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The Slow and Steady passive portfolio update: Q1 2019

The portfolio is up 7.65% year-to-date

Heresy! Prepare the stake and firelighters, for I am about to commit passive investing heresy most foul. I am going to invest part of our Slow & Steady portfolio into an active fund.

I can see the mob forming now. Loathing hangs in the air like smoke, torches spark, lips snarl, my mother turns her back.

But allow me to… explain.

We need inflation protection. When inflation runs amok, the only reliable guard is inflation-linked bonds. Yes, equities outpace inflation over the long term but they’re likely to be mauled when price rises get out of control. Witness the -74% smashing of UK equities from 1972 to 1975.

As for gold and commodities more broadly – neither are dependable allies.

No, it has to be inflation-linked bonds and I believe there’s an active fund that addresses the needs of the Slow & Steady portfolio better than any rival index tracker.

The answers to three questions explain my thinking:

  • When is it okay to choose an active fund?
  • What is it about this fund that makes it the chosen one?
  • What’s wrong with the competing index trackers?

Let’s go through these questions, and then you can burn me as a heretic and scare the children with my blackened bones.

My championing of passive investing and index trackers is not ideological. It’s pure pragmatism based on the overwhelming evidence that low-cost investments and strategic asset allocation win better results for investors (as a group) than high cost investments and market-timing techniques.

I’ll choose an active fund when:

  • It’s cheap.
  • Its purpose is aligned with my strategic asset allocation objectives.
  • It’s not a black box. In other words, its workings are reasonably well communicated, and the manager’s freedom of action is so constrained that I don’t have to worry they’ll be piling into palladium futures next week.
  • It serves my needs better than any equivalent index trackers.

I believe my chosen fund meets these tests.

What’s the active fund?

It’s the Royal London Short Duration Global Index-Linked Fund – hedged to the pound.

This fund mostly trades in the high-quality, low volatility, inflation-linked government bonds needed to protect the Slow and Steady portfolio from high and unexpected inflation.

It’s cheap at 0.25% OCF – the same price you’d expect to pay for a global government bond index tracker that’s hedged to the pound. It’s not as cheap as the Vanguard UK inflation-linked gilt fund it’s replacing in our model portfolio. But that fund and others like it have a major problem.

The problem with UK inflation-linked gilt funds of all stripes is that they harbour real interest rate risk. They’re like prime beef cows carrying a nasty brain disease you’d rather not take a chance on.

In summary:

  • UK inflation-linked gilt funds are dominated by long bonds.
  • Long bonds are likely to suffer most if real interest rates rise.
  • Real interest rates have been bouncing along the historical bottom since the Global Financial Crisis.
  • If rates rebound then the long bond vulnerability of inflation-linked gilt funds could drown out their anti-inflation benefit – and stiff you with significant losses.

The fix is a fund that invests in shorter duration inflation-linked bonds. This way you get inflation-protection with lower real interest rate risk. A short duration fund will still take a hit if interest rates rise, but it’s less sensitive because it quickly replaces low yielding bonds as they mature with higher yielding versions.

The only shortish inflation-linked UK gilt funds I can find come with eye-watering price tags because they must be bought through approved financial advisors.

In contrast the Royal London fund is reasonably priced, widely available, and its global inflation-linked bonds can stand in for gilts due to their high quality and returns that are hedged back to the pound.

The Royal London holdings have a short average duration of 5. This means the fund stands to lose 5% of its value in the face of a 1% interest rate rise – which compares well with a 21% loss for the Vanguard inflation-linked fund in the face of the same rate rise1.

The fund holds a diversified portfolio of bonds with credit ratings that are mostly as high or higher than UK equivalents.

Global inflation-linked bonds won’t precisely match UK inflation rates but the evidence suggests they’re reassuringly close and owning them adds a diversification benefit to boot. And more than 20% of the fund’s holdings are in UK bonds.

The Royal London fund has existed for over three years and stuck to its mission of investing mainly in global inflation-linked and UK bonds.

It can invest in conventional bonds, corporate bonds, and in fixed income instruments with a lower credit rating than enjoyed by the UK government. But Royal London publishes plenty of information so I can keep an eye on things and sell if the managers head off the map.

I’m comfortable that the fund fulfils the Slow & Steady’s anti-inflation asset allocation requirements now and in the probable future.

I’m not interested in the fund’s recent performance. This move is about building fit-for-purpose inflation-proofing into the portfolio; short-term results are irrelevant. I expect this allocation to hand us a slightly negative return in the years ahead, given how low bond yields are and the market’s low inflation expectations.

So I’ll keep our inflation-linked bond asset allocation at 5% for now, but build it up quite quickly to 50% (of the total fixed income allocation) as our time horizon ticks down.

With plenty of recovery time still on our portfolio clock, I think we’re currently better served by mostly holding conventional government bonds with greater powers to counterbalance equity losses during a recession.

Must you do this?

There is an index tracker alternative: the Legal & General Global Inflation Linked Bond Index Fund.

I could happily invest in this fund, too. The trade-offs are:

  • It’s an index tracker so there’s no need to worry about mission creep.
  • It’s less diversified because it’s ex-UK – so no UK bonds at all.
  • It’s a touch more expensive at 0.27% OCF.
  • Its duration of 8 carries slightly more interest rate risk. However, that duration still fits with our model portfolio’s remaining 12-year time horizon.

There isn’t a huge amount in it. If you’re uncomfortable with going over to the active side, and have a time horizon greater than eight years, then the L&G fund is worth researching. (Shout out to Monevator reader Mr Optimistic for reminding me of both these global linker funds in the comments to the last episode of the Slow & Steady portfolio).

Incidentally, the real interest rate risk embedded in the Vanguard inflation-linked fund hasn’t materialised in the four years we’ve held it. And it has performed creditably for us: 8.93% annualised return, which ranks fourth out of seven funds.

But the results aren’t the point. What matters is we can’t rely on it to play its part in our portfolio and we have better alternatives.

Using an active fund like this does not change our passive investing stance in my view. We’re not market-timing, we’re not choosing the fund because we think it’s hot. We haven’t abandoned our investment principles. We are simply using the best fund available to meet our long-term asset allocation needs and to protect ourselves from foreseeable risk.

Hot! Hot! Hot!

I don’t know if I’ve done enough to extinguish the purifying flames. Hopefully the wood bundles are being taken away and I’m welcome back to the fold as a black sheep rather than roast lamb.

Either way, the Slow & Steady Portfolio has had a smoking quarter. It’s recovered much of the ground lost between October and December, with our annualised return now clocking in at a healthy 9.15%. Check it out in EyeBurn Neuro-vision:


The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £955 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.

New transactions

So as mentioned ever so briefly above, we’re selling off our Vanguard UK Inflation-Linked Gilt Index Fund. We’ll replace it with the Royal London Short Duration Global Index-Linked Fund.

Every quarter we also contribute £955 in new cash that’s split between our seven funds according to our predetermined asset allocation. The Royal London fund therefore picks up the share of new cash allocated to inflation-linked bonds: £47.75 or 5%.

We rebalance using Larry Swedroe’s 5/25 rule but that hasn’t been activated this quarter, therefore our trades play out like this:

UK equity

Vanguard FTSE UK All-Share Index Trust – OCF 0.08%

Fund identifier: GB00B3X7QG63

New purchase: £47.75

Buy 0.236 units @ £202.44

Target allocation: 5%

Developed world ex-UK equities

Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.15%

Fund identifier: GB00B59G4Q73

New purchase: £353.35

Buy 1.007 units @ £350.93

Target allocation: 37%

Global small cap equities

Vanguard Global Small-Cap Index Fund – OCF 0.38%

Fund identifier: IE00B3X1NT05

New purchase: £57.30

Buy 0.2 units @ £285.94

Target allocation: 6%

Emerging market equities

iShares Emerging Markets Equity Index Fund D – OCF 0.26%

Fund identifier: GB00B84DY642

New purchase: £95.50

Buy 59.95 units @ £1.59

Target allocation: 10%

Global property

iShares Global Property Securities Equity Index Fund D – OCF 0.22%

Fund identifier: GB00B5BFJG71

New purchase: £57.30

Buy 25.963 units @ £2.21

Target allocation: 6%

UK gilts

Vanguard UK Government Bond Index – OCF 0.15%

Fund identifier: IE00B1S75374

New purchase: £296.05

Buy 1.744 units @ £169.72

Target allocation: 31%

UK index-linked gilts [Previous allocation, getting sold]

Vanguard UK Inflation-Linked Gilt Index Fund – OCF 0.15%

Fund identifier: GB00B45Q9038

Sell all: £2185.46

Sell 10.964 units @ £199.34

Target allocation: 5%

Global index-linked bonds [Previous allocation, getting bought]

Royal London Short Duration Global Index-Linked Fund – OCF 0.25%

Fund identifier: GB00BD050F05

New purchase: £2233.21

Buy 2157.691 units @ £1.04

Target allocation: 5%

New investment = £955

Trading cost = £0

Platform fee = 0.25% per annum.

This model portfolio is notionally held with Cavendish Online. Take a look at our online broker table for other good platform options. Look at flat fee brokers if your ISA portfolio is worth substantially more than £25,000. The Slow & Steady portfolio is now worth £45,000 but the fee saving isn’t quite juicy enough for us to push the button on the move yet.

Average portfolio OCF = 0.18%

If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.

Take it steady,

The Accumulator

  1. In principle, all things being equal, and all manner of extra caveats that could fill the internet. []

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{ 62 comments… add one }
  • 51 Gentleman's Family Finances April 5, 2019, 2:03 pm

    Slow and steady is good – but I would suggest that keeping it simple is just as important.

  • 52 The Investor April 5, 2019, 2:08 pm

    @J.D. — Thanks for the nice comments. Regarding the maths, there is a logic to author @TA’s apparent madness. He said to me:

    They don’t. It’s because you’re adding uk linkers and global linkers. But we replaced U.K. with global. I left the allocation in so people could see it was a straight swap. I can see how it could be confusing though.

    I can see the use of leaving it in for this month but also agree it’s confusing. So I’ve amended the headings of the two relevant tranches. Hope it’s clearer now. Cheers!

  • 53 The Rhino April 5, 2019, 4:14 pm

    @Duncurin – have you compared and contrasted your actual returns (net return after all costs) against the vanguard literature data for VGLS80 by any chance? How do they stack up? I think I’m going to attempt a similar calculation. Are you looking at the acc. or inc. version?

  • 54 Vanguardfan April 5, 2019, 7:18 pm

    @duncurin, I think I’m with you. Every time TA writes about some kind of nuance it stresses me out, now I’m thinking ‘yikes, should I get this shiny new inflation protection too?’
    Ok I know the real answer is to switch off Monevator, but it’s too good…
    I am edging towards more and more simplicity though. The interesting thing is that I looked after my father’s assets and had no problem dumping the whole lot in LS60, why can’t I do that with ours?

  • 55 Duncurin April 5, 2019, 8:57 pm

    I don’t keep detailed records. I’m in drawdown. On 4th April 2016 my (accumulation) units were worth £145.05 each (some were sold at that price). On 1st April 2019 they were worth £199.91 each (again sold at that price), which represents an increase of 37.8%. Fiddling about with logs gives an annualised 3 year gain of 11.28%. According to Morningstar the official 3yr annualised gain was 11.62%.

    In 2016 they were held by Charles Stanley Direct and I was paying 0.25% pa charges. When CSD increased their charges to 0.35% I switched to Vanguard who charge 0.15% pa. So presumably if I’d been with Vanguard all along (not possible as they didn’t offer investment accounts in 2016) my net annualised gain over the 3yr would have been 11.47%.

    Sorry if this all sounds hopelessly naive!

    I think Monevator is great too. I read it a lot before deciding to stick everything in LS80 (heavily influenced by that Lars chappie). I still read it out of interest, but I know that fiddling about would cause me anxiety. I’m just glad that LS80 seems to be doing fairly well compared to The Accumulator’s slow & steady portfolio.

  • 56 Duncurin April 5, 2019, 9:11 pm

    Oops! Sorry, I meant that my annualised 3yr gain after deduction of 0.15%pa fees would have been 11.13%.

    That really is rather pleasing, despite the various dangers that could strike without warning at any time. According to the BoE inflation averaged 2.9% pa over the past three years, so the portfolio has increased by about 8% pa in real terms.

  • 57 The Accumulator April 5, 2019, 9:37 pm

    @ Vanguardfan – sorry for stressing you out 😉

    I think a Lifestrategy portfolio is a fine choice. However, Duncurin is in the enviable position of not being reliant on his portfolio. I think I’m right in saying, Duncurin, that your pension takes care of your essentials. On the assumption that your pension (perhaps a mix of final salary and state) is index-linked then you have plenty of inflation protection. The pension replaces the linker fund in this scenario. I will not enjoy that level of in-built inflation protection. So if I was boiling everything down to the simplest solution for me: I’d choose something like LifeStrategy and add an inflation-linked fund. Intriguingly, Vanguard Target Date funds do increase their allocation to index-linked gilts as the target date nears.

  • 58 Grislybear April 5, 2019, 10:09 pm

    Very good article on index linked funds. I can follow your thinking and your conclusions. I had a good think and done some research on linkers last year. I came to the conclusion that the best way for me to reduce duration was to combine a regular UK linker etf (duration 22 years) with a US 5 year tipps fund (duration 2 years). The end result would be a duration of whatever you want depending on the mix.

  • 59 uhm April 10, 2019, 10:14 pm

    Did you look at the X-trackers Global Inflation Linked Bond ETF GBP Hedged? It has a fee of 0.25% as well. Was the duration or the average maturity a factor?
    I have held it and the actively managed Fidelity Global Inflation Linked Bond Fund (as recommended by Tim Hale at the time). Between the two, the x-trackers ETF has performed far better.

  • 60 Haphazard April 11, 2019, 9:48 am

    Great article on how to deal with inflation linked funds. I’d be tempted by the Royal London fund. But I’ve never bought distributing funds – not in an ISA. Wouldn’t that mean charges for reinvesting – at least with some brokers? There doesn’t seem to be a non-distributing version of it. Or am I missing something?
    And does all of this matter to those of us with a 20-25 year horizon?

  • 61 The Accumulator April 19, 2019, 10:58 am

    @ Uhm – I think XGIG is a reasonable choice. For the Slow & Steady portfolio, the duration is a little high. It’s around 12 and I’d only have to introduce a shorter duration fund in the next few months anyway to start bringing that down. That’s a bit too much faff. However, if your time horizon is above 12 then it’s worth a look especially as it looks to contain around 30% index-linked gilts. There are a couple of other things that make me uncomfortable: it tracks the Euro version of the index even though it hedges to £. I’d need to look into that more deeply to understand the full implications but intuitively that makes me uneasy. Secondly, important information on the ETF’s asset allocation is based on the index rather than the ETF’s actual holdings. It samples the index rather than fully replicates. I’d prefer to see how faithful the ETF is to its index. All that said, the very fact that it tracks a developed world linker index is a step up from active management, so certainly this ETF should be in the mix if you’re looking for inflation protection. The Fidelity fund seems fine too but expensive at 0.51% OCF. Active management too, and quite a wide-ranging remit, but they publish plenty of info so you can keep an eye on it. How long have you held them both?
    Thanks very much for bringing up these two funds, btw. Helps round out the discussion and widen everyone’s options.

  • 62 The Accumulator April 19, 2019, 11:10 am

    @ Haphazard – You can reinvest distributions at the same time as making new contributions, so there’s no need for an Inc fund to increase your dealing costs if your broker charges them. I also find Inc distributions handy to set against platform fees. There does seems to be an Acc version on Royal London’s books but I couldn’t find a broker that actually makes it available.
    Re: 20-25 year time horizon. This is a great question. For me, it depends on your risk tolerance. All things being equal, and assuming you’ll review your position as the time horizon counts down, I think it matters much less. But it depends on how you’d react during a period of rampant inflation that hit the rest of your portfolio hard. It’s a credible scenario and I’m inclined to protect myself from it by diversifying into the best asset class available. I’d choose a longer duration fund with this time horizon though I still wouldn’t have the courage to opt for an index-linked gilt fund.

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