Once more the contrast between my daily diet of media-amplified fear and the damage done to our Slow & Steady passive portfolio surprises me.
The portfolio is down just 3.5% since its peak last quarter [1]. Essentially, we’re back where we were six months ago.
That’s despite the arrow-headed threats of stagflation, economic crisis, and a geopolitical winter converging on our positions.
We count our blessings as private investors who sleep soundly at night. As ever, you only need glance at the conveyor belt of horror on the news to gain a proper sense of proportion.
Nothing to be down about
In writing about a rare down period for the S&S – when nothing in the portfolio offers much cheer – I’m minded how rarely I’ve had to report a knock back.
The table below shows how often a World equities portfolio has historically registered a loss, depending on how often you checked in on it. (See the ‘Look frequency’ column on the left):
[2]Albion Strategic Consulting is passive investing champion Tim Hale’s [3] firm. This table was published in wealth manager BRWM’s regular newsletter [4].
The Slow & Steady portfolio has only nosed down in ten quarters out of 45, which is just 22% of the time. That compares well with the 31% chance of a quarterly loss suggested by the table.
Negative years have rained on our portfolio’s parade twice in eleven years. That’s 18% of the time versus an expectation of 23%.
We’ve lived through a benign era, which only heightens our fear that it might come undone.
Bond-o-geddon
Indeed, the long-predicted bond reckoning does seem to be upon us. Our bond fund inflicted an 8% loss in the last three months. That compounds a poor 2021.
Here’s this quarter’s portfolio carve-up brought to you by DystopiaVision:
[5]
The Slow & Steady portfolio is Monevator’s model passive investing [6] portfolio. It was set up at the start of 2011 with £3,000. An extra £1,055 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story [7] and find all the previous passive portfolio posts [8] tucked away in the Monevator vaults.
The one-year return for our UK government bond fund is -6%. Layer on the current annual inflation rate of 5.5% (CPIH) and you’re looking at a real return loss of 11.5%.
Conventional UK gilts [9] are quite capable of inflicting double-digit annual losses.
2013 and 2021 both returned a -10% inflation-adjusted loss.
Before that, 1994 brought -14% worth of bond pain.
You have to go back to the stagflationary 1970s to see big bond losses in consecutive years though. UK government bonds took a -47.6% real terms pasting between 1972 and 1974.
Nasty, but it’s not wealth-wrecking on the scale of UK stock market storms such as:
- -73% 1972-74 [10]
- -41% 2000-02
- -45% 2007-09 during the Global Financial Crisis [11]
- -32% in a single month of the coronavirus crash [12]
Moreover the bond losses quoted above measure the hit to long gilts. You’d have suffered less if you held intermediate or short-dated bonds.
This post on bond prices [13] explains how bond losses (and gains) work.
It’s always darkest before dawn
People seem to intuitively understand mean-reversion when it comes to equities, but miss how bonds sow the seeds of their own resurrection.
Capital losses today mean your bond holdings will reinvest in higher-yielding varieties tomorrow.
That mechanism will eventually put you further ahead, compared to if yields hadn’t risen.
Inflation-linked bonds go AWOL
Notably our global inflation-linked bond fund isn’t covering itself in glory – despite spiralling prices in the shops and on the petrol station forecourts.
Our fund somehow managed to return -0.26% over the last quarter. How can that be?
The data below shows that investors were bidding up index-linked bonds from 2019 – well before official inflation rates took off in 2021.
[14]
[15]
Source: Royal London Asset Management [16]
The market saw inflation coming and our fund did okay these last three years. Though it still lags all of our equity funds over the same period.
The problem is short-dated government bonds only offer so much juice. And inflation-linked bonds are battling a negative yield [17] headwind before they can even register a gain.
Also note that our fund can drop if the market anticipates lower inflation, even while we grit our teeth when filling up the car.
A short-dated fund like this is not going to make you rich. It’s about capital preservation.
If inflation explodes then it’ll protect a corner of your portfolio while equities and conventional bonds get their marrow sucked.
From that perspective, our inflation-linked fund is doing its joyless job.
If I was an early to mid-stage accumulator then I’d likely dispense with this asset class. I’d rely on equities to beat inflation over the long term instead.
Investing in index-linked bonds is probably something that can wait until you’re on the glidepath to decumulation. Perhaps ten or even just five years out.
We have an upcoming post on inflation hedges [18] that will investigate the reasons why.
Leave well alone
We only need rewind the clock a couple of years to recall that inflation worries were about as fashionable as a mutton-chopped general preparing to fight the last war.
Chalk it up as another piece of evidence that few can predict what’s going to happen next.
Conventional bond losses could mount. On the other hand, they could be your best refuge if a colossal recession lies around the bend.
It always makes sense to maintain a dry powder store of bonds to cushion your losses and buy equities on sale.
That’s why given the balance of risks, in recent years we’ve been advocating capping bond exposure rather than throwing them overboard.
If you own a 60/40 portfolio [19] then perhaps you can tolerate a 65/35 or 70/30 equity/bond mix.
Your defensive asset allocation [20] is hard to judge. Tread cautiously, and assume your risk tolerance [21] is lower than you think.
New transactions
Every quarter we buy £1,055 of ammunition for the skeet shoot that is the global market. Our shots at glory are split between seven funds, as per our predetermined asset allocation.
We rebalance using Larry Swedroe’s 5/25 rule [22]. That hasn’t been activated this quarter.
These are our trades:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF [23] 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £52.75
Buy 0.223 units @ £236.50
Target allocation: 5%
Developed world ex-UK equities
Vanguard FTSE Developed World ex-UK Equity Index Fund – OCF 0.14%
Fund identifier: GB00B59G4Q73
New purchase: £390.35
Buy 0.728 units @ £536.24
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
New purchase: £52.75
Buy 0.133 units @ £395.58
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.19%
Fund identifier: GB00B84DY642
New purchase: £84.40
Buy 44.858 units @ £1.88
Target allocation: 8%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £52.75
Buy 20.303 units @ £2.60
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £305.95
Buy 1.83 units @ £167.17
Target allocation: 29%
Global inflation-linked bonds [24]
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £116.05
Buy 102.608 units @ £1.13
Target allocation: 11%
New investment = £1,055
Trading cost = £0
Platform fee = 0.35% per annum.
This model fund portfolio is notionally held with Charles Stanley Direct. Take a look at our online broker table [25] for cheaper platform options if you use a different mix of funds. InvestEngine [26] is even cheaper if you’re happy to invest only in ETFs.
Average portfolio OCF = 0.16%
If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund [27] such as Vanguard’s LifeStrategy series [28].
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? This piece on portfolio tracking [29] shows you how.
Take it steady,
The Accumulator