It’s a hard time to be a risk-averse investor. All the funds in the Monevator model portfolio are burning red and raw. And whereas in previous market beatings our bonds have acted like a shock-absorbing magazine down the trousers, this time they’ve been as much relief as barbed wire underpants.
Let’s cut to the gore. Brought to you in 5D-Nightmare-O-Vision:
The Slow & Steady portfolio is Monevator’s model passive investing 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 and find all the previous passive portfolio posts tucked away in the Monevator vaults.
Year-to-date the model portfolio is down 10%. In cash terms, we’ve given up one year of growth.
That doesn’t sound so bad… until you slap on 9% inflation.
In real terms we’re heading into bear country.
Big picture, that’s still okay. You’ve got to be able to handle bear markets. They run wild at least once a decade.
But things seem especially grim right now because nothing seems to be working.
In particular, if you thought bonds were ‘safe’ then the current crash must feel bewildering. Unfortunately, high, unexpected inflation is the bête noire of bonds.
Long bonds have had a dreadful year so far. 2022 looks like it could inflict scars as deep as 1974’s real loss of -29% or 1916’s -33% on holders of UK gilts.
Other fixed income sub-asset classes have been various shades of awful, too:
What rampant inflation does to fixed income
Source: justETF. 7 Dec 2021-9 Jul 2022. (I’ve used representative ETFs for ease of charting).
When high inflation takes the world by surprise this is what you’d expect to see.
Fixed income funds take capital losses because bond prices fall as their yields rise.
Long duration gilts crash hardest. They’re full of low-yielding bonds with decades to go until they mature, and so their prices fall farthest when their interest rates climb.
Long-dated index-linked bond funds (labelled ‘long linkers’ on the chart) face-plant for the same reason. They’re stuffed full of low-interest bonds that are uncompetitive versus the higher-yielding bonds now entering the market. So their yields must rise – and their price fall – to bring them back in line. We first warned of the dangers baked into such funds in 2016.
Short gilt funds are less perturbed by rising yields. Like the other bond funds their holdings are repriced as interest rates rise, hence the small loss we see on the chart. But as their bonds have only a few years left to run, they were already priced closer to their redemption value. This means there’s less scope for capital losses. Moreover the uncompetitive bonds they own will mature sooner and disappear off the books. The fund will recycle the money released into higher-interest paying bonds. Over longer timeframes this process can offset the fund’s capital losses with higher income, bolstering total returns.
Better than nothing
As a bond holder, earning a higher yield will make you better off. But it takes time to recover from the initial price drop.
The higher-yielding bonds we now own are like nanobots. Laying down interest like beads of protein, they’ll eventually seal the hole that was torn in your wealth by rising rates.
Every bond fund benefits from this same self-regenerating mechanism. But it takes higher-yielding long bond funds more time to redeploy and they have a bigger hole to fill. Hence the greater losses we see.
The upside is that in a stable or falling interest rate environment – such as the past decade – long bond funds eventually outperform their shorter-dated brethren. (Something to look forward to again, someday.)
A medium or intermediate gilt fund (labelled ‘medium’ on the graph) is a muddy compromise sitting between the long and short bond paths charted above.
Even short index-linked bond funds (labelled ‘short linkers’) suffer capital losses from rising yields. When those falls overwhelm their inflation-adjusted interest payments, the funds disappoint despite the inflationary backdrop.
That’s what’s happening right now with the Short Duration Global Index Linked fund in the Slow & Steady portfolio.
We’d prefer it to stiffen against inflation immediately like a bulletproof vest. Unfortunately we must do some bleeding first.
At least our linker fund is less bad than most of our other holdings. (How’s that for a glowing recommendation?)
Cash is like an extremely short-dated bond, hence there are no capital losses in the chart. That’s as good as it gets in the current moment. Though obviously cash is still down after inflation.
No good choices
While long and medium government bond funds will unfortunately be a liability if market interest rates continue to rise, you’ll thank god for them if the economy tips into a deep recession. (Of the non-stagflationary variety).
That’s why you’d be wrong to throw your medium bond holdings onto the fire.
You might be cursing your luck if you’ve recently been burned. But you shouldn’t question your need for diversification. For an escape pod with a decent chance of working when the wheel of fortune suddenly spins again.
Personally I’ve felt like a bystander caught in a Mexican standoff for a while now. Trapped between the cocked pistols of rising rates, market shocks, and inflated asset prices.
There was no way out without getting hurt.
The best we could do was advocate a multi-layered defence against the uncertainty:
- 60% Global equities (growth)
- 10% High-quality intermediate government bonds (recession resistant)
- 10% High-quality index-linked government bonds (inflation resistant)
- 10% Cash (liquidity and optionality)
- 10% Gold (extra diversification)
A young, risk-tolerant investor should probably opt for more in equities and allow future decades of compounding to smooth out the potholes in the road.
Ready for anything
There seems a reasonable probability that higher inflation will stink the place up for longer than most of us imagined 18-months ago.
If that’s so, then our portfolios are in for a hard time.
But don’t mistake probability for certainty.
The masters of the universe didn’t see inflation coming. They said it was transitory. Now it could herald regime change.
They don’t know and neither do we.
So keep your options option.
New transactions
Every quarter we buy £1,055 of shots for our portfolio punch bowl. Our poison is split between seven funds, as per our predetermined asset allocation.
We rebalance using Larry Swedroe’s 5/25 rule. That hasn’t been activated this quarter.
These are our trades:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £52.75
Buy 0.234 units @ £225.24
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 0.78 units @ £500.22
Target allocation: 37%
Global small cap equities
Vanguard Global Small-Cap Index Fund – OCF 0.29%
Fund identifier: IE00B3X1NT05
New purchase: £52.75
Buy 0.145 units @ £363.39
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.19%
Fund identifier: GB00B84DY642
New purchase: £84.40
Buy 45.867 units @ £1.84
Target allocation: 8%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £52.75
Buy 22.265 units @ £2.37
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £305.95
Buy 2.01 units @ £151.93
Target allocation: 29%
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £116.05
Buy 106.273 units @ £1.09
Dividends reinvested: £80.72 (Buys another 73.92 units)
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 for cheaper platform options if you use a different mix of funds. InvestEngine is even cheaper if you’re happy to invest in ETFs only.
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 such as Vanguard’s LifeStrategy series.
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? This piece on portfolio tracking shows you how.
Take it steady,
The Accumulator
Tough times for all of us and going to get tougher
My very conservative portfolio 32/63/5 -equities/bonds/cash down 9%
(3 Global Index funds only-equities and bonds)
Add inflation……..
No where to hide
I am slowing down at 75 anyway but a dose of frugality unfortunately awaits us all
Reality (which seems to have been in hiding for many years) in all its various manifestations (Putin,gas prices etc etc) is a hard task master
No doubt all will pass as it always does but “How long O Lord how long” Psalm 13
I away to read a good (long) book!
xxd09
Yes, grim times. This too shall pass.
Cash, Gold and a dodgy currency are hiding a lot of sins in my portfolio. Checking my latest valuations, I’m nominally down less than 1% since end of December. in reality, I suppose about 20% with inflation and devaluation.
Ho-hum.
Don’t panic.
Epictetus put it this way:
Do not ask things to happen as you wish, but wish them to happen as they do, and your life will go smoothly (Handbook, 8).
Down 7% nominal, but life goes on…
Not too shabby considering the circumstances @TA, it could have been a lot worse.
Mine has been accidentally cash heavy since Xmas which has saved me a bit and the downtown in the stocks and shares has just been covered by an unexpected voluntary redundancy package (go me) so I find myself retiring two months earlier than planned. .. not before time. Chilling in Portugal now with friends and family, a little tidying up at work and I’m done. The next stage of funemployment is about to commence. Bring it on.
This is the most excitement I’ve seen in a Slow And Steady Passive Portfolio Update post ever…
…I might need a stiff drink and as sit down
Hi Acc,
Really good synopsis. Loved it.
On circa 11 years I make that a 4.2% compound rate before inflation – presumably due to the bond weighting as the share ETFs have done well over the last 5 plus years. I see my faves of VWRP / VWRL are “only” down 9% YTD (eeeek!) .
Now the big question. You suggested a younger more risk tolerant investor may re-weight to equities, so what’s the higher end of “young” in that scenario?
Again, great update
Scratch the 4.2% – you’ve diligently put in 4k per year so its considerably more than that
Share prices can go down and assets with low/negative correlation sometimes refuse to always follow this rule. These things happen. Often.
I split my bond allocation four ways, with splits between gilts and corporates, and long/short duration. Yes, not exactly by the book, but neither was boots being filled with global infrastructure as a deeply-debatable bond proxy either.
I can look at our pension and ISA portfolios with mild disappointment rather than serious angst, and this despite us being retired and in drawdown.
Great stuff as always.
Forgive my lack of technical ability to work this out myself, but has the S&S outperformed Capital Gearing NAV since inception? Would be quite fascinating to compare. Thanks.
Great update, very informative!
I follow my portfolios once a week to collect more data points for analysis. Last week, I went up by a tiny bit in sterling (3bp) compared to the week before but down 0.5% if I convert the valuation of all portfolios to USD. So now I’m down 2.92% from my peak at the end of April in £, but converting into USD I’m down 5.65% from the latest peak.
Another great update, despite the gloom.
@Marked – anyone under 40 I would say. Enough time for allowing a 10/15 year growth cycle.
Put it this way, I’m 36 and dipping into growth in my ‘active’ portfolio of investment trusts, recently buying and adding too Witan, Mid Wynd and Monks (and Capital Gearing and Murray International) alongside the bigger, regular monthly purchases of Vanguard LS80 as my core.
To throw in a bit more benchmarking:
Year To Date, the “recommended” ” multi-layered defence portfolio”,
implemented as VWRP,VGOV,RoyLon,SGLN,Marcus, is -6.25%.
Perhaps a bit more in line with what people here are buying.
If you hedge the gold it drops to -7.66%.
Isn’t the big picture much more about FX though? The truest 60/40
must be something like 60%VTI/40%VGIT, in dollars, it’s -16%YTD,
and to balance it today, the holder would be selling 10% of their bonds
to buy VTI which has dropped further – just like it should in a proper crash!
It’s really striking just how much linkers have fallen and thus utterly failed to do the job that investors expected them to do.
Not that there’s anything incorrect with how the asset class is performing, as you write, it’s just the duration swamping the inflation effect.
One wonders if an investor can every purchase those in order to hedge inflation given its performance is far more impacted by interest rates.
In which case, it makes more sense just to buy ultra long gilts if you think rates may fall.
Presumably they will start to out perform in a situation where rates do not move but inflation unexpectedly moves higher so one can still see a role although it’s smaller than being your main bulwark against inflation.
For that reason and to hedge the currency decline, I much preferred the US $ TIP equivalent that has a lower duration. Nothing this all smells like currency speculation, asset timing etc as opposed to being purely passive so I appreciate that could have gone wrong and even $TIPS haven’t really performed particularly well.
Some stoic responses out there – good to see. Anyone out there got any crypto? I was having dinner with a couple of friends the other night and it turned out they both had large crypto positions. ‘Had’ being the operative word.
@ JimJim – Huge congratulations! The moment has finally come. Great that you’re kicking off Life 2.0 with a sojourn to Portugal. It’s baking here too, though!
@ Meany – cheers for doing that calculation. That’s interesting. Gold is having a good crisis yet again.
@ Seeking Fire – yes, it must be pretty hideous for anyone who bought a UK linker fund and thought they were set. I just got an interest statement from my small tranche of index-linked savings certs – the interest was more than five times normal. No capital loss to worry about. So at least they’re doing an anti-inflation job.
I’m seeing US articles asking “Are TIPs broken?” too. Perhaps the falling pound makes yours look better relative to a US investor?
@ Marked – Now that’s a personal question 😉 I stopped feeling young when I realised I was within 5 years of the finish line. With hindsight, I rode my luck somewhat. If valuations are high, as they still are, then I’d start winding my risk in with a decade to go. I’d guess I’d take more risk for longer if valuations were low, hoping to surf some mean reversion. It’s such a fraught and personal decision though.
@Seeking Fire – For many years linkers have been a way to preserve a chunk of your future buying power with the downside being that you had to accept the loss of at least some of it. Our only linkers are as many NS&I Index Linked Bonds as we were allowed to buy before they were shut down. We’ve kept on rolling them over for well over a decade but they are now pegged to CPI rather than RPI, and so few basis points above CPI that it’s not worth mentioning.
@TA, on the crypto front, not personally other than a very small amount in a blockchain etf. Interestingly went to my partners parents at the weekend and my father in law proudly sat us through his recent ‘crypto academy qualification’ and how it all ‘works’ (he has no real idea – hope its a play thing with a small amount). Had a few friends who went in big on crypto ‘investing for a house deposit, you should try it’. I haven’t enquired recently how it’s going but don’t delight in schadenfreude.
People need to remember that index-linked bonds should probably be renamed real yield bonds. With nominal bonds you are exposed to changes in nominal yields, with linkers you are exposed to changes in real yields. Since 10-year real yields have moved from -3% to -1.5%, then yields have risen 150bp to levels last seen in 2018. You had locked in a -3% real loss per annum for 10 years. You’ve now taken a 15% or so hit but you’re loss going forward is just -1.5% per annum. Swings and roundabouts etc.
At the end of the day, something like the SS portfolio is just long of stuff. What that stuff is to some degree doesn’t matter. Prices are a function of a projection curve (dividends, coupons, growth rates etc) discounted back off a discount curve. The discount curve has gone up so everything is worth less, even if the projection curve is unchanged. So prices fall. You’ve spent the better part of a decade (if not three) taking the benefit of a lower discount curve, PVing upfront all those gains. Now, you’re seeing a small fraction of those upfront gains being unwound. If you are only long of stuff, then there is no way to hedge that in the same way then there was no way to avoid seeing the gains. Only selling would have helped but that ain’t passive.
agreed with all the comments on linkers etc.
I’m just making the point that for the uninformed and lets be honest, it’s not as if these funds, passive or active funds market themselves as being impacted by interest rates, you’d be thinking, ok inflation at 10%, my fund is up by 10%….whoops. So if you understand duration then you are ok, if not….and I don’t think many people do, then it’s a nasty surprise. It will be a tough sell from here persuading people to buy those funds.
$TIPS have just performed better for a £ investor relatively due to the currency decline and the lower duration. But equally I could have just bought $ and done even better!
I have a few National Savings Certificates but not many. I agree they are worth holding. I can’t see UK gov ever re-offering these whilst they can raise finance at a cheaper rate.
ZX – your comment on discounts rates and PV to date of future gains is disappointingly accurate. I just don’t have the confidence to be short of anything and so have just mentally dialled down the performance of my portfolio to achieving a real return of zero for the next decade. That’s not very good.
@JimJim, nice!
@TA, quite a bit of btc and eth. Since before it was mainstream. Still holding, not bothered about the current fall – seen crypto cycles before. FWIW have several values on the portfolio spreadsheet: current in GBP and USD, estimate for maximum (based on historical) drawdown from previous high for current allocation and another which imagines crypro is zero.
Long time reader, first time commentator. Just a quick one, but the advert on this blog for sofia date has a fairly distasteful “DATE UKRAINIAN WOMEN!” ad emblazoned halfway through the article.
I know the site needs ads to stay alive, but it seems far beneath the quality of your content. Might be worth a tighten up.
“Even short index-linked bond funds (labelled ‘short linkers’) suffer capital losses from rising yields. When those falls overwhelm their inflation-adjusted interest payments, the funds disappoint despite the inflationary backdrop.”
This is something I struggle understand. How inflation-adjusted interest payments are not able to offset the losses caused by rising interest rates when inflation is at 9%. It must be some very small adjustments. Linkers are such a disappointment in the current environment. They don’t do what was said on the label.
@JOSee — Thanks for the feedback. We don’t select the adverts though, they’re served by a third-party agency and Google, targeted to a reader’s previous browsing habits / whatnot (or random I guess if it hasn’t got data on you).
There’s a problem at the moment whereby lots of investment / money companies have drawn in their horns after the horrendous first-half. It’s very visible in our revenue and also I agree in the sort of ads that are served.
Interestingly I keep reading the same from Facebook, Trade Desk, and others. Possibly a reflection of the times, or of worse to come!
@Peter — With respect, I don’t think you’re accepting what the article is saying, rather than you don’t understand it. 🙂
Linkers are doing what they said on the label, people just didn’t understand the price they were paying in the past and how that meant the yields were very low.
At times over the past few years linkers have been priced to deliver NEGATIVE real yields to maturity, unless there was a surprise inflation event (like the one we’re seeing now).
This is what happens when interest rates are very low for years but pension funds and others were forced (regulatory / structurally) to buy index-linked gilts.
See this article from 2019:
https://www.thepfs.org/technical-articles/2019/january/just-say-no-to-negative-real-yields/
This was why @TA changed the constitution of the S&S model portfolio somewhat a few years ago, to try to offset some of these risks.
The shifting interest rate picture has roiled every aspect of the market, as I’ve been warning about since the start of the year (and then moaning when people told me to pipe down haha). Linkers are no different.
Personally I’ve been writing for years that I own no bonds and instead preferred cash. However I am a super-active investor with a high tolerance for risk; I saw my long-term inflation hedging coming from equities, and I was aware of the big drawdown risks and also ready to trade, for good or ill, on my whim.
Most people are not like this, which is why a passive portfolio with a bunch of different assets rebalanced is a better bet for most.
But there will always be something doing badly; right now nearly everything is doing badly for private investors. Linkers are getting their turn in the stocks, but they’ve been a good investment for many years before 2022.
I have finally started building up small positions in INXG and IGLT (long-ish duration gilts and linkers) in 2022 after they finally came off quite a bit but I haven’t decided if they are long-term holds yet. And I’m already underwater on both! Currently the plan is to average down into them over several years.
With all that said, these are long-term assets and one shouldn’t be judging their performance on a quarterly basis alone.
I record my portfolio in euros:
YTD down approx. 8.3 %
The Asset Allocation is a bit random (i.e. slightly overweight UK, underweight US equities, a bit of gold, a chunk of bonds and some in-expert stockpicking) but I’m quite disciplined at rebalancing.
Inflation currently about 10% so, like most others with conservative type portfolios, approaching 20% losses in real terms.
I was much, much, more stressed during the short Covid crash in 2020. If this is the once in a decade bear market I think I can handle it OK 🙂
@TA, Thanks for the update. Ill own up to having some crypto- Ether mainly. Enough to be interesting. Not a complete tail of woe – the first tranche I bought is up over 100%, but recent ones down over 50%. Overall down. Luckily not caught by Celisus, or Anchor but lost a small Luna holding overnight. My thoughts aren’t changed too much – in for the long term.
On a could have, should have note – I looked into the possibility of put options in the early part of the year as insurance but couldn’t find a suitable vehicle!
For perspective this is a smaller part of more sensible stuff including SIPP portfolio (down 15%), and small time property. Maybe time to simplify on the property which is one thing that has held up well.
@ Hague – agreed, psychologically this is very different to the corona crash. Or even the GFC. The speed at which those events moved gave them a ‘things are falling apart’ quality that was deeply unsettling. This feels more like a slow-motion car crash. Not necessarily less damaging but it gives the mind longer to adjust.
Interesting comments on crypto. It felt like I came close to folding during the recent bubble and making my first purchase. I couldn’t do it though. I knew I didn’t understand what was going on. And it felt like a massive bubble. I see crypto purely as a speculative asset class, so am pondering a dabble at these prices given the chance it could rise again.
@ JDW – crypto for a house deposit? That’s insane! Yeah, not surprised you’re staying away from that conversation.
@TA
For me it’s not the speed, from memory I the GFC played out slowly. Covid ( or the lockdowns) were just so unprecedented. There was no history of similar economic conditions to give any context.
The current situation feels much more predicatable. We expect that asset bubbles unwind and we can understand why it’s happening now (inflation, climbing interest rates, etc.). In March 2020, I had no idea how lockdowns would work (or not work) what would be their long-term affects on economy, society, how successful would government support be, etc.
No worries at all! Funny my workplace has had an absolute nightmare trying to advertise through FB at the moment. Definitely a minefield out there.
Keep up the good work. You folks are my go-to recommendation for anyone in the UK. Much appreciated!
@Hague “The current situation feels much more predictable.”
I tend to agree but anyone who hasn’t been actively investing since before GFC might perhaps disagree. Yields had to rise, interest rates had to tick up to something close to long term trend, the FAANGs can only run so far (ditto crypto/ponzi), so a bit of a return to normality.
Yes we have wars (boo!), yes we have silly fuel prices (boo!), but we’ve had them before and we know they tend to blow themselves out and normalise.
I’ve spent the last 12+ months rotating my boring global ETFs (mainly VWRL) into boring income ETFs (mainly GBDV) as a kind of pre-dotage making it even more boring exercise, and I’m going to keep it up TBH.
I may end up at 60% (or even, gasp, 75%) income ETFs and 25% long gilts. This is where I’d have been at retirement if I hadn’t retired when yield curves where mad as a mad thing.
I think the current situation tends to feel more predictable because of our human tendency to take present trends, especially negative ones, and project them outwards. We’re much less imaginative when it comes to predicting countervailing forces or unexpected events that ricochet us on to new trajectories.
In March 2020, the market had a fairly clear view about what a pandemic meant – a tanking economy. Hence fastest bear market in history.
It didn’t turn out that way. On a personal level, it turned out I didn’t need the stocks of basic foodstuffs I bought in a week before supermarket shelves got stripped, because supply chains adjusted with amazing speed.
So what I fear is 1970s stagflation. But it’s too soon to say that’s the path we’re on. There appear to be plenty of exit ramps before we’re irrevocably strapped onto that hell ride.
Plus we no longer live in a 1970’s world, and current policymakers have learned from the mistakes of that era. (I hope).
In much the same way that the GFC did not lead to Great Depression II (as some predicted at the time) partly because we’d learned the lessons of Great Depression I.
FWIW, my memory of the GFC is that it played out incredibly quickly from Lehman on. The world changed from that moment as the financial system locked up and the implications of that hit home. The aftershocks played out for years but the news was unrelentingly bleak from Sep 2008 through much of 2009.
@JimJim:
Nice one.
A good way to measure your redundancy package is months/years of living expenses over and above any other residual income you may still have. Then the challenge: how far can you comfortably stretch it?
@TA:
Not too shabby a YTD performance given the headlines floating around.
ILSC’s are that rare thing called good news these days?