Best bond funds and bond ETFs - Monevator (2024)

@TA. We’re getting into the weeds here but surely the Vanguard Gilt ETF/funds were the best performing because they have the longest duration and the Gilt market rallying over the last 5 years+. Hence also why the’ve done worse over the last year – the Gilt market sold off 60bp. It’s not due to costs, it’s just a different longer duration index they track.

Over the past 5 years, iShares Core UK Gilts generated 24.4bp/unit duration. The worst performing was the Vanguard bond fund with 23.1bp/unit duration, so 5% worse. In bonds, you should always look at duration weighted returns, not cash-weighted returns.

I’d say you’d want unhedged if the whole purpose of global government bonds is to protect you from something like your own country going to pot – otherwise you’ll go down with sterling. – At the same time as you might also lose work in such a local crash.

Paying more to lose your currency diversification?…

Mogul

@ James – classic workplace pension – missing out key funds! Absolutely, you can blend durations by using the average weighted portfolio principle laid out in this piece:

https://monevator.com/how-to-work-out-your-portfolios-cost/

This piece was about cost, so multiply by each bond fund’s duration and its asset allocation to get your portfolio’s average weighted duration.

@ ZXSpectrum48k – [slaps forehead] I should have thought of that! Have corrected the post. Thank you.

@ TRS80 – there is an argument but the papers I’ve read have shown that so called risk-off currencies change over time. I wrote this piece about US treasuries which worked well in the last few downturns but didn’t help at other times:

https://monevator.com/do-us-treasury-bonds-protect-uk-investors-better-than-gilts/

Mogul

@ Matthew – here’s the rational argument for currency hedging:

https://www.institutional.vanguard.ch/documents/institutional/going-global-with-bonds-uk-eu-ch.pdf

@TA – It does indeed make the case that in a 100% bond portfolio you’d need currency appreciation of >5% for USD, >10% Canadian $ or >20% Aus$ to make the volatility of not hedging worth it – but suppose it did… Suppose for some reason the value of sterling did drop like a rock, although I can imagine vanguard sees that as very unlikely and for the purposes of bonds giving discipline they would rather have that steadiness and hope nothing extreme did happen.

It does show that where you have more equities, like 60:40, a currency appreciation of 1.5% for USD to 5.6% for AUS$ would do it – not really a huge threshold. More equities would therefore make it even more marginal, probably because you need every bit of diversification in a crisis.

@windinthefens – exactly, it would protect you from total loss of value if sterling plummeted (which might help if that caused us to have knock inflation) – whereas because we’re globally diversified, it’s not going to kill us anyway if a different country lost currency value, so the defensive ability of hedging to retain value is limited.
Protecting the value of what you have in global terms Vs protecting the nominal number in sterling terms.

If we globally diversify but currency hedge, you are diversifying credit risk but you still have all those particular eggs in sterling, so then what is the point of buying global? Might as well but gilts and save the costs if that’s what someone wanted to end up with (ie generic first world government debt denominated in sterling).

Any thoughts on ESG bond funds? For shares, going ESG doesn’t make a lot of difference to the companies’ cost of capital, but for bonds you could be directly lending money to sh*theads, so it’s arguably a bigger deal. Typically ESG only seems to apply to corporate bonds – I haven’t seen anything equivalent for government bond funds that avoid unsavoury regimes. The country distribution for a typical EM bond fund is enough to put some of us off.

In my limited research, I’ve seen a GBP-denominated ESG corporate bond ETF from Invesco (ticker: IGBE, OCF: 0.1%) but it’s not available in my Hargreaves Lansdown SIPP. iShares also offer a GBP-denominated ultrashort ESG corporate bond fund (ticker: UESG, OCF: 0.09%).

Obviously none of this is a problem if you stick to UK gilts, which is probably the easiest solution for most of us.

Mogul

@ Matthew – if you believe that sterling is prey to some catastrophic risk that wouldn’t systematically affect other currencies too, then by all means don’t hedge.

However, if you think the end of sterling is a low probability event, but want to diversify your bond holdings while retaining their ability to dampen volatility in a portfolio – best to currency hedge.

What does the bond side of your portfolio look like?

@TA – Long term my biggest pension is a DB one, which I consider to be like linkers in sterling – and if we value that by x25 the income then I’m effectively 80% bonds, linker gilts at that, not counting the house, so I’m very underweight in equities and going all into that in the sipp and Lisa. At least though it’s inflation proofed. A drop in sterling is unlikely but never say never – the purpose I believe is peace if mind, and if we’re retired eventually we’re nolonger so stuck to the UK.

But for short term emergencies rather than keeping cash beyond immediate needs like I should I use vls20 for sheer convenience and cover the risk with unused credit cards, so there’s no opportunity cost.

@Matthew – isn’t the reason to own your own country bonds or bonds hedged to your own currency is, for most people, that’s the currency they’ll spend in? Bonds are to provide stability, not return so for me, if Sterling tanks, my nominal is unaffected if I own Gilts or am hedged.

However, I have hummed and harr’d over this and do own some US Treasuries and unhedged AGBP “just in case.” But I also have temporary Spanish residency (thank you Brexit) and if we go permanent it might make sense. (But oh! The tax….)

This is a timely article, as (you may remember from previous comments over the last year or two!) I’m trying to finally an alternative portfolio, so not everything I have is invested with Vanguard.

It’s (almost) the missing piece to put an end to my procrastination/indecision. But, there seems to be one final decision to make.

So, given the diversification benefits of global government bonds why would you go for a 100% gilts tracker?

Mainly because the gilt trackers are one-third less costly to own, offer more yield, and promise marginally more crash protection.

So the decision is whether or not to go globally hedged, or UK (gilt) based.

I suspect there’s an argument (to diversify, and avoid indecision) for investing in both, but if so in what proportion. 50/50, 75/25, 25/75. I suspect in the long run any of the three allocations would provide similar long turn returns (and protection against volatility). Are there any that would seem more, or less sensible than the others?

Maybe 50% global (for diversification) 50% UK (for returns, and crash protection)?

P.S. Unfortunately sweating the small stuff seems to be my thing :-/

Mogul

@ Kevin – the risk of long bonds is that if interest rates rise continually then they’ll take large capital losses. This piece will help:

https://monevator.com/bond-prices/

@ Jonny – I hear you on sweating the small stuff 😉 My personal opinion is it doesn’t matter. I prefer to keep it simple and choose one or the other. I suspect that over many years, you won’t notice the difference.

To that end, I chose gilts – lowest cost, marginally better crash protection. Those are my priorities. The only thing that would worry me is if the UK credit rating deteriorated faster than other leading nations. If that was my primary concern then I’d go global.

If you the incremental complexity doesn’t bother you then split them 50:50. It worked for Markowitz!

I went for a mixture of the Vanguard Global Bond Index Fund and the Vanguard US Bond Index Fund. My main reason for avoiding the GILT funds is their long durations and the accompanying interest rate sensitivity. The 7-8 year average durations of the funds I picked just made me feel more comfortable.

One question I have is whether to bother with linkers when in the accumulation phase. They seem so expensive right now.

@ hapshade

There’s been a fair bit of discussion in the comments of the last few bond articles about asset allocation etc.

From memory TI has 60% global equities, 10% gilts, 10% linkers, 10% gold and 10% cash.

I think it depends on where you are on your journey.

I’m a way off becoming FI and an very much still in the accumulation phase so am much heavier on equities. I pretty much just keep an emergency fund in cash with a year or so expenses in bonds split 50/50 between gilts and linkers and the rest in equities. All my contributions are going into equities.
I’m comfortable with this and will maintain the years expenses in bonds regardless of returns, but I’m a decade or so away from FI so my situation may not suit many others.

@ Rosario: You write:

From memory TI has 60% global equities, 10% gilts, 10% linkers, 10% gold and 10% cash.

I believe you mean @TA (The Accumulator 🙂 ) though I don’t believe he has anything like that much in gold?

I wouldn’t want people to get the idea I had anything like such a clean portfolio! 🙂

– The Investor aka @TI, who nobody should be following too closely 😉

@TI
Yes, of course I meant to reference TA not your good self. Excuse my error.

For what its worth I think the contrasting approach of yourself and TA really is part of the value to this site. At first it was slightly confusing but I figured out what was going on fairly quickly and after that I found I really enjoy musing over the different strategies. Finding a resource which enables you to work out where you sit on the scale, and then caters to that, is really quite unique.

I think that early on in ones investing life a passive approach works really well, there’s usually lots of other things in life to focus on (growing income, career progression, young family etc etc) and the numbers are usually small. Personally I think as I’ve grow my net worth and I approach FI I am taking more and more interest in the active side of investing. Not moving away from a passive core of investments at all but certainly adding on a few active parts. Your posts really allow people like me to indulge that and grow at our own pace into that space. It would be a great loss if you were to stop writing about “the dark side!”.

@StellaR. The 5-year inflation breakeven rate between nominal fixed-rate Gilts and inflation-linked Gilts sits at around 3.5%. So for you to outperform by holding linkers over nominals, RPI would have to average > 3.5% over that 5-year period.

In the last 20 years, there was a short period (4Q2009) where, over the next 5-years, RPI was greater 3.5% (it got to 3.7%). In all other periods it was lower, typically around 2.5-3.0% on RPI.

So what you are saying is already to a large degree priced into the market. If you believe inflation will average 4, 5, even 10% then yes, linkers are much better than nominals. That, however, is clearly an active view. What do you know about RPI that other’s don’t?

@ Rosario – your comments about valuing the passive/active dichotomy in the site go straight to the heart of a debate TI and I have been having about the blog for years. He’s reticent to write about the Dark Side (though sometimes he can’t help himself) and I keep saying that even committed couch potatoes like myself love to take a walk on the wild side every now and then. So interesting that you value that split.

Re: a defensive allocation of:

10% nominal/conventional government bonds (defends against recession)
10% cash (lesser defence against recession but better against rising rates)
10% linkers (inflation defence)
10% gold (max diversification – hedge against equities, bonds and cash failing to work)

That’s not quite my allocation but I mentioned it on the other thread as a simple way to show that you can diversify against an uncertain future without committing so much to any single asset class that it’ll torpedo your portfolio returns.

So many commentators talk as if interest rates must rise without quantifying what that actually means for their portfolio, or how they’d cope in a recession when a risky portfolio plummets, or acknowledging that people have been making that prediction for over a decade and have been dead wrong.

A portfolio should be thought of as a team – each with a role to play and compensating for each other’s weaknesses.

@ StellaR – I agree, inflation is a risk. It always is. Equities, linkers and, to a lesser degree, cash offer varying degrees of protection against it.

Nominal / conventional bonds offer me the best protection against recession. Agreed, we don’t know when the next recession will hit, but that’s the point – I hold bonds because it could be tomorrow, next week, or next year. One thing is for sure though, another recession will occur.

High inflation on the other hand is not a risk guaranteed to materialise. I think everyone should be ready for it, but not to the point of believing it’s a done deal. As you say, we don’t know what’s going to happen.

I understand the normal advice is to hedge overseas bonds but I take a view that a large part of a passive global equity portfolio is held in or tied to the US dollar and if one holds government bonds to counter this, then there is logic in holding unhedged US government bonds.

My father who has lived in the US off-and on , reminds me the exchange rate was once $4 to the £ in the 1940’s when he was living there.

Looking at the level of local inflation since then the current exchange rate is consistent with that, perhaps over time the volatility works out and inflation adjusted purchasing power dominates.

Hedging is not 100% efficient and adds costs plus interest rate differentials come out in the hedging process.

Hi,
Thank you for your fantastic website.
I am new to passive investing, and currently building my portfolio.
Are inflation-linked gilts and index-linked gilts the same thing?
for example,
Vanguard U.K. Inflation-Linked Gilt Index Fund
Legal & General All Stocks Index-Linked Gilt Index Trust

Which would be best to guard against inflation alongside my Vanguard U.K. Government Bond Index Fund.

Thanks
Gary

Mogul

@ Gary – yes, inflation linked and index linked mean the same thing. You’ll also come across references to linkers which is just an abbreviation of the same thing.

In principle the two funds you mention above are good anti-inflation products but there’s a potential distortion in the UK linker market.

These two pieces explain more about it, though I’m afraid it’s a lot to take in when you’re just starting out:

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/

If you concerned about the points raised in the two articles above then this piece has some leads for global index-linked funds:

https://monevator.com/low-cost-index-trackers/

Check out the ‘Global inflation-linked bonds hedged to £’ section.

This ETF could also do a job but it’s new and not widely available yet:
https://www.lyxoretf.co.uk/en/instit/products/fixed-income-etf/lyxor-core-global-inflationlinked-110y-bond-dr-ucits-etf-monthly-hedged-to-gbp-dist/lu1910940425/gbp

Mogul

Hi AMG – I took it out for 2 reasons:

Trustnet’s data showed it to be weirdly volatile. That could have been a problem with Trustnet rather than XGSG but the issue wasn’t showing up with the iShares equivalent.

XGSG is domiciled in Luxembourg which potentially puts it at a slight disadvantage vs iShares Ireland domicile because Ireland typically has superior double-taxation treaties with other countries.

I think the index you have for the Vanguard UK Government Bond Index Fund is wrong – it should be the “Bloomberg U.K. Government Float Adjusted Bond Index”. Which explains the difference between that and the Vanguard UK Gilt ETF.

Is there any reason to prefer the Bond Fund over the Gilt ETF, given the higher OCF? I see you recommend the Bond Fund in your lazy portfolios and hold it in the Slow and Steady.

Mogul

@ Evan – good spot. Updated. Thank you for taking the time.

The main reason you might choose the bond fund over the ETF is if it reduces costs at your broker. For example, a relative newcomer benefits from zero dealing fees on funds and pays little for platform fees on a relatively small portfolio.

You can see that the difference in OCF has made little practical difference to return over 5 years – the longest comparable time-frame we have for the two products. Still, the ETF has the slight edge.

Any reason you’ve not considered transaction cost above? My understanding is that this relates to hidden costs that the fund pays while trading (correct me if I’m wrong).

For example -The Fidelity website lists transaction costs for the iShares UK gilts all stocks index fund as 0.01% and for the Fidelity index UK gilt fund P as 0.18%. Seems like quite a big difference?

This article has been really useful to me, even if it is from 2021.
Currently all my bonds are UK based, for which I have paid the painful price over the last year. Belatedly I am looking to balance with some non UK bonds. I note though that US govt bond funds (Vanguard U.S. Government Bond Index Fund – GBP Hedged Acc) have much lower costs (OCR) than the Global bond funds you discuss – 0.17% for the above cf 0.27% for the Vanguard hedged Global bond index fund and a whopping 0,43% for the Global Aggregate Bond hedged ETF.

Given that majority of holdings in these global funds are presumably US anyway, why not reduce costs and go for the pure US version? A big saving for the price of some loss of geographical diversity?

Interested to know your thoughts.

@ incus – cheers, 2021 seems a long time ago 🙂 I too am reconsidering the wisdom of concentrating my bond holding in gilts after this year’s Trussonomic debacle.

I think your question is really interesting as it hinges on a recurring dilemma:

*Is it worth giving up some diversification potential to save on cost?*

A cost saving of 0.1% saves £10 per year per £10,000 invested.

The iShares Global Government Bond ETF (IGLH) is 51% US according to the website.

In my view, the additional diversification benefit of IGLH is a price worth paying vs concentrating in US treasuries.

I would not have worried about this ten years ago. But the election of Trump has raised significant doubts in my mind about the strength of American democracy.

So if I’m going to diversify my bonds, I might as well go the whole hog and avoid the concentration risk inherent in any single country.

I appreciate that not everyone will agree. I think you’re doing the right thing by reconsidering your approach to bond diversification. My personal viewpoint is that the rise of populism has increased the threat of any given developed world country going off the rails to the detriment of bondholders (along with everyone else!).

@ TA – thanks.
Very good points. I sincerely hope Trussonomics was a unique brief spasm, albeit one we are still paying the price for. And yes US democracy doesn’t look stable right now, but despite 4 years of Trump madness, bonds didnt tank did they?.

I am currently with Bestinvest but for various inheritance planning reasons I am probably shifting to the Vanguard platform , where my options are just Vanguard funds /ETFs I think, hence IGLH is not an option and as you pointed out Global gov bond index hedged is a gap in Van’s arsenal. Anyway I shall have to weigh up risks and costs.

Cheers

My fear with Trump was more about what would happen if he got a second term. Autocrats such as Putin, Erdogan, Orban et al typically proceed cautiously initially. The velvet gloves only come off once they have their fists firmly on the levers of power. Thankfully Trump was incompetent!

You’re right of course, though. I could be being unnecessarily alarmist. American democracy is not so fragile (I hope).

Anyway, good luck with your move and planning – I hope it all works out 🙂

I think this is out of date:
GOVG is cheaper now? (https://monevator.com/low-cost-index-trackers/)

“iShares Global Government Bond ETF is the clear leader in the best bond funds hedged to GBP category. That’s because it’s the only dedicated government bond fund in our pack.”

https://monevator.com/low-cost-index-trackers/

@ The Accumulator I’m revisiting this (still to make a decision – despite asking questions 2 years ago :-/

You previously said (here in ‘Best bond funds and bond ETFs’:

“To that end, I chose gilts – lowest cost, marginally better crash protection. Those are my priorities. The only thing that would worry me is if the UK credit rating deteriorated faster than other leading nations. If that was my primary concern then I’d go global. ”
(https://monevator.com/best-bond-funds/#comment-1288883)

And in the main post said:

“So, given the diversification benefits of global government bonds why would you go for a 100% gilts tracker?

Mainly because the gilt trackers are one-third less costly to own, offer more yield, and promise marginally more crash protection.”

In ‘How to choose a bond fund’, you later wrote:

“Gilts got pummeled relative to global government bonds when Truss and Kwarteng went on their bonkers Britannia bender.

UK government bonds have since climbed someway back out of the hole. Sanity has been restored, but this was a wake-up call. A stiff lesson in the danger of concentrating your risks in a single country.

We Brits proudly think of ourselves as members of the premier league of nations. So was this a one-off shocker or evidence we’re on the brink of relegation?

Your answer to that will determine whether you choose gilts or global government bonds. ”

I’m not trying to call you out for a contradiction. Obviously, your first post was back in 2021; You did in fact caveat in your first comment that something like this could happen; I know you can’t guarantee anything; Who was to know that the infamous mini-budget lied ahead! Etc. etc.

Given that vebose intro(!) I’d be really interested in hearing your thoughts on making allocations to bonds now (global, vs uk gilts, vs some combination of each)?

Mogul

@ Jonny – Unfortunately Truss proved single country risk is all too real. In fact the last four years (at least!) has shown just how susceptible we are to having the levers of power seized by people who aren’t up to the job.

If you want to keep things simple, then isn’t this all the proof we need to just go global govies?

But what have I personally done? Personally, I’ve done nothing. I’m still 100% gilts. Why? Partly inertia. Partly because I still believe in the country and hope for better days ahead. It’s not very hard-headed of me.

In my mind, I guess I still justify it by thinking about the higher yield on gilts, cheaper costs, greater duration offering the potential of a higher flight-to-quality bounce in a recession.

I don’t think those advantages really overcome the strategic weakness of the single country risk we’ve just witnessed though. Especially when I place it within the wider context: Brexit has clearly diminished the UK’s significance in the world, not enhanced it.

It’s something that needs to be dealt with. I could come up with a new ratio: 50:50, 75:25 one way or the other.

It’s just another complication though. And the longer I invest the more enamoured I am with keeping things simple. So, if I were personally to make the change, I’d just go 100% global gov bonds hedged to GBP.

Why take a risk you don’t need to take for uncertain benefits that are quite marginal and could prove moot if the country continues to slide?

Reading the article i can see that IGLH is the idea ETF to hold for government bonds due to its high bond quality, global diversification and hedging. Im keen to find a fund that offers the same qualities as this ETF, the best i can find is the abrdn Global Govt Bond Tracker B GBP Acc (GB00BK80KQ76) fund. It is the same cost as IGLH at 0.25%, also hedged to GBP and is more globally diverse but does carry about 8% more BBB grade bonds. Is this a suitable fund replacement? as it seems to tick all the same requirements as IGLH.

As the general thinking before bondaggedon was to hold my bond allocation in Gilts. Switching to a globally diverse fund would mean going from a 100% Gilt holding to something around the 5% mark, while pushing my reliance on US to around 60%. Im not too sure i trust the America government to be any more sensible with economic decisions than bonkers Britain as the moment in time, so i am thinking about a blend of a Gilt fund and a hedged Global Government bond fund something like 40:60? Or am I just over thinking this?

Mogul

Great find, Chris. I haven’t spend a lot of time on this, haven’t investigated the index for example, but the Abrdn fund looks decent.

It’s cheaper (OCF 0.14), similar amount of BBB bonds, and performance is very similar to the iShares ETF over the 3 years since launch.

Hard to say whether you’re overthinking the decision to diversify your main bond holding. I think it’s more a question of how much portfolio management you wish to put up with vs what helps you sleep at night.
Given the likelihood of US / UK government default is unlikely but not implausible (and I was reminded the other day that the price of US treasuries has been known to go up when wrangling in Congress threatens government shutdown), decisions like this are more about what makes you comfortable.

For anyone who is intrested in the geograpic breakdown % for abrdn Global Govt Bond Tracker B GBP Acc (GB00BK80KQ76) fund. As its not easy to find it is as follows:
US 48.77
Japan 18.1
France 6.39
UK 5.77
Italy 5.7
Germany 4.76
Spain 3.81
Canada 2.15
Australia 1.72
Belgium 1.4
Netherlands1.02
Demark 0.25
Sweden0.16

The fund also has an effective duration of 7.04

@ The Accumulator – Yeah finding useful information for the abrdn Global Govt Bond Tracker B GBP Acc (GB00BK80KQ76) fund was not easy.
The first mention that I could find of the duration was in the July 2023 Fund Provider Fact Sheet that I found on the Fidelity website

https://www.fundslibrary.co.uk/FundsLibrary.DataRetrieval/Documents.aspx/?type=packet_fund_class_doc_factsheet_private&id=f51aa6ea-52db-42e0-8bab-652a0bb846c0&user=hrynGNcqAhY3II8Pbyv9dkZq%2fUlvqBPylcy%2bnnGZ5OyXGpRVfKqISgLfp9ZnQkDo&r=1

To work out the geographic breakdown, abrdn state they follow the JP Morgan Government Bond Global Index (Hedged to GBP) again taken from the above factsheet. This index can be found here;

https://www.jpmorgan.com/insights/research/index-research/composition
Selecting DM Sovereign > GBI Global

Sady this just displays the security name and its weight % for every bond the index tracks. So with a beer and a spreadsheet I set about calculating the geographic breakdown of the index;

US 48.77
Japan 18.1
France 6.39
UK 5.77
Italy 5.7
Germany 4.76
Spain 3.81
Canada 2.15
Australia 1.72
Belgium 1.4
Netherlands 1.02
Demark 0.25
Sweden 0.16

And just for giggles here are the S&P credit ratings for each country in the index;

https://tradingeconomics.com/country-list/rating
US (AA+)
Japan (A+)
France (AA)
UK (AA)
Italy (BBB)
Germany (AAA)
Spain (A)
Canada (AAA)
Australia (AAA)
Belgium (AA)
Netherlands (AAA)
Demark (AAA)
Sweden (AAA)

Using the AJ Bell Cost Calculator, the fund costs come out as TCO 0.25% (OCF 0.14%, Transaction 0.11%)

Considering the cost, duration, geographic breakdown and credit rating I think this fund is just as good as iShares Global Govt Bond ETF (IGLH) if not slightly better.

Great work! I’ve found these links too:

https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F000015IKJ&tab=3

https://www.abrdn.com/investmentsfundcentre/fund-centre#literature

Maven

I went back and forth on this one and settled on a slightly complicated split between UK Gilts and US Treasuries hedged to GBP for my fixed income. I’m also using the ERNS Ultra Short ETF to drawdown from, rebalancing once a year. 20% equal starting allocation to each.

IGLT – iShares Core UK Gilts – TER 0.07 / YTM 4.65% / Duration 8.43

IGLS – iShares UK Gilts 0-5yr – TER 0.07 / YTM 4.86% / Duration 2.08

GOVP – iShares $ Treasury Bond (Hedged) – TER 0.1% / YTM 4.55 % / Duration 5.95

IBTG – iShares $ Treasury Bond 1-3yr (Hedged) – TER 0.1% / YTM 4.98% / Duration 1.79

ERNS – iShares £ Ultrashort Bond UCITS ETF – TER 0.09 / YTM 5.7% / Duration 0.20

Average = TER 0.086 / YTM 4.95% / Duration 3.69

It might prove more aggravation than it’s worth, but the aggregate funds are quite a bit more expensive and dominated by the US anyhow. Using IGLH as the example, TER 0.25% / YTM 3.67% / Duration 7.31 – almost 3x the fees, current yield is significantly lower, and the duration is longer than I settled on for drawdown.

Just thought I’d add my 2p to the conversation.

Mogul

@ Ade – Cheers for this! I think your observation that the US dominates global gov bond funds is a very fair point. It accounts for 52% of IGLH right now.

I’d add that a higher yield implies greater risk so there’s no free lunch.

Mogul

@ Chris – you can’t hold bond funds until maturity (they’re rolling investments), doubtless that was just a typo though, and you meant to say, “I should get my capital back from both funds if held for the duration.”

Yes, you will get your capital back if you hold for the duration though that’s different from earning your expected return or a real return.

Scroll down to the ‘Bond duration: making your money back’ section of this post:
https://monevator.com/bond-duration/

This post also useful:
https://monevator.com/rising-bond-yields-what-happens-to-bonds-when-interest-rates-rise/

Personally, I don’t try to duration match anymore for the reasons outlined here:
https://monevator.com/duration-matching/

I choose intermediate gov bonds for recession protection (though long bonds are plausible now interest rates have surged and inflation hopefully tamed) and short bonds / straight cash for nearer term needs.

I’ve ended up keeping my gilts rather than diversifying into a global bonds fund but I can’t say I’m 100% comfortable with that. If I’m being truly objective then I doubt the extra yield / cheaper cost of UK bonds is worth trading away the diversification protection yet I struggle to believe the UK will go pop or the same couldn’t happen to Italy, Japan, or even the US one day.

Hi Accumulator, I try to understand bonds but it just goes over the top of my head…

I’m not asking for advice as such, but if YOU were starting again today from scratch, and was only investing on the Vanguard (UK) platform, which (if any) bond/gilt fund/s would you add to your personal portfolio. This is for someone with approx 5-10yrs (age 49yrs) to retirement and currently 60% global equities and 40% Vanguard Sterling Short-term money market fund. Many thanks

(great site btw 🙂 )

Mogul

Hi Half Full,

The fund I’m in (and I’m of similar age to you) is: Vanguard UK Gilt ETF. Vanguard don’t have a global government fund which makes the decision much simpler. I’d be happy to hold some of my allocation in the money market fund too.

Thanks, The Accumulator – your reply is much appreciated! Am i correct in assuming the fund you refer to is: U.K. Gilt UCITS ETF (VGOV)?

Also if you don’t mind me asking – why VGOV rather than something like their Global Bond Index Fund (0.15% ocf) which i believe is hedged to the pound? Could this be a tactical move based on the 3-year -32% loss reversing? Thanks again and much appreciate your responses : )

Mogul

Mogul

“A bond fund with a duration of 10% will lose around 10% of its market value for every 1% rise in its interest rate.”

Should the first % be years?

Mogul

Very informative post, but as you say the recent performance of bonds has been dreadful and shows that a product thought of as low risk sometimes is not. With this in mind my Sipp is balanced 80% equities 20% money market.

(CSH2) The Lyxor Smart Cash – UCITS ETF C-GBP is a UCITS compliant exchange traded fund that aims to achieve short term returns higher than the benchmark rate Sonia with extremely low volatility.

So returning about 5.2% at present with very little risk at a cost of just 0.07%

At this rate why would I risk my safe money on bonds?

I do appreciate if base rates drop back down below 4% this strategy may well need to be revisited.

Hi TA,
In light of the update, and no mention of the bond ETF I am currently invested in (eek!), I wondered if you had an opinion on it? It’s global, government bonds, GBP hedged, and inflation-linked:

GILG – iShares Global Inflation Linked Govt Bond UCITS ETF

Ongoing charge is 0.20%

Maven

Do many here use a combination of bond funds and individual gilts together, to get their desired duration mix?

I quite like the idea of using shortish duration global funds for diversification and then a few longer gilts (10 to 15 year) for precise control of longer duration bonds aligned with my horizon. Though I’ve not yet implemented that…

Mogul

@DaleK. Linkers immunise you against rising spot inflation. You are still exposed to changes in real yield expectations. Real yields went up 400bp, hence they lost quite a bit in value.

Conventional (nominal) bonds expose you to changes in both real yield and inflation expectations.

So whether you buy linkers or nominal depends on what you want to achieve. Protection against falling inflation and real yield expectations, buy nominals. Protection against falling real yield expectations, but not inflation, buy linkers.

A possibility for Gilts is GOLDMAN SACHS ETF ICAV ACCESS UK GILTS 1-10 YEARS UCITS ETF CLASS GBP DIS (GBPG)

Duration is just 4.5 years and cost .07%

Mogul

@ DaleK – Linkers aren’t mentioned purely because I have to limit the scope of the article to make it doable and readable.

I need to follow up with a similar piece on linker funds and a piece that shows the differences between intermediates, short, and long dated funds.

Ideally, this post would be nominal government bond central and include short and long bond fund tables too.

Great name, btw.

@ JMoose – GILG is intermediate duration. I try to use shorter duration linker funds to reduce the rising real yield problem that ZXSpectrum48k mentioned.

On my shortlist:
GISG
Royal London Short Duration Global Index Linked Fund M
abrdn Short Dated Global Inflation-Linked Bond Tracker Fund

All GBP hedged, though I haven’t taken a close look at the abrdn fund yet.

@ Gary Grand – I need to write a post on that too, but you’ve answered your own question: to protect against rate drops / the next recession.

If rates rise from here I’d definitely rather be in cash. If they drop then I’d rather be in a longer-dated fund. Because we don’t know which way rates will go, intermediates are my muddy compromise. Over the long-term bonds generally beat cash.

This is why I don’t think money market funds should be thought of as safe:
https://monevator.com/money-market-funds/

@ Hariseldon58 – Cheers! That looks interesting. Short dated but a bit longer than most existing short gilt funds.

Minor observation/addition to domicile and Tax:
If you hold Gilt ETFs outside of a tax wrapper (ISA or SIPP) then the reporting status of any overseas/offshore ETFs should always be checked. If its not UK reporting/distributing then the gains are taxed as income and not capital. Offshore bond ETF distributions are also treated as ‘foreign interest’ for tax purposes (even though the underlyings are UK Gilts).

When held outside of a tax wrapper – they are not really as tax efficient as individual gilts (which are free of CGT). However, there can be a benefit to holding your bond ETF allocation outside of a tax wrapper (when you have exceeded your SIPP and ISA allowances). In times of rising yields – Gilt ETFs can be used to generate realised capital losses (by selling one Gilt ETF and repurchasing a ‘similar’ Gilt ETF), with the loss then available to be offset against capital gains.

@TA
Thank you for the clarification.

I have a couple of grand in GILG right now, and my current position puts me £80 down, which isn’t too painful to realise. [Not financial advice:] in my position would you eat the deficit and immediately put the money into something with a shorter duration, or leave it there and begin anew into something shorter with my future investments?

Mogul

Mogul

@ J Moose – personally I’d move to the fund I want. I don’t think this will make much difference over the long-term though it stings a bit now.

@ Half Full – It’s certainly well diversified! And overcomplicated. The thing is that the LifeStrategy funds are all about simplicity. The compromises are reasonable if you don’t want to manage more than a single fund.

I’ve got my mum in LifeStrategy because she really doesn’t want to know.

Maven

Thanks for the article, my limited knowledge of bonds makes it hard to turn into strategy in my specific scenario, perhaps you can help?

I bought on these dates and hold the following:

April 19 – Vanguard Glb Bd Idx £ H Acc (IE00B50W2R13) – 7% down
July 21 – Vanguard UK Inflation Linked Gilts (GB00B45Q9038) – 38% down
July 21 – Vanguard U.K. Government Bond Index Fund GBP Acc (IE00B1S75374) – 32% down

I can afford to hold long term (e.g. until retirement, 20 years), is this the right approach as the issue is cyclical? From the bond yields article my takeaway is the best strategy is to hold if I can afford to for higher yields and for diversification. These bonds were around 20% of my portfolio (originally, valuations have shifted) vs global all cap equities.

It feels like this must be a scenario many people are facing…

Thank you!

My previous venture into bonds consisted of buying a few and holding to maturity. I’m tempted to repeat the trick, but with a more conscious attempt at constructing a “ladder” of gilts.

Last time a couple of my “bonds” were convertibles. I’ve not seen that asset class mentioned in ages. Why so?

Mogul

@NotThomYorke – people do talk about bond cycles but our problem really stems from the fact that we’ve witnessed an abrupt hike in interest rates from a historic low point. That turned 2022 into one of the worst years in bond market history.

If this happened in equities then lots of people would be advising each other to “buy low, sell high,” not “buy high, sell low.” The same is true for bonds.

Higher yields now mean bonds are better value than they’ve been for years. Unfortunately, we’ve also got to stare at those capital losses too, and that hurts.

Ultimately, you’re holding bonds to strategically diversify your portfolio. Bonds with higher yields are better equipped to do that than they were.

If the economy tips into recession and interest rates plummet then you’ll make back some of the lost ground.

In other words, the bonds you own still make sense, despite the losses.

What’s the point selling them – and crystallising those losses – if they’re still capable of doing the job you bought them for?

Many people will regret dumping their bonds if there’s a flight-to-quality during the next stock market crash.

As ever, it’s a balancing act. If interest rates keep rising and inflation keeps surging then more bond losses will follow. But we don’t know what interest rates will do next. Experts are notoriously bad at forecasting future rates.

I don’t know your personal situation but 20% in bonds isn’t high. In the long-term your results will be dominated by your equities. If you dump your bonds now then you won’t be diversified at all when TSHTF in the stock market.

If you haven’t seen these posts then they’re useful descriptions of how higher yielding bond funds recover their losses:

https://monevator.com/rising-bond-yields-what-happens-to-bonds-when-interest-rates-rise/

https://monevator.com/bond-duration/

The issue that’s tricky to solve is your UK linker holding:
https://monevator.com/why-uk-inflation-linked-funds-may-not-protect-you-against-inflation/

As ZXSpectrum48k noted, this fund will do well if real yields fall but it’s not a great inflation hedge sadly.

It may be better to eat the loss on that one if you’d prefer to hold a fund that’s a better match for inflation – though none of the options are ideal as the post explains.

Hopefully this helps a bit. It is a tough situation. FWIW, I hold the ETF version of your Vanguard UK gov bond fund, so know how you feel.

Mogul

@NotThomYorke #77, @TA #80: You might just be in luck. Inflation’s come in lower today, contrary to expectations, and the second surprise in a row to the upside (in terms of wanting lower inflation, for lower rates). If the rate cycle is close to topping out, then bonds, especially longer duration, should do well. As always, it’s future performance which matters, not what’s just happened, however painful. Fingers crossed. Even if rates stay high, it does at least mean that, as bonds mature and get reinvested, they get reinvested at higher coupons and better YTM, thereby accelerating the process of being made whole again.

As someone who is, and has been since 2013, basically nearly all in shares myself (~90% in global equity trackers, much of rest in equity related ITs), the question which I have is: What duration (and type, conventional or IL) of UK Gilts give best expression to a ‘rates are now heading persistently much lower’ thesis? Up to last month I was in the rates are going much higher camp. But, as the data changes, so one has to assess if one needs to change one’s mind; and I’ve concluded that I do, and I have now. Basically, I am looking for the maximum capital gain upside for an unwrapped (i.e. not ISA or SIPP, as used allowances) direct Gilt holding, even at the consequence of duration and rate risk if I’m wrong (i.e.such that rates keep going up; which would presumably be due to some sort of combo of persistent high inflation, constrained supply, a new supply shock, and/or a stronger than expected economy being less responsive to existing rate rises).

@TLI: if your gilts are to be unwrapped it’s tempting to go for those ILGs that give an income yield of about one eighth of a percent. Shelter that income using your Savings Allowance. The bulk of the yield to maturity is in the capital gains and they are untaxed.

Mind you, I’m an amateur so this is not Advice.

If you are old and a-feared of Inheritance Tax then piling up capital gains may not be a bright idea.

Mogul

Maven

@ZXSpectrum: “In bonds, you should always look at duration weighted returns, not cash-weighted returns.”

Could you explain this in more detail please, if you have the time?

Maven

@Ade
“IGLS – iShares UK Gilts 0-5yr – TER 0.07 / YTM 4.86% / Duration 2.08”

Sorry if this is a really thick question, but what does “Yield to Maturity” mean in this context? I understand that if I bought a single gilt today, due to mature in 2.08 years then, come rain or shine, the coupon and the redemption are entirely predictable, and thereby so is my YTM as it’s just a function of the price I paid plus coupon value and redemption date.

But what does it mean in the context of an ETF like IGLS, where the fund *isn’t* just going to hold all its current holdings to maturity and then wind itself up, but is going to buy new gilts to replace the ones that mature within the 2.08 years and thereby perpetually renew itself?

I’m really missing this vital point.

Thanks
V

Valiant (86): I hold IGLS as well. Factsheet says: Weighted Average Yield to Maturity of the ETF is calculated as the average of the underlying bonds’ yields, adjusted to take account of their relative weight (size) within the fund.

Which makes sense as you say, but doesn’t give a good indication of forward performance especially as the yield curve right now is inverted and relatively volatile.

And on that note… rather than topping up IGLS I chose to buy some 1yr US T Bills at 5.4% yield… assuming I hold to maturity this beats the daylights out of most short duration funds. I don’t necessarily believe Fed Powell’s “higher for longer” speech but thought it was worth the punt now.

Maven

@Valiant

You can still use YTM as the expected return of the ETF, it’s just less clear when that would be achieved. There’s a rule of thumb that says ‘assume sometime between duration and 2x duration of the ETF’.

Some good articles about this right here on Monevator. Also on Occam Investing and on Bankers on Wheels.

Mogul

@Valiant. People often think in cash allocation terms: 50:50, 60:40, 70:30 etc. That’s fine for equities but it’s not ideal for bonds. Imagine 60:40 where the Gilts are in fund with duration 2 or a fund with duration 15. The portfolio duration of the first is 40%x2 or 0.8. So, for every 100bp move in yields, the portfolio will make or lose around 0.8% (remember this is approximate). Even if yields go back to zero or double from 4% to 8%, the bond portfolio will struggle to make or lose 4% in capital terms. Contrast that with the portfolio duration of the second which is 0.4%x15 or 6. So now for the same moves we’re looking at 24% loss or gain to the overall portfolio. Even on a 30% stock market drop, the 60% cash allocation to equities would only lose 18%. That’s too much bond risk. So, two bond allocations, same cash invested, one pointless, the other too much risk.

Imagine instead you have a 70:30 portfolio. You are concerned about a big nasty recession where the stock market might drop 30%. So, with a 70:30 portfolio, you might be looking at a 21% loss. You’d like the bonds to take the edge of that loss. Say reducing it by a third or 7%. You look at the yield curve and see the last time they cut, yields went down 3% to 4%. Let’s call it 3.5%. To make 7%, you need an overall portfolio duration of about 2 since 2*3.5%=7%.

Now you are only willing to allocate 30% to bonds. You need 2/0.3 or a fund with a duration of about 6.66 years. You look down the list of preferred funds and your favourite has a duration of 10. So not as to over allocate to bonds, you only put =6.66/10*30% = 20% in that fund. The residual 10% stays in cash.

If this sounds a bit like TA’s recent article on duration matching, then that’s because it is. Essentially, you start with the portfolio bond duration you want (the risk you want) and reverse out the bond and cash allocations that requires.

Maven

Thanks @ZX (#89), you’ve gone a long way to answering a question I’ve had rattling around in my head, specifically how bond duration risk should be applied to the basic long-term equity, govt bond, cash portfolio.

I’m not sure I’ve seen it expressed or calculated it in terms of risk vs. equity quite like this. Most of the articles I’ve read talk about using it for a future expenditure matching etc. When what I’m really interested in is how to use bond fund duration to calibrate an offset to a 2008 style crash and recession for example without taking on too much risk. I’m conscious each crash is different, but the ‘flight to quality’ scenario is where I expect the govt bond holding will be most effective.

I’ve had a play around with the basic tools I have available, using a mix of a Gilt fund (IGLT) and US Treasuries (GOVP) blended with cash to hit various durations, using the recent ‘COVID crash’ to observe the effect.

One half of my brain is starting to think my target duration in drawdown of ~4 is not enough risk as the positive move mid-March 2020 is pretty mild. The other half reminds me this portion of my portfolio is for primarily security of expenditure, and a lower duration would have kept the recent 2022 capital losses manageable.

It’s probably an unrealistic expectation to find a goldilocks number, but your comment makes me think I can use more than just rules of thumb to find that sweet spot. I just need to work a bit harder to calculate the best trade off.

Mogul

@Algernond #91: Agreed. I tend to see US Treasuries as the arguable reference risk free asset with ultra short duration TIPS the paradigm as minimum term and unexpected inflation risk.

Of course risk free can be return free, but that’s a lot better than return free risk, which sadly is what a static bond allocation delivered in 2022.

My sense is that an investor seeking total return in fixed income should consider something along the lines of the following questions:
1. Is there any benefit to taking on non-sovereign risk (i.e. default risk)? CBs are at 6.5% and UK gilts 4.5% with Treasuries at 5%. So for me the answer is ‘no’ to that as not enough extra reward for additional risk.
2. Am I holding to maturity and rolling over or am I holding in the hope of a return and selling or at least top slicing if achieved? For me its the latter. If the former though, then yield to maturity will be more important than duration risk.
3. If duration risk is important to you, do you then think that long term market rates are going up or down? If you think up, steer clear of long duration and possibly give bonds a miss and go for cash instead. If though you think down, then maximising duration maybe makes sense.
Of course, no one anywhere knows what happens next to long term market rates. If I could ask Aladdin for one financial data point from the future it would be the YTM of newly issued 30 year US Treasury Bills in say 2035 (i.e. maturing in 2065).

Mogul

Maven

@David C – I’m in a similar position, with both DB and DC funds, so I’ve faced the same question.

I accept the theory that my DC should be 100% equity, but I also know that in reality a substantial crash isn’t something I’d want to experience with that positioning.

As you hinted, it’s much better to work backwards: decide how much DC income you want to be ‘safe’ and pick an equity % that fits with that framing. To me, that’s the far more pragmatic and realistic solution.

@ZX another thanks from me for post 89. I hadn’t seen it framed that way, but it fits well with Hale’s differing advice for people on bonds, depending on the equity % they hold.

Mogul

@David C, that is an excellent point. I’d been thinking to rejig my asset allocation to count DB pension as bonds and up the equities in the DC part, but you’ve given me pause.

The usual assumption for a rebalanced portfolio – the basis of SWR calculations – is that when equities are down you will live on the bonds (indeed even sell bonds to rebalance into equities), but as you say you can’t do this if your ‘bonds’ are a DB pension, so the usual SWR numbers may not be applicable. I wonder if a better mental approach is to consider the DB pension as cancelling out a big chunk of living expenses and the remaining expenses are covered by the DC pot. Then you choose the allocation of the DC pot according to how flexible you can be in the top 40% of your spending and how much you want to trade off probable higher income vs increased risk of serious belt tightening.

I’m still firmly in accumulation territory, but sequence of returns risk applies to accumulation too. Food for thought.

@ David C et al – any reliable income stream that’s available on day 1 of retirement (e.g. DB pension, State Pension etc) can just be deducted from your income requirement.

What’s left over is the income that must be supported from your volatile defined contribution pot.

Assuming your sustainable withdrawal rate will be anywhere from 2.5%+ then I’d stick to a conventional allocation. For example, 60/40 or 70/30 for retirements of 25+ years.

If your SWR is 2% or less then you can probably do what you like – you’re unlikely to run out of money – but it still makes sense to keep a minimum 10% in bonds. More depending on risk tolerance.

If your DB pension arrives some years after your retirement date, and you’ll rely on DC pension to plug the gap, then this piece from Early Retirement Now is helpful on the SWR bonus you can award yourself:

https://earlyretirementnow.com/2017/07/19/the-ultimate-guide-to-safe-withdrawal-rates-part-17-social-security/

I use this to judge the SWR tailwind I’ll get from the State Pension.

Obviously SWR is higher if you expect to spend DB pension income on top of whatever the DC pension can support.

In accumulation, it makes sense to me to calculate the capital value of a defined benefit pension and think of that as the bond portion of a larger portfolio.

But with 10 years to go until retirement, I’d start upping the bond allocation in my DC pension to cushion it against a crash ruining my plans.

There’s also a nice rule of thumb in the latest edition of Tim Hale’s Smarter Investing to help a pot deal with sequence of returns risk:

Hold 10 years worth of essential expenses plus 5 years worth of nice to have cash in bonds.

That would provide enough fixed income to get you through most crashes:
https://monevator.com/bear-market-recovery/

Mogul

@ Mike T – by the looks of things that’s the distribution yield i.e. interest paid over last 12-months.

Vanguard publish yield-to-maturity here (it’s currently 4.6%)
https://www.vanguard.co.uk/professional/product/fund/bond/9148/uk-government-bond-index-fund-gbp-acc

Yield-to-maturity is effectively the annual expected return for an intermediate fund if you hold to duration. So if you hold this fund for 10-years you can *expect* to earn 4.6% annually for next 10-years. That’s not the same as what you *will* earn though. Literally nobody knows that. It’ll depend on future path of interest rates.
The expected return is just a best guess based on a known correlation between bond yield-to-maturity and return over time.
You’d also need to deduct inflation from any investment’s return to get its real return.

Mogul

Hi Tom – inflation-linked bonds need their own post. It’s on my to-do list but have got to it yet. There’s some leads here though:

https://monevator.com/why-uk-inflation-linked-funds-may-not-protect-you-against-inflation/

https://monevator.com/low-cost-index-trackers/

Maven

Mogul

Hi D_D,

I’d say the passive choice re: bonds is allocating to bonds that best match your strategic objectives – as opposed to hoping to pick the winners.

So long bonds would be most appropriate for an equity heavy portfolio that you don’t intend to tap into for a couple of decades nor mind the volatility associated with long bonds. In this case, long bonds are most likely to zig when equities zag (relative to short or intermediate bonds). The trade-off is that long bonds are most vulnerable to inflation and other interest rate rises.

Hopefully this piece will help you think through your choices:
https://monevator.com/how-to-choose-a-bond-fund/

@D_D — Just to add to what @TA wrote, I like this take from Rubin Miller, which argues persuasively that bond allocation *should* feel trickier, and be more personal:

https://www.fortunesandfrictions.com/post/don-t-take-it-personal

You need to have a big think about your time horizon, your risk tolerance, your aims, and your likely interest in rebalancing and tinkering over the next few decades to come up with a good fit for bonds.

At least they’re promising a should-be fairly decent return from here, post the rout. (Assuming inflation abates)

Maven

@ Ben – VGVA is the accumulation version of the Vanguard Gilts ETF.

https://monevator.com/low-cost-index-trackers/
This piece lists accumulation funds where available so you’ll probably find a couple more options here, although it’s true most bond products prioritise Inc

I’ve been looking for a fund only global bond solution.

I’d decided on the at the iShares Overseas Government Bond Index Fund (UK), but I can’t find it in the Lloyds ISA.

I then decided on the Abrdn Global Government Bond Tracker Fund B Acc. It’s YTM has increased to 3.74% so more closely aligns with the other global government GBP hedged bonds in the table, but I noticed Morningstar lists it as having almost 75% exposure to derivatives and only 25% in Government sector (https://www.morningstar.co.uk/uk/funds/snapshot/snapshot.aspx?id=F000015IKJ&tab=3). Am I reading this right. That 75% of the fund is invested in derivatives?

This seems like it should be a concern and adds risk, when looking to add the “safety” element to my portfolio. Should it be of a concern?

For comparison, the iShares fund had almost 100% exposure to government sector, though a higher risk rating of 4 (compared to 3 of abrdn).

Mogul

Hi Jonny, that is what Morningstar are saying but it’s almost certainly wrong. Morningstar make these kind of data entry errors fairly regularly.

The fund factsheet lists the derivative allocation as 0.2%. That’s far more plausible for this type of fund.

The factsheet lists the top ten holdings – they’re bonds, not derivatives.

You can also dig in to the annual report for a full list of holdings. The vast majority are bonds. Derivatives are listed as 2.32% of assets as of June 2023.

You can find the documentation here:

https://www.fidelity.co.uk/factsheet-data/factsheet/GB00BK80KQ76-abrdn-global-government-bd-tracker-b-ac/charges-and-key-documents

Thanks for your input @TA

After years (and years, and years) of ~~analysis paralysis~~ deliberating to find some alternatives to diversify away from a pure VG LS portfolio, I finally pulled the trigger (with the Abrdn fund making up some of my alternative bond allocation).

I had read the other documents you’d linked to, though was just doing a belt-and-braces comparison using Morningstar which then got me worried. I should have spotted the difference. It just goes to show how even when I think I’m starting to understand the minutiae of reviewing a fund before purchase – it turns out I don’t!

Mogul

Bonds are so confusing.

These pieces may help if you ever need a refresher (which I do all the time):

https://monevator.com/bond-terms/

https://monevator.com/how-to-read-a-bond-fund-webpage/

Mogul

Good question @Chris.

My understanding was the same as yours, but with following 3 nuances:
– Global AA-AAA type rated sovereign/government bonds for equity market ‘crash protection’ with longer duration providing greatest protection for deflationary/disinflationary reducing rate environments. Hedged to £Stg if avoiding currency risk is desired. Short duration if high/er inflation and rates feared.
– If US Treasuries are thought to be the reference global safer asset (in terms of default and devaluation risk) then either or both of conventional Treasury bonds and/or TIPS might be preferred by some. Same comment as for global gov. bonds applies to duration risk. Obviously the US option introduces country specific risk.
– UK conventional gilts and/or linkers might be preferred by some if they want to avoid currency risk and not to pay for FX hedging (or if they’re holding outside of a tax wrapper – due to favourable CGT position for gilts and linkers). Again, single country risk then applies.

I can’t envisage what advantages Hale would see for corporate bonds over sovereign ones (other than that there’s usually at least slightly more yield from corporate bonds).

I suppose that you could make the argument that some of the largest and most successful companies are as credit worthy as even governments in developed markets; but it’s a bit of a stretch given that highly rated developed market government debt is issued in the currency of the country in question and that country controls its own currency (obviously, the € would be an exception to this).

A company like Microsoft might be tremendously credit worthy, but even it doesn’t control the US $, and cannot create $ at will like the Federal Reserve can.

Incidentally, Man Group has a February 2024 paper on regime based investing covering what assets work best in a equity risk off environment under different rate and inflation regimes:

https://www.man.com/maninstitute/road-ahead-regime-based-investing

The original 2021 paper covering high inflation regimes is here:

https://eprints.pm-research.com/17511/58502/index.html

And the 7circles site summarises the paper on Friday here:

https://the7circles.uk/regime-based-investing-man/

Mogul

Mogul

@ Chris – Very interesting point. It’s been a feature of Smarter Investing that the space devoted to bonds has declined with every edition. The message has now been highly simplified whereas I’ve personally found that bond investing is more complex, and requires more explanation, than other mainstream asset classes.

I wonder if Tim’s ambivalence between corporate and government high-quality bonds is explained by his short duration recommendation? As in, he doesn’t expect a short duration corporate fund to be much more volatile than a government one, and in the long-term he expects the extra yield to make it a wash?

That said, the chart on p.178 shows short corporate bonds took a much bigger hit than short government bonds in 2022. Moreover, corporate bonds enjoy a higher yield precisely because they’re riskier than govies and that risk tends to show up during an economic crisis. Precisely the moment you hope your bonds will counterweight tumbling equities.

Why short bonds instead of intermediate or long for crash protection? Could be that longer durations are a hard sell after 2022. Could be Tim’s audience skews older and he’s lost the space where he used to explain that longer bonds were more suitable for younger investors.

There’s some evidence that bonds low correlation with equities during downturns was a function of a declining interest rate environment. Could be that Tim’s confidence in that pattern enduring has evaporated.

Those are just some ideas. Even as I get older, it seems clear to me that I should hold some longer government bonds as a diversification measure.

I no longer believe the ‘match your bonds to your investment horizon’ rule-of-thumb.

These posts explain why:
https://monevator.com/bond-duration/

https://monevator.com/duration-matching/