the triple-lock was introduced in 2011. This halted an ongoing decline in relative terms that was previously making pensioners ever poorer.

And that outpacing has come even though in most years the State Pension has only increased by 2.5%, as cited by the BBC:

That’s the great thing about guaranteed increases from a mechanism like the triple-lock, at least if you’re not the one who has to pay for it.

You always get some cream, without ever suffering a sour year.

Screw who

With that point conceded to the triple-lock, an 8% rise does look dumb.

David Willetts, the president of the Resolution Foundation think tank, argues the annual earnings link should be replaced by figure that better reflects workers’ experiences of pay increases and declines:

“The Covid crisis has laid bare the design faults of the triple lock, with a severe jobs crisis last year inadvertently contributing to an unnecessary and unjustified 8% rise in the state pension next year.

The chancellor should take the opportunity this autumn to replace the triple lock with a smoothed earnings link.

This would mean the state pension would rise in line with the living standards of working-age people – a change that would be fair to all generations.”

You may remember Willetts was the unusually bold former Tory minister who in 2011 published The Pinch – a book highlighting potential inter-generational fallout from the good fortune of the Baby Boomer generation.

Since then Boomers have only gotten richer, and pensioners could now see an 8% uplift to their state income in the wake of millions of their grandkids being (rightly) ordered to stay at home, in large part for the sake of the elderly.

True, the UK’s State pension is not especially generous. Those who rely on it are not the same people that Willetts and others finger for hoarding an undue proportion of the nation’s wealth.

On the other – other – hand, one can argue today’s pensioners already had their chance to save during three decades of prosperity.

In contrast, today’s young now have to save for their future – at a time of financial crisis, lockdowns, globalization, Brexit, and near-zero interest rates, with houses unaffordable to most to boot.

But how many hands have you got? Because yet another point is that pensioners vote.

Something their favourite newspapers have pointed out repeatedly in calling for the 8% rise to sail through.

Pick your pension poison

It seems to me the 8% uplift is clearly a bug caused by unforeseen circumstances. In software terms, it needs a patch to update it.

However it’s also true the triple-lock was introduced to stop the state pension becoming inadequate over many decades of longer retirements and rising living standards. We all know that story.

Pundits who’ve never seen a state benefit they didn’t want to double argue we should all want to retain the triple-lock, because today’s young people will benefit from it in their old age, too.

Whereas ironically, many young people suspect they’ll never get a State pension – partly due to its high cost funded by a shrinking pool of workers.

A cost that could be made even worse – to the tune of £3bn forever – by this glitchy 8% uplift!

Finally, we have speculation – see my links below – that chancellor Rishi Sunak is looking to claw back money by further reducing the amount you can put into a private pension or by cutting the tax relief you receive.

You don’t need to be Daniel Kahneman to see that all this tinkering with the rules that govern payouts that you won’t receive for decades is deeply sub-optimal.

Pensions 2.0

I’m not especially old, and I’ve seen big pensions changes in my lifetime, myriad tweaks, and annual speculation that this allowance will be chopped or that relief will be scrapped.

That’s not even to get into the shifting age limits as to when you can get your hands on your money.

It’s pretty ridiculous.

Indeed I’m starting to wonder if we shouldn’t do a hard reboot towards a system so simple that everyone understands it – making it harder for future politicians to meddle with – albeit at the cost of more turmoil today.

I haven’t attempted to cost out the following idea, but in theory it could sweep away a lot of this ongoing nonsense in one go.

We evidently believe as a society that old people should have a minimum standard of living.

We also believe younger people should know they have a comfortable future to look forward to, for all kinds of good reasons.

Finally, we understand it’s incredibly difficult to make any forecasts and commitments about the far future – financial or otherwise.

Funding your retirement been described as the hardest problem in finance, due to all the uncertainty.

But perhaps the one entity that can make firm commitments is the State, backed as it is by taxpayers.

So – maybe we should set a universal state pension at a much higher level than today’s payout. Say 50% of a median workers earnings.

That would deliver a State pension of about £15,000 a year right now, compared to less than £10,000 under the current system.

Wow, right? But how do we pay for it?

Well for starters we then scrap the entire artifice around private pensions and tax relief.

All of it. Everything.

People could still save and invest whatever they liked in the usual way, of course. There would be no prohibition on aiming to be a multi-millionaire in your old age.

But the government wouldn’t help you get there.

So there’d be no private pensions. No annual allowances or tax-free lump sums. No crystalization events or similar. No tax wheezes at the margins.

All gone, at a huge (though possibly not sufficient) saving to the government of time, money, and bureaucracy.

Possibly ISAs could remain. We’d have to do the sums. But before you get too indignant, remember you’d be getting that far bigger state pension, too.

Don’t worry, be happy

Obviously the lower-paid and poorer would gain the most though from this system. I’m not sure that’s a bad thing, given the direction of travel of society over the past 20 years.

But richer people like most of us are (or will be) would benefit, too.

Our retirement plans could be built on stronger foundations. Difficult choices about whether to lock money away and what would happen to it would be replaced by simply saving as much as you could and wanted to.

Billions would be saved in accountancy costs and other fees.

One snag would be it would make the Boomers even richer. The wealthiest cohort of society would suddenly get a far higher State pension despite not paying much towards it. (They’d pay something – they pay tax, remember).

Perhaps we’d need a windfall wealth tax to smooth the transition? If that meant Boomer retirees short on liquidity moving out of their mostly empty five-bedroom homes to release capital or whatnot, that’d probably be a good thing, too.

Now as I said I haven’t costed out my alternative pension system.

Why bother? Even if I was an elected MP there’d be zero chance of it being implemented.

But I think it’s worth thinking about big alternatives to this ongoing muddle.

Otherwise we will battle on for years with shifting rules and benefits and a future target that looks more like a swarm of bees than a bullseye.

More patches and glitches – and the occasional threat of a crash – forever.

Good business for financial planners, politicians, and tax specialists. Not bad for money bloggers, either.

But a pretty dumb way to encourage people to plan their way through life.

Have a great weekend everyone. Stay hydrated!

[continue reading…]

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Emerging Market bonds: why they belong in your portfolio

Image of the various currency flavours of emerging market bonds

There’s credible evidence that Emerging Market bonds are a useful diversifier in passive portfolios. Albeit in a very different role from the one that bonds traditionally play.

Instead of slotting into the defensive ramparts of your asset allocation, Emerging Market bonds belong on the growth side.

They may offer equity-like returns while lowering overall portfolio risk.

Sounds too good to be true? Let’s see…

The case for Emerging Market bonds

We were tipped off about the potential of Emerging Market bonds by Monevator reader and hedge fund quant – ZXSpectrum48k.

Regular readers will be familiar with ZX’s insights over many years. They’ve dropped into our comment sections like messages from a friendly extra-terrestrial, with access to technology far in advance of our own.

ZX’s thesis is:

  • Emerging Market US$ denominated sovereign bonds have historically produced better returns than Emerging Market equities.
  • They’ve done so while being much less volatile than Emerging Market equities. As such, they’ve inverted the standard risk-reward relationship for more than 20 years.

That sounds like a good deal. Especially as Emerging Market bonds exhibit lower correlations with global equities than Emerging Market equity.

And ZX isn’t alone in noticing the special properties of Emerging Market debt. Vanguard’s research paper Emerging-market bonds: a fixed income asset with equity-like returns (and risks) states:

Their strong historical returns and high yields, along with the improved economic fundamentals of their issuers, have generated investor interest in holding them as a distinct portfolio allocation…

…We find that emerging market bonds have performed more like equities than like bonds.

Emerging Market bond types

Emerging Market (EM) debt divides into three main categories:

  • Emerging Market US$ sovereign bonds – government debt and government guaranteed debt, denominated in dollars.
  • Emerging Market local sovereign bonds – government debt and government guaranteed debt, denominated in the issuer’s local currency. This local EM debt is typically more volatile and less diversified than its US$ counterpart.
  • Emerging Market US$ corporate bonds – corporate debt, denominated in dollars.

The three flavours diversify across Asia Pacific, Eastern Europe, Latin America, Africa, and the Middle East, in quite different proportions to Emerging Market equity index funds. Holdings include a blend of investment and sub-investment grade bonds (also known as junk bonds).

You could mix all three types, but that’s taking complexity too far. Emerging Market US$ sovereign bonds bestow the benefits we’re after. That’s also what ZX uses. 

The chart below is from JP Morgan. It shows EM US$ sovereigns sitting close to the efficient frontier that denotes the risk-return sweet spot. (Okay, it’s a curve not a spot. Shoddy journalism, I know…)

Emerging Market US$ sovereigns sit closest to the efficient frontier according to this JP Morgan chart

We’ll focus on Emerging Market US$ sovereigns for the remainder of this three-part series.

Emerging Market bonds: historical returns

The primary return drivers for Emerging Market US$ sovereign bonds are:

  • The credit risk of Emerging Market governments
  • Interest rate exposure to US Treasuries

The EM US$ sovereign bond market has existed in its contemporary form for just over 30 years. History therefore offers us fewer crumbs to crunch on than our usual century’s worth of Developed Market data.

Publicly available EM sources are also few and far between.

However the research does suggest that something is going on:

Emerging market bond returns versus other global assets in table form.

Source: Vanguard. “Emerging-market bonds: a fixed income asset with equity-like returns (and risks).” August 2018. Page 8. US$ returns (2002 – 2017).

Emerging Market US$ sovereign bonds beat all other asset classes including global equities and US equities during this period. Only US bonds bested EM sovereigns on a risk-adjusted basis.

Emerging market bonds returns and volatility versus other global asset classes in chart form.

Source: State Street. “Case for Allocating to Emerging Market Debt.” February 2021. Page 7. Euro returns (2002 – 2020).

This second graphic shows Emerging Market US$ sovereign bonds on the far left. It’s labelled as Hard Currency Sovereign Debt. Compare its turquoise drawdown bar against Emerging Markets Equity on the far right.

While equity returns nosed ahead, EM US$ sovereigns won on a risk-adjusted basis. They inflicted less than half the pain for a similar gain.

Emerging Market bond returns including the pandemic

That’s all very well. But has the pandemic torn EM government balance sheets a new one?

We can compare EM US$ sovereign bond returns versus Emerging Market equities using iShares ETFs.

Here’s the data from February 2008 up to June 2021:

Emerging Market bond returns vs Emerging Market equity chart Feb 2008 to June 2021

Source: justETF. (Cumulative GBP returns, income reinvested)

  • Emerging Market US$ sovereign bonds: +208% (Blue line).
  • Emerging Market equities: +118% (Red line).

As you can see, the EM debt idea has not been torpedoed by the pandemic.

Yes, there was a sell-off during the Coronavirus Crash of March 2020, followed by a moderate dip earlier in 2021.

But recent performance doesn’t suggest the market thinks that EM economies are being crushed.  

Emerging Market volatility during the Coronavirus Crash

Emerging Market bond returns vs Emerging Market equity during the coronavirus crash

Source: justETF. (GBP returns, income reinvested)

The lower volatility of EM US$ sovereign bonds relative to EM equities held up during the Corona Crash:

  • Emerging Market US$ sovereign bonds: -14% (20 February to 19 March 2020, blue line).
  • Emerging Market equities: -23% (20 February to 23 March 2020, red line).

Emerging Market volatility during the Global Financial Crisis

Emerging Market bond returns versus Emerging Markets equity during the Global Financial Crisis

Source: justETF. (GBP returns, income reinvested)

The lower volatility thesis for EM US$ sovereigns also delivered during the Global Financial Crisis. EM hard currency bonds dropped less than a third as much as EM equities when the market hit rock-bottom:

  • Emerging Market US$ sovereign bonds: -16% (18 May to 23 October 2008, GBP, blue line).
  • Emerging Market equities: -53% (18 May to 27 October 2008, GBP, red line).

Emerging Market bond returns including the 1990s EM Financial Crisis

I know what you’re thinking. What about the 1997-98 Emerging Market Financial Crisis? Surely the returns above all hark from the Noughties because the Asian Contagion of the previous decade strips this notion bare like a Chinese groom cling-filmed to a tree, in a pre-wedding hazing ritual? [Er, indeed… surely? – Editor]

Not so.

The Bogleheads are a wonderful online community of passive investors. And one of the Bogleheads’ key statistics wizards provided the following returns data over a period that also includes the 1994 Mexican Peso Crisis:

Sub-asset class Annualised return (%) Volatility (%)
Emerging Market US$ sovereign bonds 8.8 12.9
Emerging Markets Equities 5 31.5

Source: Bogleheads, JP Morgan Emerging Market Bond Index Global Diversified (JPM EMBIGD), MSCI Emerging Markets Index. US$ returns (1994 – 2018).

Yes, Vanguard and State Street could have an incentive to data-mine. They want to support their Emerging Market fixed income products.

But neither ZX nor the Bogleheads are trying to sell me anything. And I’m further reassured by their reminder that the evil twin of equity-like returns is equity-like falls:

ZX cautions:

As a fixed-income credit product, it’s definitely not low-risk. For example, the index dropped 21.8% between Jun ’08 and Nov ’08.

Meanwhile the Bogleheads point out that Emerging Market bonds dropped by 40% in 1998!

Buyer beware. If you need to find room for Emerging Market debt in your portfolio, please replace a percentage of your equity asset allocation. Do not swap out any of your defensive bonds.

Does this data hold up for UK-based investors?

I calculated annualised returns and volatility in GBP (pound sterling) terms for EM US$ sovereign bonds (1994 – 2021):

  • Annualised total return: 8.85%
  • Annualised volatility: 13.66%1

Source: JP Morgan EMBIGD index. Monthly sterling total returns (31 December 1993 – 28 May 2021).

The data is from the market-leading index. It runs from its inception date to the latest month available as I write.

In comparison to the earlier Vanguard numbers, return is down and volatility up. The gloss has come off a little.

But we are still looking at equity-like returns with lower volatility.

Portfolio diversification

The Emerging Market bond story stacks up so far. The bonds outperformed Emerging Market equities, on a historical risk-adjusted basis at least.

Good portfolio building materials include asset classes that add return and reduce overall volatility.

Portfolio-level volatility can be lowered by asset classes that offset each other’s performance. If Asset A rises when Asset B falls, then your portfolio’s volatility is reduced.

Correlation measures the closeness of the relationship between the prices of two such asset classes.

A correlation score of:

  • 1 means that the price of two assets rise and fall in lockstep.
  • 0 means there’s no relationship between the two. Think of a random walk.
  • -1 means one asset rises when the other falls, in perfect synchronicity.

According to State Street2, the correlation scores for Emerging Market US$ sovereign bonds were:

  • 0.49 with MSCI World equities
  • 0.4 with Emerging Market equities
    (January 2003 – December 2020)

So EM US$ sovereign bond prices tend to move in the same direction as the two equity classes above. However the relationship is relatively modest.

State Street calculated that Emerging Market equities correlation with MSCI World equities was higher still, at 0.76.

In other words, Emerging Market US$ sovereign bonds were a better diversifier than Emerging Market equities, in portfolios dominated by World equities.

Naturally, asset correlations aren’t static. That would be too easy. They change over time, and differ by data source.

However, Schroders’ correlation-check shows a similar, if less impressive relationship between EM US$ sovereign bonds and equities:

  • 0.6 with global equities
  • 0.7 with Emerging Market equities
    (December 2002 – December 2018)

EM equities were again more highly correlated with global equities, at 0.9.

Hat-tip to Monevator reader c-strong who shared the Schroders piece. (Note, Schroders labels it as marketing.)

How much difference do Emerging Market bonds make?

The Vanguard and State Street papers include back tests. And it’s fair to say a slug of Emerging Market sovereigns wouldn’t have changed your life.

Vanguard’s test is the least shonky. It shows a 0.5% increase (at best) in annualised portfolio returns (from 1993 to 2017).

Emerging Market bonds improve portfolio return and volatility - Vanguard backtest

Source: Vanguard. “Emerging-market bonds: a fixed income asset with equity-like returns (and risks).” August 2018. Page 11. US$ returns (1993 – 2017)

The lime green line shows the uplift that accompanies replacing progressively bigger wedges of equities with EM US$ sovereign bonds.

The plum line usually refers to The Accumulator’s telephone number. But in this case it shows that risk-adjusted returns are improved by larger EM debt dollops. 

Finally, we performed the first-ever Monevator backtest using our patented data-torturer methodology.

Okay, really I threw together a passive portfolio using the longest-running and most relevant ETFs I could find:

  • 10% iShares JP Morgan USD Emerging Markets Bond
  • 70% iShares MSCI World
  • 20% iShares Core UK Gilts

This portfolio made a cumulative gain of 227% from 15 February 2008 to 19 June 2021.

That’s a marginal improvement on the 217% gained if I substitute the EM bond ETF for iShares MSCI Emerging Markets Equity ETF.

If the grass is always greener, this is like moving from ‘moss green’ to ‘kale’ on the Pantone chart.

Emerging Market bonds: the underlying rationale

Asset classes must show more than juicy historic returns and hopes of lower volatility to justify their place in a passive investor’s portfolio. 

We also need a rationale. Something to explain why an investment can repeat that performance in the future.

ZX points out that EM US$ sovereigns are partly propelled by the carry trade:

It’s a classic carry product but backed by the fact that the debt fundamentals of most EM countries are in far better shape than developed market governments or, more importantly, the private sector.

Carry refers to the tendency for higher-yielding assets to deliver superior returns to lower-yielding assets. The carry factor is closely associated with currency markets. But it shows up in other asset classes, too.

Essentially, you can expect to earn a carry premium as compensation for investing in riskier, high-yielding assets versus safer, low yield assets.

But as with the equity risk premium, expected average returns are no guarantee of future returns. The premium may disappear, or not materialise in your investing lifetime. That’s the nature of risk. It’s not peculiar to the carry trade, of course.

As with any source of risk, the carry trade is a double-edged sword. It cuts both ways:

  • It’s moderately correlated with the stock market overall, and provides an additional source of diversification. 
  • But the carry trade is highly correlated with other risky assets during downturns. 
  • The carry premium is historically robust. It scores a moderately high average excess return, according to research
  • But it can inflict major losses during a crisis as capital flees to safe havens

You may well have exposure to other sources of carry, too, such as in high-yield corporate bonds3, and via EM equities, UK equities, Value, and Small Cap. 

Carry on investing

This piece is meant to be the case for Emerging Market bonds. I’ve saved the case against for part two. 

But I think it’s already clear the upside to reallocating to EM debt is likely to be marginal-to-vanishing for most Monevator readers. Especially if you’re a passive investor whose secret weapon is simplicity

Nevertheless I’m tempted

Vanguard’s backtest shows much improved risk-adjusted returns with Emerging Market bonds. That’s the main potential win.

The prospect of bagging a substantial discount to the swingy-ness of Emerging Market equity has me seriously thinking about a switch. Or perhaps giving half my EM equity allocation to EM bonds, as I do like the idea of a heftier diversification to the carry trade.

My main concern is the historic data may just reveal a one-off, golden period of outperformance. 

Emerging Market bond yields have fallen a long way since the dark days of the 1990s. Yields are always a key driver of bond returns. That ‘equity-like’ performance could be a thing of the past. 

I’ll get deeper into EM debt in part two. Get ready for enough downers to suck the soul out of Motown.

Take it steady,

The Accumulator

  1. Standard deviation []
  2. Case for Allocating to Emerging Market Debt. February 2021. Page 10. []
  3. Which share commonalities with EM market bonds. []
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A guide to personal finance for immigrants to the UK

Image of an airplane to represent a new financial life in the UK

This guide to personal finance for immigrants is by The Learner from Team Monevator. Come back every Monday for another fresh perspective.

A new adventure? Relocating for work? I recently moved to the UK, too, from Australia. That meant rebooting my financial life.

Moving country is a huge job and so I’ve prepared the following guide on personal finance for immigrants from my own experience of coming to the UK.

I hope it can help to make your transition that bit easier!

Before you leave home

1. Build up your savings ready for the move

However much money you think will be enough, double it.

The UK government guide on coming over with a Tier 5/Youth Mobility visa (a live/work visa for under-30-year olds) suggests you’ll need a minimum of £2,530 in savings.

But there are so many things you wouldn’t imagine you’d need, and the extra stability and security will help when everything is new and changing.

My recommendation is to bring whatever amount you need to make a substantial change of game plan.

For example, you may get here and suddenly discover you aren’t able to find jobs in the field you want to work in. Or, you may fall in love with a beautiful foreigner and want to study a foreign language instead.

Even if you have secured a job in advance, it’s not a bad idea to plan for a change.

In addition, your first few months will be fun (plus a few moments when you’ll want to pull your hair out) so consider a small budget to treat yourself, too.

You’ll also want to have drinks with new housemates, catch up with old friends that live here, and to explore your new surroundings.

2. Have an address – your first accommodation sorted

This is critical. It’ll be pretty much impossible to get or plan anything without first knowing where you’ll be staying.

Whether it’s an AirBnb or a friend’s place or a flat you rent, you need an address to apply for everything, from SIM cards to bank accounts.

I rented a place in advance on a six-month lease. But looking back, I would have been better off staying in temporary accommodation, and taking the time to suss out locations, transport, and to figure out what’s value for money in the UK. (Hint: set the bar low if you’re coming to London).

If you do choose to get permanent accommodation in advance, rental agencies will typically want either proof of income and savings or else ask you to pay three-to-six months upfront and/or to have a guarantor, such as a family member, who will cover you financially and legally if you fall short.

Once you know where you’re staying, help yourself out by choosing to pick up your BRP card (proof of legal immigration status) at a Post Office nearby.

3. Check out your banking options

If you can begin to sort out a bank account in advance, why not?

In the UK, there are retail banks that have physical branches across the UK, and mobile banks where you will only interact via a mobile app.

You can research different current account options via a variety of internet sources, including:

Mobile banks and apps such as Monzo, Starling, and Revolut are popular for their ease of use, low-cost, and efficiency, although some people still value the reputation of traditional banks such as Barclays or Lloyds.

Note that signing up for a mobile bank is done via the bank’s app. Ironically, when you try to download this app via Apple’s App Store, Apple ID might ask you for a local credit card to proceed.

I found myself in this ‘hilarious’ endless loop circumstance where in the end I had to use a housemate’s card details to download the mobile bank’s app – in order to get my own local card!

Whichever bank you pick, keep in mind you will go through some kind of application process where the bank will want to verify your identity.

I suggest giving it a go before your move. However, if they need to see your BRP, you will have to wait until you arrive in the UK!

Some banks will only open a new account with you in-person at a branch. If this is you, book your appointment in advance for when you arrive, after you pick up your BRP card.

This was a surprise for me. In Australia, I was used to being able to walk in and see someone immediately. In the UK, appointments for new accounts can be booked up for weeks in advance, especially in busy periods. 

You can research savings accounts using the same services I listed earlier.

Savings accounts tend to require less rigour in their identity checks, so you could very well open one from abroad, provided you have your UK address.

Keep in mind the interest rates for savings accounts in the UK are currently quite low. 

4. Learn about pension and investment options in the UK

To have a pension in the UK, you’ll need to have a National Insurance (NI) number, which may have been given to you automatically with the BRP.

If not, don’t fret. You can apply for an NI number online, and visit a centre once you’re in the UK.

There are both workplace and private pensions (for the self-employed and others) available. Check out one of the many online guides for more info.

As for selecting investment platforms and brokers, peruse Monevator’s comprehensive guide.

The UK offers tax-efficient wrappers called Individual Savings Accounts (ISAs) to encourage you to save tax-free. Note that there are strict annual allowances on how much you can put into your ISAs each year.

5. Can you transfer your pension to the UK? How will your investments be affected?

How will moving affect your existing pension and investments? Arrangements between different countries and the UK will differ, so check specific sources to your country.

When in doubt, please seek out an expert financial advisor.

For pensions, if your current country partakes in the Qualified Recognised Overseas Pension Scheme (QROPS), you can potentially look at using QROPS to consolidate your pensions into one plan.

As for your investments, it’ll help to learn about the UK’s tax laws. Expatica has a useful guide to start you off.

After you’ve arrived in Britain

6. Transfer funds into the UK

Once you’ve set up your bank account, you can use low-cost transfer agencies such as Wise to send money internationally to the UK

Typically, you’ll be asked to make a local transfer to a Wise intermediary bank based in your ‘from’ country (Australia in my case), and then be paid from Wise into your new bank account in the UK.

Transfers can happen in a matter of 1-2 days, but I’d plan for one week.

7. Set up your credit profile for success

You’ll need some time to build up a credit profile in the UK.

There are three main credit agencies in the UK – Equifax, Experian, and TransUnion.

The following services are free, and will enable you to check your credit profile across the various agencies:

MoneySavingExpert has a good guide on building your credit profile in the UK.

You’ll want to:

  • Sign up on the electoral roll.
  • Try to minimise the number of credit applications and hard searches on your profile (which can be tough at first when setting up utilities, mobile phone accounts, and so on.)
  • If you have been offered credit, keep your credit utilisation low (between 1-20%) and make all minimum payments or pay your card off monthly, in full.
  • Take out a credit builder card if you need extra help, such as Aqua.

Monevator has a legacy guide to the best credit cards that covers what to look for – but needs updating on the specifics. (Hint hint!)

8. Embrace open-mindedness and a growth mindset

Now that we’ve got you prepped financially for your new life in the UK, it’s time to enjoy it.

While exciting, coming to a new culture can be tough, so it’s important to stay open-minded and curious about learning about the UK.

Be sure to speak up for yourself, network, and share your own background and culture with love. Nurture your ‘growth mindset’.

Personal finance for immigrants is all part of our adventure

Surprises, twists, and turns will come your way, so stay present in the journey and trust your ability to adapt.

After all, you’re learning and growing.

Oh, and welcome to the UK!

Monevator has lots of non-native born readers, so please share your tips and experiences on personal finance for immigrants in the comments below. And do check back for more articles from The Learner.

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