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Junk Bonds

Gilts, bonds, and interest-bearing shares
Aminatidi
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Junk Bonds

#452720

Postby Aminatidi » October 24th, 2021, 5:35 pm

Looking for a different perspective from another set of people as forums can be a bit "groupthink" sometimes :)

I'm in my 40's and am cautiously (not a fan of volatility) accumulating as I'm working.

£280K invested and £2K/month going in.

I don't need actual income right now.

Around 50% of my money is spread across RICA and CGT and they're slowly doing their thing.

The other 50% is across Fundsmith, Smithson, and Buffettology.

I'm considering moving an 10% out of the 50% equities allocation and into "Junk Bonds" along the lines of something like 50/50 between a couple of typical funds in this sector.

Rear view mirror but 7.8% annualised over 10 years and a Trustnet FE of 35 with 9% volatility.

Doesn't look too shabby to me.

Obviously the term "Junk Bonds" doesn't sound especially inspiring and perhaps technically some of these funds are investment grade but thoughts welcome.

Image

GoSeigen
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Re: Junk Bonds

#452726

Postby GoSeigen » October 24th, 2021, 5:50 pm

I'm going to stick my neck out and say this is a particularly bad time to be increasing allocation to junk bonds. Their yields are at very low levels, almost negative in real terms which is borderline insane. Of course they can fall further so if you accept this view you may need to be bloody minded to continue holding it until you are rewarded -- especially as we seem not to be at the end of this bull run yet. However I think it was Rockefeller who said he got rich by selling too early so you'd be in good company.

GS

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Re: Junk Bonds

#452749

Postby JohnEdwards » October 24th, 2021, 7:25 pm

Wasn't it Rothschild who said you should always leave something for the next person?

formoverfunction
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Re: Junk Bonds

#452828

Postby formoverfunction » October 25th, 2021, 8:27 am

I broadly invest in fixed income, collectives, charity, single company, start-up yield producing convertables for "high yield" I've used WiseAlpha, amongst other strategies, as it's possible to build a portfolio with modest amounts of cash. For example there's limited offers available with 20% YTM and as you can invest from £100 in their fractional issue, so it's much more viable than the usual £100,000 needed.
I also buy NCYF monthly, which can be achieved with dealing costs of between £0 to £100.
You might find WiseAlpha's University helpful. It's free and very detailed for getting a better understanding of the risks and analysis of high yield.
Over all my well diversified high yield portfolio has delivered 9% income and c20% capital return.
Good or bad time to buy? Well that depends very much on the assets and strategy you pursue.
There's also occasional high yield available on the green/ethical platforms like Triodos, Abundance, Ethex and on a selective basis I've also bought into those. Today on Abundance you have GB Light on an 10% return. That's not an endorsement.
Dabbling in this area needs consideration of total loss, liquidity and counter party risk....if you want the additional risks/return you should think hard and long about it.

Aminatidi
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Re: Junk Bonds

#452963

Postby Aminatidi » October 25th, 2021, 4:12 pm

Thanks All, I think the likes of WiseAlpha are a bit too "hands on" for me :)

If I did anything I'd be looking at well regarded funds in that area similar to the ones in the Trustnet chart in the first post.

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Re: Junk Bonds

#452966

Postby Lootman » October 25th, 2021, 4:19 pm

GoSeigen wrote: you may need to be bloody minded to continue holding it until you are rewarded

I am not sure that you can assume that you WILL be rewarded. Only that you MIGHT be.

Interest rates went down for about 40 years, making anyone who was invested in bonds look like a financial genius rather than just lucky. Who's to say rates won't go up for the next 40 years?

Of course that applies to all fixed income, whereas junk bonds can give more like equity returns, albeit with equity risk. And the risk is not just that rates will go up, but also that the issuer may default. So you have interest rate risk and credit risk and, with junk bond yields as low as they are, it doesn't seem to me that you are getting paid for taking all that risk. Research may reduce the credit risk, or not. But nobody knows what rates will do.

Lootman (0% invested in bonds of any kind)

GoSeigen
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Re: Junk Bonds

#452997

Postby GoSeigen » October 25th, 2021, 7:31 pm

Lootman wrote:
GoSeigen wrote: you may need to be bloody minded to continue holding it until you are rewarded

I am not sure that you can assume that you WILL be rewarded. Only that you MIGHT be.

Interest rates went down for about 40 years, making anyone who was invested in bonds look like a financial genius rather than just lucky. Who's to say rates won't go up for the next 40 years?

Of course that applies to all fixed income, whereas junk bonds can give more like equity returns, albeit with equity risk. And the risk is not just that rates will go up, but also that the issuer may default. So you have interest rate risk and credit risk and, with junk bond yields as low as they are, it doesn't seem to me that you are getting paid for taking all that risk. Research may reduce the credit risk, or not. But nobody knows what rates will do.

Lootman (0% invested in bonds of any kind)



Lootman, it looks like you completely misinterpreted that part of my post -- an unfortunate consequence of quoting only half my sentence...

I wasn't referring to holding the bonds but to holding the view that yields are too low. The reward of course is the ability to buy at much better prices when the inevitable yield spike comes.

So I agree with pretty much all of your post... :-)

GS

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Re: Junk Bonds

#453064

Postby JohnW » October 26th, 2021, 2:19 am

Aminatidi wrote:Around 50% of my money is spread across RICA and CGT and they're slowly doing their thing.

What is 'the thing' that they do, because that sounds a bit vague given they're not particularly cheap to own?

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Re: Junk Bonds

#453108

Postby Gan020 » October 26th, 2021, 9:24 am

Note that you are proposing to invest in bond funds not bonds.

Over the last 20 years+ bond funds have performed above the yields on the underlying instruments due to capital appreciation on the bonds held as a result of falling interest rates.

If you see interest rates which have moved from 15% to currently 0%, continuting to move to -15% then bond funds are the place to be.
If you see interest rates rising over the long term, then there will be capital losses on the funds.

The exception is if you can find a bond fund holding lots of floating rate bonds where the underlying coupon will go up with interest rates.

I sold all my mid and long duration bond funds about 3 weeks ago as inflation is worrying me.

As an aside some of them look overvalued to me regardless. People are buying NCYF at 9% premium to NAV. That's just ridiculous.

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Re: Junk Bonds

#453141

Postby Newroad » October 26th, 2021, 10:50 am

Hi Gan020.

I have a vague recollection you were in BIPS - if so, have you sold that too?

Regards, Newroad

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Re: Junk Bonds

#453143

Postby JohnW » October 26th, 2021, 10:53 am

Can't quibble with that, but to flesh it out a bit....
Rising rates over the long term with push down fund prices and at the same time increase their coupons and yield. The price drop will be short lived compared to the price rises that come from the fund holding better yielding bonds as they are rolled over. Are you a short term investor or a longer term investor? A lot of us are investing for the next 20 years at least, so a bond fund with a duration of less than 20 years makes perfect sense since it is the duration roughly which is how long it takes the better coupons to compensate for the price falls. Indeed, you won't even notice the bond fund price fall, amongst its normal value gyrations, if the interest rate rises occur slowly enough; you just get a progressively increasing fund value (with the usual daily/weekly price wobbles). Bond holders, those holding sensible duration bonds/funds (not too long duration) should be praying for interest rate rises so their yield improve in the coming decades.
Inflation is a different monkey. That will do a nominal bond fund damage if it's too rampant. Better hold linkers for that.

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Re: Junk Bonds

#453175

Postby GoSeigen » October 26th, 2021, 11:56 am

JohnW wrote:Can't quibble with that, but to flesh it out a bit....
Rising rates over the long term with push down fund prices and at the same time increase their coupons and yield. The price drop will be short lived compared to the price rises that come from the fund holding better yielding bonds as they are rolled over. Are you a short term investor or a longer term investor? A lot of us are investing for the next 20 years at least, so a bond fund with a duration of less than 20 years makes perfect sense since it is the duration roughly which is how long it takes the better coupons to compensate for the price falls. Indeed, you won't even notice the bond fund price fall, amongst its normal value gyrations, if the interest rate rises occur slowly enough; you just get a progressively increasing fund value (with the usual daily/weekly price wobbles). Bond holders, those holding sensible duration bonds/funds (not too long duration) should be praying for interest rate rises so their yield improve in the coming decades.
Inflation is a different monkey. That will do a nominal bond fund damage if it's too rampant. Better hold linkers for that.


To add a crucial point to JohnW's fleshing out: the better yields compensate for price falls such that you don't lose out on the yield when you purchased the bonds. IOW, matching Duration to Holding Period maximises the probability of achieving the purchase yield over the entire period whatever the rises or falls in the interim.

The point is your returns will always be close to those offered when you purchased the bond, and at the moment those yields are very very poor. So don't be tricked into thinking that if prices fall higher yields later on will help -- they will not.

The problem will be compounded if there is significant inflation because your return will be fixed but the value of your capital will be eroded by the higher inflation.

I still think gilts and other fixed interest are a bad idea outside of very specific situations (e.g. equity-like PIBS, linkers).

GS

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Re: Junk Bonds

#453200

Postby Gan020 » October 26th, 2021, 1:02 pm

JohnW wrote:Can't quibble with that, but to flesh it out a bit....
Rising rates over the long term with push down fund prices and at the same time increase their coupons and yield. The price drop will be short lived compared to the price rises that come from the fund holding better yielding bonds as they are rolled over..


This will depend on how fast interest rates rise and how long the duration of the existing bonds in the bond fund portfolio.

If rates rise slowly and the duration is short (say less than 5 years) then broadly speaking the increase in coupon on the new bonds will balance out the loss in capital on the existing bonds.

If rates rise fast and the duration is long (say 20 years) then the capital losses on the existing bonds are going to outweigh the improved coupons on the new bonds.

To illustrate:
Recently gilts have taken off moving around 0.6% on the 10 year gilt in the last month. A comparison on some of the bond fund shows: (although admittedly there are other factors at work as well as just interest rates)

HDIV is a very long duration fund and it's NAV has fallen from around 93p to 91.5p,
BIPS is fairly long duration and it's NAV has fallen from 197.5p to 196p (adjusting for XD)

NCYF is fairly short duration and it's NAV has increased from 53.0p to 53.2p
AXI is the shortest duration and it's NAV has increaed from 105.5p to 106p

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Re: Junk Bonds

#453204

Postby Gan020 » October 26th, 2021, 1:07 pm

Newroad wrote:Hi Gan020.

I have a vague recollection you were in BIPS - if so, have you sold that too?

Regards, Newroad


I sold NCYF, BIPS and HDIV 3-4 weeks ago. I retain NBMI & AXI

NBMI because 66% of the fund is floating rate notes and shortish duration
AXI because it's short duration bank and insurance T1,AT1 & T2 capital. Indeed I added to AXI this morning because on top of the short duration I managed to get some more at a 12.5% discount to NAV.

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Re: Junk Bonds

#453246

Postby Newroad » October 26th, 2021, 2:58 pm

Thanks, Gan.

I still hold HDIV and BIPS - but interestingly, was considering switching one of the BIPS holdings (they are currently in SIPP and JISA) into NBMI. However, on balance, I think I am unlikely to.

The reason I ask about BIPS is that I note

    (1) The NAV has moved from circa 196p to circa 193p - that makes sense from an XDIV perspective, but
    (2) The net gearing as risen from around 7% recently (IIRC) to around 11% now - which strikes me as more unusual

I suppose it could simply mean they have borrowed more to buy more, with the NAV simply netting out in the short term.

Regards, Newroad

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Re: Junk Bonds

#453254

Postby Gan020 » October 26th, 2021, 3:17 pm

Newroad wrote:Thanks, Gan.

I still hold HDIV and BIPS - but interestingly, was considering switching one of the BIPS holdings (they are currently in SIPP and JISA) into NBMI. However, on balance, I think I am unlikely to.

The reason I ask about BIPS is that I note

    (1) The NAV has moved from circa 196p to circa 193p - that makes sense from an XDIV perspective, but
    (2) The net gearing as risen from around 7% recently (IIRC) to around 11% now - which strikes me as more unusual

I suppose it could simply mean they have borrowed more to buy more, with the NAV simply netting out in the short term.

Regards, Newroad


Yes, the gearing has moved from 6% to 11% in about 10 working days of which the XD accounts for 1.5%.

It is my view that up to a month ago bond yields were very low and the investment manager was not investing. BIPS target 10% gearing but are allowed to go much higher. As gilts and corporate bond yields have risen in the last month the investment manager has been attracted to invest more.

I can understand why the investment manager is doing this, (as it SMIF who have issued a bunch of new shares) but my research shows that they both tend to buy more of what they already own rather than that buying new issues. This supports their NAV or props up the market if you are cynical like me. I will not actually have any insight into what BIPS are buying until we get the next factsheet.

The fund manager has done well to sit on his gearing waiting for better prices to invest at. The question is whether he's gone in too early or timed it just perfect. If I knew the answer to that one I'd be running BIPS not investing in it :lol:

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Re: Junk Bonds

#453361

Postby Newroad » October 26th, 2021, 8:56 pm

Interestingly, Gan020.

There is an argument that rate rises might not be one directional, even in the short term. Specifically, some are now saying that the Fed (and others) might raise sooner rather than later, but might then need to backtrack quicker than expected.

If so, locking in slightly higher rates, before a putative backtrack, might work well for medium to longer durations. However, a bit like you, I'll leave such considerations for the Investment Managers to muse on.

In the meantime, I sit on a 50/50 combination of VAGP (duration around 8 years) and either HDIV/BIPS (the average duration for each is not clear to me - quite a bit is intermediate, e.g. 2025-2030 maturity, but then also some perpetuals and 50-60 year stuff) in the bond component of each sub-portfolio, so we'll see what develops.

Regards, Newroad

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Re: Junk Bonds

#453367

Postby Alaric » October 26th, 2021, 9:09 pm

Newroad wrote: However, a bit like you, I'll leave such considerations for the Investment Managers to muse on.


Looking at the holdings of the funds mentioned, it appears they hold sizeable amounts of floating rate bonds, Prices of these would not be directly affected by changes in interest rates unlike fixed interest bonds.

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Re: Junk Bonds

#453427

Postby hiriskpaul » October 26th, 2021, 11:52 pm

Most junk bond funds are of short duration, so I would not be too concerned with duration risk. However, the credit spreads have become very compressed and I would be concerned about them widening again. Interest rates rises may put the issuers at risk of default as they try to refinance their debt, or at least, investors might be concerned that might be the case and so lead to increased credit spreads. Those increased spreads themselves make it more expensive for stressed issuers to refinance debt...

There has been far too much yield chasing and personally I would stay well clear of any high yield funds at present.

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Re: Junk Bonds

#453471

Postby Gan020 » October 27th, 2021, 9:15 am

Alaric wrote:Looking at the holdings of the funds mentioned, it appears they hold sizeable amounts of floating rate bonds, Prices of these would not be directly affected by changes in interest rates unlike fixed interest bonds.


I agree some of the funds hold sizeable quantities of floating rate bonds. NBMI being the one with the highest imho at 66%.

However, some do not. HDIV for example. By reference to page 72 of the 2021 annual report £22.5m are floating rate and £179.6m is fixed so only 11.1% is floating. However, the bank loan and overdraft of £26.1m which supports the gearing is also floating. If you take this into account 102% of the fund is fixed rate.


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