Tim Hale’s classic book Smarter Investing [1]
It answers more questions than an energy company boss before a Parliamentary Select Committee – except that with Hale the answers are usually satisfactory and the light bulbs should stay on.
Perhaps the most important question of all is: “Does the 2013 third edition contain new insights that may change a passive investor’s strategy [3]?”
And the answer to that is: it may well do because Hale has updated his advice on bonds.
A shortage of interest
Historically low interest rates, vast amounts of QE being forced into the vaults of the financial system like fracker’s slurry, and investors clamoring for yield have put the why bonds? [4] conundrum at the top of the agenda.
Hale’s response is – like a number of American commentators – to go short-dated and to consider diversifying your bond holdings.
Short-dated means holding bonds with maturities of between one and five years. That way the losses you suffer will be staunched in comparison to longer bonds in the face of interest rate rises.
Short-dated bonds are less vulnerable to interest rate risk because they mature relatively quickly. You get your capital back and can reinvest it in new bonds with higher yields – hastening your recovery from losses.
Hale has nixed his earlier talk of long bonds for aggressive investors intent on accumulation. The losses you risk are no longer worth the incremental returns.
Cautious investors should err on the side of short-dated inflation-linked bonds. Although this is easier said than done.
Index-linked National Saving Certificates [5] would be the ideal bolt-hole but have been cast into deep freeze by the Chancellor.
The other options aren’t great either. Index-linked gilt trackers generally have maturities around the 17-year mark, so could be hit pretty hard if and when rates go north. And investors are so desperate for linkers that available yields are generally negative in the secondary market. In other words, it costs you to hold ‘em.
Faced with this, Hale turns to heresy, suggesting investors throw in their lot with active managers who offer short-dated linker funds.
Credit controller
Note that we’re no longer talking about investing purely in UK gilts.
The UK’s downgrade from triple-A status frees Hale to offer an additional fixin’ of global and corporate bonds scored AA and above by the credit rating agencies.
The benefits are extra diversification and yield, though Hale emphasises the importance of ensuring global bonds are hedged to Sterling. (There’s no point taking on currency risk in the portion of your portfolio that’s meant to cushion you against volatility.)
Commodities [6] are also off Hale’s menu of acceptable assets.
He cites doubts over the counter-party risk [7] and conflicts of interest that may compromise the structure of Exchange Traded Commodity (ETC) funds run by large investment banks.
Hale is clearly ambivalent about these risks, as he continues to make a good case for the role of commodity futures in a portfolio. However, when forced off the fence he decides that discretion is the better part of valour this time.
He has no such doubts over the merits – or not – of gold and structured products [8].
Hale sets about dismantling the case for both with the speed of a bomb disposal officer who wants to get home in time for EastEnders.
Outlook moderate
Hale has also downgraded the return expectations for his range of model portfolios that form the centerpiece of the book. The effect is most pronounced on portfolios with a heavy bond allocation, but the drag was enough to make me wince even on a 60:40 equity/bond allocation.
Of course, nothing is certain and Hale’s underscoring of the investing vagaries is one of the great favours he does DIY investors.
He takes pains to show that you may hit the jackpot over an investing lifetime, or you may hit the skids. Even reasonable return numbers are a 50:50 punt.
In other words, he does a great job of trying to stop investors anchoring themselves to a notional number peddled by a calculator, brochure, or book.
Sadly, this effort is downplayed in the 3rd edition of Smarter Investing
I think this is a product of brevity. The 2013 edition [1]
Indeed given the paucity of UK books on passive investing, it’s worth us taking a detour to see what else has gone walkies from the 1st edition.
First edition Smarter Investing
The main reason to read the 1st edition is for several lost passages on the behaviour of UK bonds between 1900 and 2004.
My hair does a Van de Graaf every time I see the -74% real loss of the 1900s or the -73% shaft on the graph that is the 1940s.
More chilling still is the -4% real loss p.a. that occurred over the worst 30 years of UK bond investing history or the 47 years it took to recover the real purchasing power of your bonds lost during the bear market of the 1940s to 1970s.
It’s a graphical insight into the havoc that financial repression and inflation can wreak upon bond investors – a topic with particular resonance today.
What’s more, this is insight into UK historical data that you can’t get from US investing books.
That’s why Hale’s work is so valuable to British DIY investors and why I think it’s worth tracking down a copy of the 1st edition for the bond section alone.
Better still, if Hale doesn’t intend to restore these passages in a future edition, it would be wonderful to see them pop up as bonus content on his website.
The extended look at property as an asset class is also worth a read, as are stiff draughts of reality like the real return of 2.5% p.a. that investors earned from the worst 35 years to afflict UK equities.
But most of the other cuts from the 1st edition make sense, and amount to a sanding down of the material into the sleeker 3rd edition available today.
All UK passive investors owe it to themselves to read Smarter Investing [1]
Take it steady,
The Accumulator