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Minimal risk asset?

Index tracking funds and ETFs
ffacoffipawb64
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Re: Minimal risk asset?

#286043

Postby ffacoffipawb64 » February 22nd, 2020, 10:57 am

Hariseldon58 wrote:
Lynx wrote:Happily Interactive Investor say that they can simply switch my Vanguard FTSE Global Index investment from income to accumulation.

I would welcome thoughts on the following. I am at somewhat of a loss how to pick between any one of the following for the bond aspect of my two-fund portfolio.

I like the short term duration of the following funds:

Vanguard U.K. Short-Term Investment Grade Bond Index Fund - Accumulation (fee 0.12%; ytm 1.3%; 3 avg year duration)

https://www.vanguardinvestor.co.uk/investments/vanguard-uk-short-term-investment-grade-bond-index-fund-accumulation-shares?intcmpgn=fixedincomeuk_ukshortterminvestmentgradebondindexfund_fund_link

Vanguard Global Short Term Bond Index Fund GBP Hedged (fee 0.15%; ytm: 1.1%; 3 year avg duration):

https://www.vanguardinvestor.co.uk/investments/vanguard-global-short-term-bond-index-fund-pound-sterling-hedged-accumulation-shares?intcmpgn=fixedincomeglobal_globalshorttermbondindexfund_fund_link

To what extent would an ETF be preferable? It would allow me to more rapidly convert from the bond investment to more of the equities investment.

If I want to go for a Vanguard ETF, the accumulation version of:

Vanguard Global Aggregate Bond UCITS ETF (fee 0.10%; tm: 1.5%; 7 year avg duration)

https://www.vanguardinvestor.co.uk/investments/vanguard-global-aggregate-bond-ucits-etf-gbp-hedged-distributing

That is 'VAGS' would seem appropriate.



@lynx

The idea of a simple two fund portfolio has merit, not sure either of the two funds selected is a minimal risk asset.

Short duration U.K. investment grade bonds have little interest rate risk but do have significant credit risk in bad times, in good times the credit risk is minimal but when bad time’s strike then you have significant credit risk.

The global aggregate bond, has more interest rate risk and less credit risk but given it contains a mix of negative yield bonds and junk bonds plus all those in between ...

How about NS&I income bonds, duration is pretty much zero, full faith of U.K. government and interest rate just over 1%


Income Bonds interest rate is due to fall to 0.7% soon. Will be moving mine elsewhere, Hargreaves Lansdown's active savings has instant access rates at about 1.1% to 1.2%.

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Re: Minimal risk asset?

#286133

Postby PinkDalek » February 22nd, 2020, 7:14 pm

ffacoffipawb64 wrote:Income Bonds interest rate is due to fall to 0.7% soon. Will be moving mine elsewhere, Hargreaves Lansdown's active savings has instant access rates at about 1.1% to 1.2%.


I appreciate you were replying to Hariseldon58's comment (which was before the NS&I announcement but he was emphasising Minimal risk asset) but a good place (other than externally) to discuss instant access accounts and similar is over at Bank Accounts Savings etc.

The NS&I reductions set for 1 May 2020 were mentioned, inter alia, over there:

viewtopic.php?f=11&t=21847

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Re: Minimal risk asset?

#286139

Postby AleisterCrowley » February 22nd, 2020, 8:34 pm

Hariseldon58 wrote:[
How about NS&I income bonds, duration is pretty much zero, full faith of U.K. government and interest rate just over 1%


lost me there - surely there is no secondary market in NS&I income bonds so duration is irrelevant/confusing?
i.e all the cash flows are known at purchase and the interest rate environment will not affect returns

I could be wrong, and await education...

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Re: Minimal risk asset?

#286142

Postby GeoffF100 » February 22nd, 2020, 9:05 pm

AleisterCrowley wrote:
Hariseldon58 wrote:[
How about NS&I income bonds, duration is pretty much zero, full faith of U.K. government and interest rate just over 1%

lost me there - surely there is no secondary market in NS&I income bonds so duration is irrelevant/confusing?

i.e all the cash flows are known at purchase and the interest rate environment will not affect returns

I could be wrong, and await education...

That is true for pretty much any conventional bond if you hold it to maturity. The duration is calculated on that assumption. Income bonds are "instant access" and that is pretty much true. I believe you can make same day withdrawals via Faster Payments, but there might be a limit on large transactions.

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Re: Minimal risk asset?

#286144

Postby AleisterCrowley » February 22nd, 2020, 9:32 pm

Ah OK , thought they were fixed term bonds (with a penalty for early withdrawal?)
big drop to 0.7% in May so not worth the effort IMO!!
I have an Investec High5 which approximately tracks the best on offer, and is currently wobbling around 1.25% having been 22bp higher
possibly shut to new money?

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Re: Minimal risk asset?

#286189

Postby Lynx » February 23rd, 2020, 9:38 am

I saw on a post by Lars on Monevator that he is dubious about GBP hedging and his book generally recommends holding minimal risk asset in UK investments for UK investors, but the following article from Vanguard made me think that nevertheless a global bond fund hedged to GBP may offer reduced volatility:

https://www.vanguard.co.uk/adviser/adv/articles/research-commentary/portfolio-construction/going-global-with-bonds

Am I mistaken in thinking that either one of the following two investments would make for a good 'minimal risk asset' to complement the equities component of a two fund portfolio, in keeping with Lar's recommended strategy?

Global Short-Term Bond Index Fund - Hedged Accumulation

https://www.vanguardinvestor.co.uk/investments/vanguard-global-short-term-bond-index-fund-pound-sterling-hedged-accumulation-shares/overview?intcmpgn=fixedincomeglobal_globalshorttermbondindexfund_fund_link

Or the accumulating version of the:

Global Aggregate Bond UCITS ETF (VAGP)

https://www.vanguardinvestor.co.uk/investments/vanguard-global-aggregate-bond-ucits-etf-gbp-hedged-distributing/overview

Looking at Vanguard's retirement funds, they seem to include a mixture of local UK bonds and global bonds, and their Lifestrategy also seem to include a mixture. I wonder if the local components are set to reduce in both as Vanguard has been reducing the home bias element of both. Either way a large chunk of each has a global bonds component.

Take the Target Retirement Fund 2055. The largest bond components are:

Vanguard Global Bond Index Hedged Accumulation (14.3%).

Vanguard UK Government Bond Index Fund Accumulation (3.7%).

Vanguard UK Investment Grade Bond Index Fund Accumulation (2.5%).

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Re: Minimal risk asset?

#286257

Postby todthedog » February 23rd, 2020, 4:47 pm

I have recently added CGT Capital Gearing Trust good record as a defensive addition to my portfolio to complement VWRL

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Re: Minimal risk asset?

#286298

Postby GeoffF100 » February 23rd, 2020, 8:32 pm

As I have said, it is reasonable to just use a hedged global bond fund. It is also reasonable to just use sterling denominated bonds. Clearly, it is also reasonable to use mostly a hedged global bond fund and two sterling denominated bond funds as Vanguard has done for that fund. Nobody knows what will work out best.

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Re: Minimal risk asset?

#286317

Postby cStrong » February 23rd, 2020, 11:13 pm

Hi Lynx

The minimal risk asset is generally considered to be a short dated government bond fund, either your own government if AA rated or better, or a foreign government hedged to your own currency. (Lars Kroijer slightly diverges from this by saying the maturity should coincide with your desired investment period, but otherwise agrees with the rest of it.) Neither of the funds you mention qualify as (i) they both have corporate bonds as well as government bonds and (ii) although they are all investment grade, this goes down to BBB. I’m not saying they’re bad investments per se and I have a holding in VAGS myself, but they’re more volatile than the MRA and also somewhat less good as diversifiers in the event of an equity market crash (corporate bonds, especially lower rated, tend to act like equities in a crash).

You might consider something like Invesco UK Gilts 1-5 Year UCITS ETF (GLT5) which has a TER of 0.06%. Alternatively you could go for a US short dated bond fund hedged to GBP, like Invesco US Treasury Bond 3-7 Year UCITS ETF GBP hedged Dist (TR7S) or iShares USD Treasury Bond 3-7yr UCITS ETF GBP Hedged (CBUG) each of which has a TER of 0.10%. I have gone for one of these purely because US treasury yields are about 1% above gilts. There are also global government-only short dated bonds funds around.

If you want to keep it simple go for one of those. Tim Hale advocates dividing your bond portfolio between normal short dated government bonds and index linked, so if you want to do that you could look at something like Lyxor Core FTSE Actuaries UK Gilts Inflation-Linked (DR) UCITS ETF - TER 0.07% (GILI).

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Re: Minimal risk asset?

#286342

Postby GeoffF100 » February 24th, 2020, 8:01 am

Lars Kroijer's term "minimal risk asset" is a misleading term here. What he is suggesting is single bond investment to partner a global equity fund. That should not necessarily be the asset with the lowest risk, and Lars clearly accepts that.

There is also an issue of what risk we are talking about. There is a risk that the company or government you lend money to might not repay the loan or keep up the interest payments. There is a risk that the price of a conventional bond will fall if interest rates rise. There is a risk that the real value of a conventional bond will be destroyed by inflation.

There is also the issue of what our objectives are. Are we trying to find a bond investment that is likely to rise in price when equity prices fall? If so, long dated conventional government bonds are indicated. Nonetheless, long dated conventional government bonds are guaranteed to have miserable long term returns and are subject to the risks above.

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Re: Minimal risk asset?

#286365

Postby Lynx » February 24th, 2020, 9:57 am

These posts are helpful thank you. Unless I have missed something, nowhere does Lars recommend GBP hedged bonds in his book. The more I read online about hedged bonds the less comfortable I feel. Lars writes the following on Monevator. It apparently leaves it open, but with a warning about costs.

Thanks for the many comments and to Monevator for explaining my view. My view is that it makes sense for a lot of investors to add both corporate and non-home government bonds to a portfolio if you are ok with a slightly more complex portfolio (which this forum would be, but far from all investors are). The reason for simplicity in my view is the most important factor has to do with costs. Any complexity tends to add layers of advice, time, tax, etc. that quickly can eliminate any advantage that adding these asset classes bring.

This piece was really about finding the lowest risk investment, not making returns, and it really does depend on your currency and time horizon (in next blog I’ll explain that more). I’m not a big believer in currency hedging, mainly due to costs and the fact that it is hard to do very accurately (leaving the exposure a bit unknown). I remember having to hedge a relatively simple set of hedge funds in only a couple of currencies, and perhaps I’m biased as a result. But of course if you want to hold foreign bonds as minimal risk assets it can make sense (but please look closely at costs).

See some thoughts on duration and age related investing and would be happy to do a piece on that. There is a chapter in my book on it too.


I have also read:

https://concentratedambiguity.wordpress.com/2018/10/11/fx-hedged-yields-misunderstood-term-premia-and-1-tn-of-negative-carry-investments/

And:

https://indexfundinvestor.eu/2019/08/29/how-does-currency-hedging-of-foreign-bond-ucits-etfs-work/

Looking at Lars book, he seems to suggest a mixture of:

A) Minimal Risk Asset [UK government bond with maturity matching investor's time horizon]
B) Risky Assets including
B1) World Equity [world equity index or as broad exposure as possible]
B2) Government bonds [diversified, real return-generating government bonds of varying maturities, countries and currencies]
B3) Corporate bonds [broad range of corporate bonds of varying maturities, risk, currency, issuer and geographic area]

And the recommended split between these is in terms of increasing risk:

A) 100
B1) 0
B2) 0
B3) 0

A) 67
B1) 25
B2) 3
B3) 5

A) 33
B1) 50
B2) 7
B3) 10

A) 0
B1) 75
B2) 10
B3) 15

A) 0
B1) 85
B2) 6
B3) 9

How about something like this then:

A) = iShares UK Gilts 0-5yr UCITS ETF
B1) = Vanguard FTSE All Cap Accumulation
B2) = iShares Core Global Aggregate Bond UCITS ETF <-- think this is unhedged?
B3) = iShares Global Corp Bond UCITS ETF <-- think this is unhedged?

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Re: Minimal risk asset?

#286403

Postby GeoffF100 » February 24th, 2020, 12:11 pm

Lynx wrote:How about something like this then:

A) = iShares UK Gilts 0-5yr UCITS ETF
B1) = Vanguard FTSE All Cap Accumulation
B2) = iShares Core Global Aggregate Bond UCITS ETF <-- think this is unhedged?
B3) = iShares Global Corp Bond UCITS ETF <-- think this is unhedged?

That does not make much sense to me.

Short dated gilts give a lousy rate of interest. Barring UK government default, they will dilute your loss in a stock market fall, but are not likely to rise much in value. You would get much better interest in a cash ISA.

A global stock market tracker looks a more sensible choice than a UK market tracker.

If you hold overseas bond funds, they should be hedged. I do not see any point in holding a global corporate bond fund, in addition to a global bond fund that invests in both government and corporate bonds.

A global stock market tracker and a global bond fund (or long dated gilt fund, if you prefer) makes more sense. Adding an all share tracker to provide some home bias (Vanguard LifeStrategy currently has 25% UK) is reasonable.

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Re: Minimal risk asset?

#286472

Postby GeoffF100 » February 24th, 2020, 7:02 pm

Actually, Lynx I think your best bet is Vanguard LifeStrategy or Target Retirement, unless you have lots of other investments that you cannot unwind. I doubt whether you are likely to come up with anything better.

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Re: Minimal risk asset?

#286514

Postby JohnW » February 25th, 2020, 12:03 am

GeoffF100 wrote:Actually, Lynx I think your best bet is Vanguard LifeStrategy or Target Retirement, unless you have lots of other investments that you cannot unwind. I doubt whether you are likely to come up with anything better.

That sounds very sensible.
How about something like this then:

A) = iShares UK Gilts 0-5yr UCITS ETF
B1) = Vanguard FTSE All Cap Accumulation
B2) = iShares Core Global Aggregate Bond UCITS ETF <-- think this is unhedged?
B3) = iShares Global Corp Bond UCITS ETF <-- think this is unhedged?

You seem to have got to this point from some sound bases and logical extrapolation, but choice 'A)' seems to have a very short duration for someone aged 34, especially if you believe in duration matching your bonds to your spending needs, as low risk as it certainly should be.
Hence the attraction of an all in one fund, as above; leave the navel gazing and head scratching to others, and get on with your life. How many angels can dance on the head of a pin?

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Re: Minimal risk asset?

#286523

Postby Lynx » February 25th, 2020, 7:03 am

Sorry yes should be something more like:

A) = iShares UK Gilts 0-5yr UCITS ETF
B1) = Vanguard FTSE All Cap Accumulation
B2) = iShares Global Govt Bond UCITS ETF
B3) = iShares Global Corp Bond UCITS ETF

I appreciate B2 and B3 could be rolled up into just:

iShares Core Global Aggregate Bond UCITS ETF

I guess I am just trying to follow Lars' recommended approach. Still figuring things out. Regarding A) I understand the point of the minimal risk asset is not to make money it is simply to protect against fall in B).

The target and Lifestrategy funds appear to have a large chunk of home bias and if my concerns about GBP hedging have some legitimacy they will could also suffer from that. They also have higher fees.

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Re: Minimal risk asset?

#286537

Postby GeoffF100 » February 25th, 2020, 8:14 am

Lynx wrote:Regarding A) I understand the point of the minimal risk asset is not to make money it is simply to protect against fall in B).

Cash or short dated bonds will dilute your loss, but they will not rise in value if the equity market falls. Long dated government bonds are likely to rise in value when the equity market falls and offset your loss. The medium dated global bond funds probably will not rise much (if at all) when equity markets fall either, but they have better maturity yields, and a wider spread of risk.

Lynx wrote:The target and Lifestrategy funds appear to have a large chunk of home bias and if my concerns about GBP hedging have some legitimacy they will could also suffer from that. They also have higher fees.

The home bias in LifeStrategy is a good thing, not a bad thing. It reduces portfolio volatility and reduces the amount of tax that has to be paid within the fund. Hedging overseas bonds is good not bad. If you do not hedge overseas bonds, you get the worst of both worlds. Low returns and high volatility. Hedging does have costs, but returns have been good nonetheless. Equities have high volatility anyway, so hedging them is not generally worthwhile.

These are complicated matters and difficult judgements have to be made. Vanguard employs a team of experts to meet every quarter to make these decisions for you.

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Re: Minimal risk asset?

#286559

Postby Lynx » February 25th, 2020, 10:22 am

Thank you that was very informative. I may in the end just opt for the target retirement. But I am at least interested in the theory of all this for the time being.

Do the tax aspects you mention still come into play for a single find SIPP?

I assume your comments about the dating of the bonds relates to what Lars describes as matching the investment time horizon?

Taking VGOV, what I am confused about is the maturity timescale being around 20 years and effective yield being 0.7%.

Lars says that the return should compensate the risk associated with period to maturity but 0.7% does not seem to offer any compensation. Am I missing something?

In terms of long horizon 'rising in value' how would that work in practice? I mean how does the short duration bond funds not rise in the same way? Would this be in the event of interest rates going down further so a lengthy timescale at certain interest rate today would then be attractive in future? Can they get lower than they are now?

I gather that holding some unhedged assets can offer some further diversity associated with currency risk? So the volatility in the context of high risk assets may make sense?

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Re: Minimal risk asset?

#286601

Postby GeoffF100 » February 25th, 2020, 12:45 pm

Lynx wrote:Do the tax aspects you mention still come into play for a single find SIPP?

Yes, but the details are very complicated.

Lynx wrote:I assume your comments about the dating of the bonds relates to what Lars describes as matching the investment time horizon?

No, but that may be relevant too.

Lynx wrote:Taking VGOV, what I am confused about is the maturity timescale being around 20 years and effective yield being 0.7%.

What is confusing about that?

Lynx wrote:Lars says that the return should compensate the risk associated with period to maturity but 0.7% does not seem to offer any compensation. Am I missing something?

The market says that 0.7% does compensate for the risk. The market sometimes says that Lars is completely wrong, and long dated bonds return less than short dated bonds (that is called "inversion of the yield curve"). That is happening now in many markets. A good rate of interest that does not outlast the crisis is sometimes less attractive than a smaller one that does.

Lynx wrote:In terms of long horizon 'rising in value' how would that work in practice? I mean how does the short duration bond funds not rise in the same way?

See the answer to the previous question. That is what usually happens is another answer.

Lynx wrote:Would this be in the event of interest rates going down further so a lengthy timescale at certain interest rate today would then be attractive in future? Can they get lower than they are now?

They are already negative in many markets.

Lynx wrote:I gather that holding some unhedged assets can offer some further diversity associated with currency risk? So the volatility in the context of high risk assets may make sense?

As I have said, it is usually a bad idea to hedge equities.

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Re: Minimal risk asset?

#286622

Postby Lynx » February 25th, 2020, 2:01 pm

Thanks again. Very helpful. Is there a historical precedent for long dated bonds rising (over short term counterparts) in the event of equities falling and how long is appropriate - 5 years, 10 years, 30 years or more? Is it related to how long a crash and recovery takes?

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Re: Minimal risk asset?

#286630

Postby GeoffF100 » February 25th, 2020, 2:50 pm

Lynx wrote:Thanks again. Very helpful. Is there a historical precedent for long dated bonds rising (over short term counterparts) in the event of equities falling and how long is appropriate - 5 years, 10 years, 30 years or more? Is it related to how long a crash and recovery takes?

Yes, many precedents, but it does not always happen. 30 years is long term. There are lots of articles saying this time is different. I do not know. Ask the experts. They do not all agree though. Nobody knows the future.

If you leave it to Vanguard, you can blame them if they get it wrong. Do it yourself and you are to blame.

Central bankers have driven interest rates to a unprecedentedly low levels. They do not want you to save. They want you to spend. If you do not save because of the miserable returns, and end up in penury as a result, they will blame you.


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