Aaargh! [Breathes deeply. Thinks about dolphins.] That’s better. [Peeks through fingers and looks at portfolio again.] Aaaaaaargh!
If you enjoyed the disaster movie Don’t Look Up, you’ll love the sequel: Don’t Look Up Your Portfolio.
Bad things are happening in there.
The Slow & Steady passive portfolio is taking its biggest run of beatings ever. For the first time in a dozen years we’re down for three calendar quarters in a row.
Our UK government bond losses are especially grim. Government bonds are on course for their worst year in history.
But let’s not get too despondent. For all the drama, the portfolio is still only down 15% in 2022.
And less – 11% – over one full year.
Step back and we’re up 6.26% for every one of the 12 years we’ve been tracking the portfolio. Call it a 4% real annualised return.1
Admittedly, if you add inflation to this year’s nominal losses then for sure we’re deep in bear market territory this year.
But previous generations of investors have come back from worse.
First we have to get through the present. And it’s natural to second-guess your decisions in the midst of market declines like we’ve seen in 2022.
In particular, you may be questioning why you bought bonds in the first place.
We do need to talk, but first let’s face up to the results. They’re not pretty:
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.
Bond-o-geddon
Nothing is working right now. Rapidly rising inflation and interest rates are scalping everything in sight.
But it’s most unsettling that bonds – supposedly our refuge in difficult times – are plunging like equities.
Our gilts tracker is down -28% year to date.
Previously the worst annual return for gilts was -33% in 1916 – recorded in the year the British army was scythed down at the Somme.
That was a real return though and they were extremely long bonds.2
This year UK long gilts are cratering even harder than their World War One counterparts. They’re down -45% year-to-date3. With inflation raining hammer blows on top.
This matters because if you’re cursing your choices it’s important to know you’re caught in the cross-hairs of history.
On one front we’re suffering the withdrawal symptoms that accompany the world giving up its negative interest rate meds.
On another we’re dealing with a needless act of economic quackery by our own prime minister, Liz Truss. Like an ill-qualified psychiatrist she’s determined to unleash her experimental electro-shock therapy while the patient lies strapped and terrified on the table.
As Truss fiddles with the voltage, gilts’ vital signs have deteriorated faster than their global peers. Culminating in a cardiac arrest that only the Bank of England could step in to relieve:
Source: justETF: intermediate gilt ETF vs intermediate global gov bonds (GBP-hedged)
This is a self-inflicted wound. It’s also a political choice.
Which means much of the harm can be undone by another political act. Polls point to a Tory rout. The party will force Truss to recant, or it will decapitate yet another leader if she won’t. They’ve got form.
Hence the UK-only damage suffered by government bonds may yet be reversed – at least in part.
But even then the wider global sell-off would make any holder plenty miserable.
Buy high, sell low?
We all know that buy high, sell low is a classic blunder. So why is your hand still magnetically attracted to the sell button next to your bond ETF?
Offloading bonds during their darkest hour is probably a mistake. Swearing off them for life is probably a mistake.
Falling prices have certainly inflicted a short-term defeat on most bond funds. But lower prices equate to higher yields. That’s bond maths 101.
Moreover as yields are up across the board, investors will demand higher coupons4 in exchange for buying the future debt issued by the government.
It takes time but these improved cashflows will actually set our bond funds on a higher growth path than they were previously taking.
As your fund sells off its old bonds, the proceeds are ploughed into the new higher-yielding variants that are coming on to the market.
And as those new bonds pay more interest, it gets reinvested (if you own an accumulation fund or do it yourself), ratcheting up the transition from low income assets to higher income ones.
Pound-cost averaging accelerates the process. New money buys more of the higher-yielding debt.
The upshot is your bond fund will eventually deliver a higher annualised return – after interest rates stabilise – than if we’d never gone through this.
How long that will take depends on the average duration of your fund. The longer duration your bonds, the longer it takes – but the greater the potential reward.
Carry on regardless?
It’s the same principle as when equities are on sale. High-quality government bonds are now a better deal than they were.
Plus, if the wind changes direction again and the economy goes into recessionary convulsions, then nominal government bonds are still the best diversifier you can buy.
Big picture it’s a bit more complicated.
We flagged problems with a simple 60-40 portfolio in 2021. Because no asset class always works, we argued for greater diversity on the defensive (40%) side:
- 60% Global equities (growth)
- 10% High-quality intermediate government bonds (recession resistant)
- 10% High-quality short index-linked government bonds (inflation hedge)
- 10% Cash (liquidity and optionality)
- 10% Gold (extra diversification)
Those were reasonable calls:
- In the passive portfolio, our short index-linked bond fund is down 6% year-to-date. Not down -30% like a long-dated UK index-linked gilt tracker. (We took evasive action back in 2019).
- Cash is currently yielding 2% and gold is up nearly 13% so far this year.
I’d still urge that level of diversification for a baseline portfolio, although we’ll continue to track the Slow & Steady as it stands, sans gold and cash.
Note your optimal allocation to equities may be higher if you can handle the risk.
Relegation form
I’d like to advocate one more change for us to think about.
I used to be ambivalent about whether to pick intermediate gilts or intermediate global government bonds (currency-hedged back to the pound) for recession protection.
Gilts were the obvious choice for a UK investor, and as a proud Brit I was happy to hold them. I bought into the idea that we belonged in the premier league of nations.
Well, the last six years and one month have smashed that delusion.
We could argue about Brexit and probably will forever. But you can’t argue with the decline of the pound and the gilt market’s verdict on Trussonomics.
If you want to know what hard-headed, independent operators think of the UK’s recent performance then just consult the charts. Money talks and it’s telling us this country is in a relegation battle.
And so I wish I’d chosen to diversify my fixed income risks with a global government bond fund.
Other countries may put maniacs and shysters in charge, but I thought it couldn’t happen here.
Come to Jesus.
New transactions
Every quarter we throw £1,055 into the market wishing well. Our hopes and dreams are 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. Thank heavens.
These are our trades:
UK equity
Vanguard FTSE UK All-Share Index Trust – OCF 0.06%
Fund identifier: GB00B3X7QG63
New purchase: £52.75
Buy 0.245 units @ £215.18
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 0.791 units @ £493.64
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 @ £362.80
Target allocation: 5%
Emerging market equities
iShares Emerging Markets Equity Index Fund D – OCF 0.2%
Fund identifier: GB00B84DY642
New purchase: £84.40
Buy 47.209 units @ £1.79
Target allocation: 8%
Global property
iShares Global Property Securities Equity Index Fund D – OCF 0.17%
Fund identifier: GB00B5BFJG71
New purchase: £52.75
Buy 23.656 units @ £2.23
Target allocation: 5%
UK gilts
Vanguard UK Government Bond Index – OCF 0.12%
Fund identifier: IE00B1S75374
New purchase: £305.95
Buy 2.344 units @ £130.52
Target allocation: 29%
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £116.05
Buy 110.84 units @ £1.05
Target allocation: 11%
New investment = £1,055
Trading cost = £0
Take a look at our broker comparison table for your best investment account options. InvestEngine is currently cheapest if you’re happy to invest only in ETFs. Or learn more about choosing the cheapest stocks and shares ISA for your circumstances.
Average portfolio OCF = 0.16%
If it all seems too complicated check out our best multi-asset fund picks. These include all-in-one diversified portfolios such as the Vanguard LifeStrategy funds.
Interested in tracking your own portfolio or using the Slow & Steady investment tracking spreadsheet? Our piece on portfolio tracking shows you how.
Take it steady,
The Accumulator
- The real return is the gain once inflation has been subtracted. It is a measure of the growing spending power of your money. [↩]
- Government bonds at the time were undated. That is, they paid interest in perpetuity or until they were eventually called and repaid. [↩]
- SPDR Bloomberg 15+ Year Gilt UCITS ETF [↩]
- The fixed interest rate paid by a bond. [↩]
Well that was bit anti-climactic
I also hold short dated gilts and my reaction to the current hysteria has been a bit of a resigned shrug investment wise
In the longer term though there is about 3-4 trn invested in SIPPs and ISAs
Given the UK has a ton of gilts to issue however the 2023 budget eventually turns out I do wonder how long we’ll be allowed to invest this overseas
I’m old enough to remember when you could only invest ISA funds in the UK
Thanks for the article, very interesting reading. So, if you held no bonds, besides some small amounts via multi asset funds, but had 60% of your portfolio in cash would you…
A. Start a position in bonds, perhaps 10% to kick things off
B. Sit on your hands, as high inflation and interest rates are supposed to be bad for bonds?, So, things may get worse. Instead, put more into equities and chase the highest savings rates
And based on your hindsight views of gilts, what passive fund would you opt for? – Assuming you feel passive is the way to go for bonds, it seems so!
Although I agree that the Government have been utterly incompetent, it is a little unfair to lay the entire blame on them for the difference in performance between those 2 bond ETFs. AGBP, the global bond fund, has an effective duration of 6.8 according to iShares. VGOV, the Vanguard ETF, report a duration of 11.5. A fairer comparison would be against the performance of 60% VGOV and 40% cash, for a weighted average duration of about 6.9. The loss would then work out at around 17% (assuming zero return on cash). Still worse than AGBPs -13%, but not quite so awful.
@Neverland, I think you must be talking about PEPs, not ISAs. With PEPs the qualifying investments were UK ordinary shares or funds which were at least 75% invested in UK shares. It would be devastating to have to go back to that. I would probably withdraw most of my investments and take the tax hit.
@Naeclue
Yep, peps. Which became ISAs. But people keep arguing that the UKs issue is a lack of investment and the funds are here in ISAs and SIPPs all being funnelled abroad. Seems like the slow and steady portfolios £18.7k will be joining that exodus pretty soon
@Labyrinth93, that is a hard question to answer as it depends on what you as an investor want from your portfolio. With gilts the risk is called interest rate risk or sometimes duration risk. As the yield of a bond rises the price will fall. It falls more as the duration of the bond increases. A good rule of thumb is to match the duration of your bond or bond fund with the average time you want your money back. So if you are looking at long term savings for retirement you can go with long bonds. If you want your money back in a few years (or may do) stick with short bonds or cash deposits.
Whatever you do, don’t choose your bond allocation and duration according to what you or anyone else thinks is going to happen to bond prices in the future.
@Neverland, I agree that the UK is short of investment, but that is down to Brexit and the behaviour of the government these last several years. Make the UK an attractive place to invest instead of increasingly unattractive and investment will come.
Personally I would not be prepared to take on the risk to my finances of investing heavily in the UK and would stick with my global portfolio, even if that means giving up the ISA status. I think it unlikely that ISAs would become restrictive again, but who knows?
Hello, 3 years in, and still a newbie.
I have 10% in Legal & General All Stocks Index Linked Gilt Index trust (I) acc,
and 20% in Vanguard UK Government Bond index fund GBP acc.
Would it be wise to diversify the bonds now, and put 10% from Vang UK Gov Bond into a global bond fund?
If so what global bond funds would you recommend?
Thanks, Gary
Newbie here also.
Been investing in Vanguard FTSE Global All Cap and 10% in Vanguard UK Government Bond fund for the last two years.
Stopped putting money in the bond fund and continued to pay monthly to the All Cap.
Position now is my bonds have dropped to 6% with a total loss of 39%.
Should I rebalance back to 10% in the UK fund, which seems counterintuitive, or I was thinking Vanguard’s Global bond fund?
Any help would be greatly appreciated.
Thanks, Alan
Well, sometimes an anti-climax is just what you need, so thanks, TA. Perfect timing for me: having spent my lunch-hour looking at my asset allocation from all sorts of angles to find an excuse for fiddling with it. Mind you, these interesting times have left my cash-heavy portfolio even cash-heavier, so I share @Labyrinth93’s dilemma. Then again, Larry Swedroe says “leave it – it’s not worth it!”
An ancient investor -aged 76-18 years retired
Sitting it out yet again!
LDI,s in the frame this time but much bigger problems really to blame-ie rank over borrowing and over spending
Been 30/65/5 -equities/bonds/cash for years
Currently 32.2/61.3/6.5
A global equities index tracker and a global bond index tracker hedged to the pound only
Cash is 2 years living expenses
Portfolio currently 7% off September highs
Here we go again!
Keep up the good work at Monevator.com
xxd09
I haven’t calculated mine precisely but I appear to be down 5% q/q and about 13% from ATH. It’s denominated in EUR.
Inflation is currently running at 17% here 😮 (harmonized European measure)… so it looks like I need to get back to work.
Long time reader, and grateful for all the brilliant articles. Easy on the stigmatising mental illness imagery though, mate.
Serious apologies-portfolio off 12% from September highs -fat finger on calculator
xxd09
So how close is S&S to rebalancing into even more gilts @TA? Is it when they drop below 24% of the portfolio?
I think people here wondering about buying bond funds now should ask (a) would I like to buy an investment paying the current yield of the bond fund to hold for the current duration (i.e. 4% for 11 years) and (b) is the market likely to start demanding rate cuts to below that yield in the next couple of years which will give my bond fund a useful cap gain.
The difference between buying it today while yields are rising and in a few months/years when it’s back at 4% on the way down is that if you buy it now you don’t have to watch for the turn but you do have to stomach the dip!
Sky News has done an article on Bonds and Pension funds, specifically
calling into question the role liability-driven investment (LDI) is having on this area of the market, @ TA & TI what are you thoughts and would this explain some of the logic behind the 2022 bond massacre?
https://news.sky.com/story/renewed-focus-on-pension-fund-investment-strategy-following-bank-of-englands-intervention-in-bond-markets-12711972
Also a good opportunity, especially for those nearing retirement, to lock in a gilt ladder. I’ve done that with 6 gilts of varying maturity for the guaranteed known returns, tax free, that match my expected spending from a planned 2024 exit
@Steve T
Have you brought gilts direct or they a fund?
Can you expand on your purchases please?
Thanks in advanced
MrBatch
Always love reading the SS portfolio update and love the comedy in your writing TI. A very funny and enjoyable read indeed and excellent points made.
Similar to labrinth93 , my safe asset is still mostly cash. Although at last I’m getting better interest rates. would like to get into nominal Gov bonds as id like to withdraw 4% from my portfolio. got some exposure to index linked short gilts. But because I’m mostly in cash , i feel i could only withdraw 3 0r 3.5% max. When I’m ready , which is not yet as i still enjoy part time work! The problem with FIRE is if you’re fit, well and of sound mind , you gotta do something productive with your time. One can only enjoy so many holidays. As TEA says the 1st icecream is delicious by the time you get to the 5th its lost most of its appeal.
@Labyrinth93 – I’d take things gently and drip feed in to get my 10% bonds. Things may get worse for bonds but they could get worse for equities or cash. The insight underpinning diversification is that we don’t know what will happen. So we create a portfolio from complementary assets that prepare us for all weathers. Naeclue is right to say it’s best not to think about what future asset prices might be because nobody knows. Our best bet is to create a strategic allocation that’s pro growth (equities) but also gives us some protection against other threats: deep recession (government bonds), inflation (short term linkers), liquidity crisis (cash), fears of global financial collapse (gold).
For passive bond funds, check out:
https://monevator.com/best-bond-funds/
Given recent events, I’d scroll down to the GBP hedged global bond funds section.
This is why I advocate passive funds over active:
https://monevator.com/passive-vs-active-investing/
@gary – see the bond funds link above for global bond funds. Personally I would diversify but not because I think global bond funds will necessarily do better than gilts. It’s because the risk of investing only in a single country has become all too apparent recently – even when that country is the UK, which we’re used to thinking of as a paragon of stability.
@ Boydster – Yes, rebalancing is definitively counterintuitive. The other counterinuitive point here is that higher yielding gilts are set to do better than global counterparts IF the UK can get a grip on its finances, control inflation, and recover its reputation.
But I for one have had a crash course in the risks we run by not diversifing away from even a highly regarded country like the UK.
Because investing is as much psychological as financial, I’d personally drip feed new money in to recover my asset allocation rather than rebalance.
That would make me more comfortable in the current situation though you could easily argue against it. The Investor, I think, has rebalanced into gilts after the falls.
@ Alex – My analogy is aimed at the authority figure (Liz Truss), recklessly and inappropriately applying treatment. It’s not aimed at the person being treated, or the underlying illness. My first draft had Truss as a surgeon hacking away at the patient. It’s the same thing. The critique is about the misuse of power. More than happy to hear if I’m missing something though.
@ Meany – It was pretty close. The gilts fund has dropped from a target allocation of 29% to 24.5%. A rebalance would have been triggered at 24%. Emotionally that would have been very difficult.
@ Paul Jones – It seems to me that the gilt freefall triggered the LDI problems rather than the other way round. Though obviously the feedback mechanism seemed to throw the market for a doom-loop hence the BOE stepping in. Still, gilt yields were up across the board even though the LDI issues were focussed at the long end of the curve, as I understand it. One of the reasons the price drops in our funds is so shocking is because yields went up extremely quickly. You’ve got to go back to 1981 to see such a rapid upward shift in the 10-year yield. And the impact of a rise would have been muted then because bond yields were so high in the first place.
@ Dawn – thank you for that! That’s fair made my day. 100% agree with you about staying productive during FIRE. +1 for working part-time too, so long as you enjoy it. Apart from anything else, it helps you enjoy the goofing off even more 🙂
The so-called LDI issue is IMO solely down to margin calls! DB funds elected to implement LDI with gearing, as few DB funds are fully funded. And, they seemed to believe (or pehaps were persuaded) that they could get something for nothing. The risk IMO was obvious from the outset, and the so called de-risking LDI approach adopted by a lot of DB funds was in reality a re-risking exercise. IMO, matching assets to liabilities (aka LDI) is, in and of itself, a sound approach and generally only becomes risky when folks try to get clever!
@TA thanks for the explanation, as someone who’s got circa 15% of their portfolio in long dated Gilts (Vanguard) I can tell you I’ve well and truly got my finger on the sell button of that bond fund, but I refuse to initiate given 1) the long term performance of this fund has been positively consistent (other than this year), 2) this fund matches my time horizon in line with Lars’ recommendation in his book, I’ve got time on my side (he says…), but I might be singing a different tune based on how the next 6-12 month pans out (fastens seatbelt)
Interesting update as always, thanks. Excuse me if I’m being dim but is there an easy way to navigate to the latest S&S update from the homepage? I sometimes go to refer to it and end up going on a journey of links through the last decade or so to track down the latest one!
I think this year is interesting food for thought as it pertains to the perennial debate on exactly how much active portfolio management is optimal for the passive investor who follows a philosophy akin to the S&S portfolio, would be interested in your perspective on the topic in light of recent events. The arguments for mechanical quarterly rebalancing and against market timing are well made and well evidenced on Monevator, it’s clearly the sound defence against succumbing to the classic behavioural biases that are ultimately injurious to performance. This year provides an interesting challenge to the merits of being 100% mechanical though. Whilst the evidence is clear in terms of index funds being a better choice for most people than active funds or stock picking, it seems the events in the bond market this year would suggest that under certain (very irregular) macro conditions, a somewhat dynamic approach to asset allocation can be preferable to a purely mechanical one. I’m certainly not suggesting trading macro trends by actively playing with your asset allocation is likely to be value enhancing for many people, only that there are very occasionally unusual circumstances in which you can realistically judge that the market is distorted and it makes sense to take some action rather than stick to a mechanical rebalancing rule. I.e. in 2021 when central bank base rates were zero or negative, 10 yr gilt yields were sub 1%, 10 yr UST yields sub 1.5%, you couldn’t ever have known inflation was going to vastly exceed everyone’s expectations and interest rates would shoot up as violently as they did, but you could have made the observation you guys presciently made with your idea to shorten duration and raise cash and gold, that holding long bonds with such low yields represented a poor balance of risk and reward. One was locking in a negative real yield and taking significant duration risk for the modest benefit that yields could possibly go even lower in an economic downturn. Central banks had artificially eradicated the duration premium in longer bonds, making avoiding them a fairly well reasoned decision rather than a speculative market timing call. So the question I am ultimately getting at is whether a passive investor following the philosophy of the S&S portfolio should write this chapter off as a one off anomaly and stick to their mechanical rebalancing guns that have generally worked over the long run or take it as evidence that a tactical deviation from their long term strategic asset allocation can be merited under certain circumstances and incorporate that into their investment approach going forward.
From my humble perspective the raft of coverage on the ‘death of the 60/40 portfolio’ makes little sense logically. Surely the return of meaningful nominal bond yields and the reversal of QE is going to result in a much more volatile market with real market derived price discovery in bonds again and thus the correlation between long duration high grade bonds and equities should logically become more negative again and a mechanically rebalanced 60/40 portfolio starts to function ‘normally’ again…
@mrbatch yes, happy to expand.
I’ve bought individual gilts, through my usual online iweb account. Note that iweb only sell gilts by phone though rather than online. Cost is still £5 to trade. You can buy gilts online through HL, but the range is smaller.
I’ve bought six individual gilts that mature from Jan 2024 to Jan 2030, in values roughly equal to my expected spending each period. It gives me a risk free yield of around 4.2% average. Obviously I don’t get the same upside of, say, a bond ETF if prices rise, but in this part of my portfolio it’s more important for me to increase certainty.
I bought low coupon gilts (around 0.1-0.3%) to minimise tax. That’s because the coupon interest is taxable but the capital gain is not, so the whole thing will be practically tax free.
Hope that helps!
@Steve T
Thanks for these intel. I need to look at ii to see if there are options there for me. Also i thought bonds/gilts were coupon along the way of its life ie 4+% annual payment and whole cost price returned at the end. Unsure how you get your 4+% return with low coupon payments – me to research more. But on the basis a portfolio SWR when in pension drawdown is now realistically less than 4% per annum very interesting for the next few years with a guarantee.
Thank you
@MrBatch the yield of a bond is a combination of its coupon and the difference between today’s price and value at maturity.
Roughly speaking that means eg if the yield is 4% then a one year, £100 face value bond with zero coupon would cost close to £96 today. However a bond with the same face value and maturity that paid a 4% coupon would cost £100 today.
So you choose the combination that works best for your circumstances, given the range of gilts on offer.
I’m sure you’ll find your research on the topic as interesting as I have!
@Steve T
Brilliant thanks. Not fresh gilts but purchase existing gilts below their par value with known maturity on 1 , 2 ,3 years etc and hold to maturity to return full par purchase value.
Will be interesting to see values offered above 1-2 years out ie 2025,2026 etc for purchase price and par value return at maturity.
Great thread and advice but as ever DYOR as”advice not really given”
Cheers
MrBatch
@Steve T. Thanks for posting. Is there any way to check individual gilt prices on the IWeb website?
@Steve T:
Well timed – were you waiting for such an opportunity, or was it just good luck?
I assume you did not buy linkers, in which case what assumptions did you make re returns vs inflation?
Also, did you consider using STRIPs?
@ Adam – you’ve raised a lot of interesting questions and put your finger on many of the dilemmas we’ve faced as DIY investors since the Great Recession. I was in the midst of replying but actually I think this should be a post in its own right and I’ll link back to your comment as the inspiration if that’s OK?
Re: navigation. Yes, it’s painful. The quickest way is to google it like this: monevator slow and steady 2022
Hi, long time reader first time commenter here.
I’m 28 years old and have a SIPP with an allocation of 90% Equities and 10% Lifestrategy 20. Would you say that the LS20 fund is a good way of gaining bond exposure within an aggressive portfolio?
My thinking is that by having LS20 I’m benefitting from owning a diversified pot of bonds and I don’t have to worry too much about rebalancing as vanguard rebalance the portfolio with equities on a daily basis. I consider having LS20 as ‘ticking the box’ for owning bonds. Is this a sensible strategy?
I note from Monevator commenters and contributors such as Lars Kroijer that you should own bonds with durations that match your likely time in the market. So in my case, long duration bonds. Therefore, am I better off owning a UK long duration bond fund as opposed to LS20 which contains short duration bonds?
Any thoughts would be greatly appreciated.
I know TA knows this, but just a reminder that I’m a *very* active investor and not somebody anyone should follow the lead of, especially in the short-term.
The gilt market is very febrile right now, and I’ve actually sold quite a lot of my (fairly recently acquired) long-dated gilts in the days after the BoE announcement in expectation of more potential volatility if/when it takes away its bond-buying backstop in a few days time.
I definitely endorse the big picture though. By all means tinker at the margins if you feel you can judge the risk/reward in the context of your ENTIRE portfolio over longer time frames, but if there was a time for passive investors to be committing massive heresy with respect to their long-term bond allocations, I’d say that time has passed.
You’re now getting something like a 2% real return on a 30-year index linked gilt, for example, and around 4% nominal from the 10 year gilt. Very different from a year ago, and some potential to buffer equities like we typically hope they would in a crash, compared to when rates were near-zero or even highly negative in the case of index linked gilts.
@Adam
To see Slow and Steady Portfolio Updates, either bookmark this link: https://monevator.com/tag/sspu/
…or use the search box on this page for the term sspu.
I’ve been unweight bonds in my overall portfolio because something sat uneasy with me about rebalancing into them given paltry yields vs holding cash. Obviously cash is losing real value even at the best deposit rates but it gave me more “sleep easy” value in terms of how long I could go while waiting for an equity bounceback in a bear market. I do need to grapple with some 60:40 thinking ahead of actually FIREing but my view remains the bulk of my portfolio is there to do heavy lifting in 5/10/15+ years time so struggle with rebalancing too fast and particularly at the wrong market timing.
Even with a largely passive view of the world there are still plenty of decisions you can make that look poor or just lucky in hindsight. I guess as long as they balalnce not too negatively and you haven’t compounded the bad by giving too much up in fees one should be phlegmatic about it.
@Norman – unfortunately gilt prices and trades are only available on the phone if using iweb. You can see prices of some gilts on HL but a much smaller range. Otherwise sites like MarketWatch have close to live gilt yields, but not sure if the price they display is also live.
@Al Cam – I’d consider it mostly luck with a small slice of judgment! I’ve avoided bonds for some time due to zero interest rates so I had the cash to invest when an opportunity arose.
In terms of inflation, I’m assuming that inflation will return to levels around the 2% target in the next couple of years, so that >4% nominal should provide a real return.
I didn’t consider linkers because I didn’t have time to do the required reading to understand them enough!
I did consider strips but I believe (and happy to be corrected) that the tax treatment is less generous than low coupon conventional gilts.
@Steve T – thanks Steve. Like yourself I’ve cash to deploy and if not for recent events I’d have probably continued to keep cash instead of bonds. Currently pondering whether it’s worth waiting for gilt yields to get pushed even higher by further interest rate rises. Some are predicting a 4% base rate by the end of this year and 5.5% by mid 2023.
Also looking anew at annuities rates, which are at a 14-year high and have risen 52% this year apparently. 15 years to make back the pension pot instead of 22 years.
I’ve had a 60/40 equities/bonds split for years, with the bonds split 50/50 between standard UK gilts funds and index-linked UK gilts funds. This seemed to be a fairly common set-up – like in Tim Hale’s ‘Smarter Investing’ – but I’m wondering (in retrospect!) whether if I’d been paying more attention I’d have realised maybe this isn’t a good idea after all, in situations like this?
Any thoughts on if it’s worth just sticking with, or should I maybe be changing strategy?
@ Steve T (#34):
Firstly, thanks for replying.
Personally, I favour floor & upside to so-called SWR or similar for de-accumulation. Thus, I have some feel for the approach you appear to be using.
My own variant of LDI flooring, to date at least, has not used gilts for the reasons you state above. Rather, I have generally used a somewhat rickety ladder of fixed rate deposits, or CD’s as our US cousins like to call them.
I recognise your returns vs inflation considerations; and therein IMO may lurk some risk. FWIW, I pulled the plug nearly six years ago and for the initial phase (prior to pensions coming on stream) I allowed for a differential of 3.5% PA compound (as I am rather conservative wrt my flooring, the average RPI since the early 1900’s is not dissimilar, and ZIRP was a real thing then). This was rather expensive but to date this has been more than adeqate – but who knows what is around the corner?
IIRC gilt coupons are fixed, so is your c. 4% nominal PA simple, rather than compound – which inflation is?
Re STRIPs, IIRC you are correct; I had forgotten about what some folks call phantom income.
I prefered principal STRIPs to those derived from the coupon.
All the best!
@OwenRhod – Hi! You’re right, LifeStrategy 20 is as diversified a portfolio of bonds as you can get in a single fund.
I’d say it’s a reasonable way of gaining bond diversification in an aggressive portfolio.
Here my counterarguments purely to give you food for thought:
LS20 is quite an expensive way to buy your bonds in terms of fund charges. It’s more than twice as pricey as some of the picks here: https://monevator.com/best-bond-funds/
Though it is cheaper than IGLH, so you could argue LS20 is worth it for the level of diversification.
From your description of your asset allocation, I don’t think LS20’s internal rebalancing mechanism would make much impact on your portfolio overall. You’d need to rebalance the bond portion of your portfolio vs your total equity allocation including whatever’s held outside of LS20 – if I’m correctly understanding your setup.
The other thing that bothers me about LS20 is I can’t see any readily available information on duration. Vanguard list blanks next to the bond portfolio characteristics here:
https://www.vanguardinvestor.co.uk/investments/vanguard-lifestrategy-20-equity-fund-gbp-gross-accumulation-shares/portfolio-data
Is that just a glitch?
If you’ve found duration information then think of your time horizon / risk as being represented by the average duration number i.e. think in terms of the entire portfolio rather than whether short duration bonds are present.
But the advice to match your duration to your time horizon isn’t set and forget.
This is a complicated area and I need to write a post on it, but it may be better to think more in terms of balance of risk.
If interest rates keep rising then long duration funds will take harder losses than shorter duration ones.
On the other hand you’re less than 10% in bonds so may not notice that much.
But given your question, I’d guess the recent losses have troubled you. If the sight of a single fund being deep in the red for years is likely to gnaw at you then I’d suggest long bonds may not be right for you.
Not because we can be certain that rates will rise for years but because that is the big risk anyone with a long bond fund is taking.
All of that should be balanced against the fact that a long bond fund is the best diversifier you can get if we’re hit by a demand-shock recession.
Rationally it’s a reasonable position for someone in your position to hold, especially if it’s decades before you’ll need to sell. Psychologically, it depends on your testicular fortitude!
@ Fabius – the funds are better positioned now than they were. But the long durations of UK index-linked bond funds set you up for more pain ahead if real yields keep rising.
Much depends on your time horizon. If it’s a decade or two before you need to sell then you’re a long-term investor who can probably wait it out and ultimately benefit from rising yields.
If you’ll need to fund retirement expenses by selling bonds within the next decade then it’s a much trickier situation.
If interest rates keep rising you’ll take more hits. If they fall you’ll make some nice gains. If you can play a waiting game then you’ll benefit from higher yields over time.
Personally, if I was short on time then I’d want a proportion of my portfolio in cash and short bonds.
This posts help explain the issues with UK linkers:
https://monevator.com/why-uk-inflation-linked-funds-may-not-protect-you-against-inflation/
https://monevator.com/the-slow-and-steady-passive-portfolio-update-q1-2019/
@TA “You’ve got to go back to 1981 to see such a rapid upward shift in the 10-year yield. And the impact of a rise would have been muted then because bond yields were so high in the first place.”
Not sure what you mean by the impact of a rise, but a bond of duration 10y will lose about a third of its value if the yield rises 4% and it will not make much of a difference if that rise is from 0-4% or from 12-16%. But the impact on the economy (loans, mortgage payments, etc.) of a 4% rise is likely to be much more severe going from 0-4% than from 12-16%.
Apols if being overly pedantic!
@ Naeclue – I was referring to bond convexity but now I go back to eyeball my sources I can see you’re right that it’s not going to make a big difference to a 10-year gilt. It looks to me the effect is more pronounced at 20-years and beyond.
BTW, if you’ve got any good sources for historic yields or how to calculate the impact do let me know.
No worries about the correction. I’ve always got more to learn about bonds (among other things) 🙂
@TA Many thanks for that.
Given my retirement, to some degree, is imminent I have some thinking to do, unfortunately.
It’s interesting that after *years* of people saying bonds were going to drop any day now, only to see them continue to rise, to find oneself having to deal with that at last. Ah well.
@TA, it depends whether you are talking about a 20-year gilt or a bond with duration of 20 years! A 20-year gilt will (usually) have a lower duration than 20 years. The higher the yield to maturity, the lower the duration (for a given coupon) , so big spikes in yield will drop the price more when yields are low (duration high) than when they are high (duration low).
Convexity is important when big yield shifts are involved, as the non-linearity of the relationship between price and yield becomes more apparent, but in this case the movement is still dominated by differences in initial duration.
OTOH a bond with duration 20 years will drop about the same amount for the same spike irrespective of its starting yield. For a 4% spike, the fall is about a third for a bond with a 10y duration, about half for one with 20y duration and two-thirds for 30y duration! The Precise amounts vary with the maturity of the bond
FWIW whilst I also think the omnishambles from our dear leaders continue (and as a side bar I cannot understand for the life of me why the PM said (a) no need to try and reduce your energy use and (b) no chance of running out) I think it’s a little harsh to blame our currency decline on them. Against the euro year on year we are fairly flat, against the AUZ we are up a little. In times of stress, in the $ we trust all else pay cash sort of thing. We’re actually not much lower £ $ than we were before the mini budget.
Now is not the time to be selling bonds imho. The margin of safety has just increased significantly. One year Gilts paying >4%, Index Linked Gilts now no longer in negative YTM territory (The Investor which ILG is paying a 2% real yield out of interest? – T68 is paying a real yield of around 0.3% by my calc currently).
Looking on the bright side, you can now get decent annuity rates, build a bond ladder worth having etc etc. The SWR has improved materially for the 2022 cohort.
I don’t like the S&P 500 val much….ERN does a better deconstruction of it in his latest article assessing the CAPE ratio.
I guess this is a good lesson for everyone that bonds / equities are valued off the discount rate and the risk free rate of return has just gone north considerably. It must surely be followed by a material fall in property valuations…If not sell everything and just by the asset which never goes down.
Remember Ray Dalio cash is trash mantra….er no. I thought back end of last year that you wanted to be holding something with a duration of zero. Only thing I could really think about was cash.
I’m reminded of Buffet’s article that equities / bonds are actually pretty similar and that neither like inflation etc and so aren’t very good hedges into that environment. The trouble is not much is from what I can see ST. Short dated $TIPS, cash, gold has helped cushion my equities fall.
To abandon though the 60:40 portfolio now makes zero sense imho. You can now get a decent nominal yield from the bond component.
@SeekingFire — Yes, looking back it seems the real yield was down to just under 1% when I wrote that comment. (Try around 30 years out.)
It’s all very volatile at the moment, as much belaboured here and elsewhere. The BoE operation had put all IL yields back into negative territory for a bit, but as prices have come down they’re back into positive territory again.
I’d estimate 99% of readers can’t and shouldn’t be thinking on such short horizons. (Again why I stressed above passive investors shouldn’t be following my actions as we are playing different games.)
And I am no kind of expert in bonds, I’m closer to a fixed income tourist!
Re: Currency, the Mini Budget definitely whipped the £ I watched it happen in real time. Granted other factors were at play, too. It’s tricky to unpick; yes (nearly) all currencies have been very weak versus the dollar and that is the major affect, but there are definitely minor notes.
You also have to think counterfactuals. If Sunak had come in and we’d had a sensible budget maybe we’d be at say $1.20? Who knows and I am not going to seriously speculate about it. But I think you’d be very hard pressed to find a market participant who didn’t believe the Mini Budget roiled the UK markets.
Bonds were always the much bigger story though. Floating currencies gonna float!
@seeking fire/TI
Please could you advise how to calculate the T68 yield? I read https://monevator.com/how-to-calculate-bond-yields/ and interpreted it would be 12.5X100/89.45, not sure where I’m going wrong. Many thanks!
@ Naeclue – I’ve been talking about maturity, sorry that wasn’t clear. Big spikes in yield impacting price more/less when yields are low/high was the effect I was referring to.
@ Seeking Fire – I was blaming the gilt losses on the government. Gilt yields spiked directly after the mini-budget and a yawning gap opened up vs Euro and US equivalents.
@Seeking Fire (#44):
I would advise against loading up on annuities in the short term because your flooring requirements may only become clear post pulling the plug. This has been my experience; and whilst we may be a bit of an outlier there is plenty of anecdotal evidence to support this. The late great Dirk Cotton initially proposed flooring his whole lifestyle, but evolved to suggesting that you should set your floor as low as practical, and organise the rest of your Pot such that the likelihood of only having flooring to live on is minimised.
Locking yourself into too much flooring could be an expensive mistake!
@Steve T – Worth noting Swedish Export Credit (100% owned by the Swedish govt and rated higher than the UK govt) has GBP bonds. The Dec-23 bond offers a ~55bps spread pick up to Gilt (+15% yield). Not worth it currently as not tax free but the spread has been wider at times historically.
@TA re #19 – Doctors causing harm is iatrogenesis. It’s notable that the famous expression is “FIRST do no harm”. Humility before ego. It has parallels to Buffet’s “the first rule of an investment is don’t lose [money]. And the second rule of an investment is don’t forget the first rule.”
I wouldn’t worry about allegedly being offensive. You can hardly say anything worth saying if you are afraid of causing offense.
@TA re #41 – You can access historic gilt yields from the BoE website below. This is particularly helpful as it shows yield over time for a given year to maturity (if you just track a single gilt yield the years to maturity is obviously declining over time). https://www.bankofengland.co.uk/statistics/yield-curves
@45 – Investor. Agree with your points
@47 – TA. Also agree with you
@48 – Al Cam. Also agree with you particularly for those in cognitive decline or subject to scams. I like the floor & upside approach using annuities but don’t think I’d want to over annuitise unless my asset to income expense was relative low (e.g. 25x or lower). It depends on your situation. Ed Thorp, Warren Buffet no need. Even Naeclue whose got a w/r of 2% very probably no need! Were I to exit the world of work today, my w/r would be around 2 – 2.5%. I couldn’t annuitise anyway as I’m too young (somewhere in the 40’s). I can’t face pulling the plug as the fear of things going wrong is too high for me :). What a loser….:)
@46 – Wage Slave….
So TN24 was offered at the highest price of 95.29 on Friday and will be redeemed in Jan 2024 at par (100) with a 0.125% semi-annual coupon. 1.25x years to expiry. If you don’t have a gross redemption yield function on a calcuator or xls tap the details into the following link, which provides a GRY of circa 4% with the interest element potentially taxable and the capital gain tax free.
https://www.hl.co.uk/shares/shares-search-results/t/treasury-0.125-31012024-gilt
https://goodcalculators.com/bond-yield-to-maturity-calculator/
The bid offer spread is not ideal on the TN24, so imho you need to hold to maturity.
For the index linked gilt 2073 expiry, it was launched in 2021 with a record negative real yield of 2.3883%. You can check that by plugging in 50 years to maturity, 400 (I believe) being the issue price, par redemption of 100, 0.125% semi annual coupon. Note I don’t quite get 2.3883% myself.
https://www.reuters.com/markets/europe/uk-sells-new-2073-index-linked-gilt-with-record-low-volume-2021-11-23/
As it’s now trading at 98.19 (what an investment it’s been lol) with a par redemption in 2073 and the par redemption level and coupon is adjusted for inflation thats a real yield of approximately zero as of today. Note what happened during crisis a couple of weeks ago when a real yield of around 1.5% was on offer for a very short period of time.
https://www.hl.co.uk/shares/shares-search-results/t/treasury-0.125-22032073-index-linked-gil
I do note the fact that people are looking at Gilts and thinking they’re interesting but not for example looking at the FTSE 250, it now trading at a lowish CAPE and saying…hmm that’s interesting too! The contrarian in me wonders!
Having said that if the 2073 falls again to 50 or even lower. Fill. Your. Boots.
@ Platformer – cheers!
@Seeking Fire- Thanks for taking the time to write such a great explanation, that’s made it much clearer to me. If it drops to around 50 I’ll try not to let the crisis go to waste!
@Seeking Fire (#50):
Absent any DB pensions, Annuities will provide you with some longevity insurance, and I can see that attraction.
I agree that there is some point when it is not necessary to use flooring.
However, IMO what that really means is that you are free to choose and not disqualified from following such an approach if you are relatively wealthy.
I strongly suspect you may find that your actual needs (post pulling the plug) will be lower than you think at this distance. But I totally agree that it is very hard to be sure and basing a long-term plan on such an ‘article of faith’ may well seem wrong. I did’nt do it even though I was aware of the phenomena.
Whilst our case may be a bit of an outlier there are several factors driving it. Amongst the main ones are:
a) what type of income qualifies as flooring:
Floor & Upside is described as a safety-first approach, and central to this premise is that only near-certain income qualify as flooring. Zwecher and Cotton and both pretty firm on this – DC tells a story of a person who lost his rental empire to illustrate the point. Ken Steiner is a bit more pragmatic (see How Much Can I Afford to Spend in Retirement. However, in reality income is income and it all spends just the same. So, if you do have non-flooring income that holds up well then this can mess with things – in a generally positive way. A more pragmatic stance (a la KS) might be the way forward.
b) needs being somewhat lower than forecast in spite of having some 25 years of detailed historical records prior to pulling the plug. This was certainly not all down to the pandemic. Which IMO incidentally provided a great opportunity to properly assess what is really “essentials”!
I jumped around my mid-fifties, having decided a decade earlier it was definitely too early. A lot happened in the intervening period some good, some not so. But then again, life has a habit of throwing you curved balls and that does not stop once you jump ship either. Bon voyage and fasten your seatbelts!