bills, bonds and more bonds

[Walkeia]

After a lot of thinking on it - today I exited all equity risk I have added since spring of '21; the proceeds + all remaining cash which has built up since this time I have invested into government backed securities of various duration exposures - 70% of my portfolio is now US 3m and 12m bills, 30y US TIPS, 18 month gilt, gilt index, UK linker index, European government bond index and gold. The remaining 30% is still equity - VWRL with a few REITs thrown in. Last spring I did add a small clip of fixed income too early but thankfully did not purchase any more until the linkers in October.

My rational is simple; the respective YTM on the securities or portfolios are US 3m (4.95%) and 12m bills (4.5%), 30y US TIPS (1.6% RY), 18 month gilt (4.2%), gilt index (3.95% duration ~9y), UK linker index (RY 1.5% bought Oct '21; duration ~18y), European government bond index (3.2% duration ~7y) and gold.

Luckily the past 3/4 years in my business have been very good so the portfolio has grown a lot and at these yields provide a large multiple of our yearly spend. This portfolio income headroom added to my business, which provides an equity payoff and throws off substantial cash flows, has had me thinking that my personal risk is sitting in cash in money market funds and not buying duration. Ie. i. if equities fall I can use incoming cash from maturities / monthly income to buy VWRL. ii. if equities stay here or go higher and we have a soft landing and/or interest rates may have to go higher to tame inflation then I can continue to use income to buy more fixed income at yield levels which are at attractive levels to me personally; although here I would be taking losses on my duration longs bought today. In this second scenario I hope my income from the business would remain buoyant.

It is a major change of strategy for me after a lot of thinking. Posting here as wondering if some are tempted to do likewise.

[tjh290633]

wondering if some are tempted to do likewise.

Far from it. I think your risk is far greater than being in equities.

TJH

[Urbandreamer]

Like TJH, I think you are taking on more risk than you think.

In my opinion, it's a viewpoint issue. Cash is seen as safe, by many. Government debt is seen as safe, the likes of the US or UK are seen as unlikely to default.

That quite simply is not my view. The UK and US governments have unsupportable debts, the interest upon which must be paid in their respective currencies. The only way I can see them managing the issue is to reduce the value of their debt and interest payments.

Hence, I seek to invest in equities etc, keeping the cash in my bank accounts relatively low. Low enough to cover 6 months spending or cover an emergency until I can liquidate a few assets.

[Lootman]

Like TJH, I think you are taking on more risk than you think.

In my opinion, it's a viewpoint issue. Cash is seen as safe, by many. Government debt is seen as safe, the likes of the US or UK are seen as unlikely to default.

That quite simply is not my view. The UK and US governments have unsupportable debts, the interest upon which must be paid in their respective currencies. The only way I can see them managing the issue is to reduce the value of their debt and interest payments.

Hence, I seek to invest in equities etc, keeping the cash in my bank accounts relatively low. Low enough to cover 6 months spending or cover an emergency until I can liquidate a few assets.

Another vote for avoiding bonds, which I have successfully been doing for 35 years.

However I have raised more cash in the last few months. Short-term interest rates are reasonable and I want to have enough living expenses to see me through a 5-year Labour government without having to sell positions, as I fear CGT rates may go up substantially.

[1nvest]

Thirds each FT250/Gold/Gilts ... has matched HYP1 total returns since its November 2000 inception, and with much more comfort (less bad worst years). When you have multiples more than 'enough' you can afford to hold a asset allocation that is more comfortable as likely any reasonable choice of asset allocation will achieve your income production objective.

Much of high UK debt was sold (timed) at low interest rate levels, a large chunk of UK nominal Gilts fixed income rates are negative in real terms, that debt is being deflated away. The issue will be as each Gilt matures and a decision has to be made whether to roll into possibly much higher and positive real rates, or just find the money to repay the loan and not roll. With Gilt maturities spread out broadly across many years that's just a ongoing management issue.

As a alternative to Gilts you can shift bond risk over to the equity side, for instance instead of thirds FT250/Gold/Gilts if you held 50/33/17 FT250/Gold/Hard Pound currency (earning nothing) the rewards/outcome tend to be much the same. i.e. stocks might reward around twice what cash interest pays. Or do the opposite, shift some of stock risk over to the bond side.

Many of the stock-heavy suggestions are founded on a great case cycle, transition from high 1980's interest rates down to very low 2000's interest rate levels, where over those years even cash deposits outpaced inflation. Counter cycle and the next gen might be much less inclined to favour stock-heavy portfolios. Your choice is not unreasonable in that respect, more forward than backward looking.

[SalvorHardin]

Another one here in the avoid bonds camp, though I can shoulder a lot of risk being an almost 60 year old retiree whose 97% equity portfolio only needs to produce a 1% yield to live on.

IMHO the levels of government debt and spending in the developed world are unsustainable and will lead to more inflation (which will be worse for bonds than equities). Developed world governments have been pursuing policies which reduce economic growth such as net zero, restricting movement within cities (the 15 minute cities), piling on regulations, shutting down farms (the Netherlands is the poster boy for this) and introducing a lot of uncertainty into the taxation and planning systems.

There will be defaults, both on benefits and debt payments. Though governments are more likely to opt for the soft default of inflation by printing money (and tax rises which will restrict economic growth) rather than cutting nominal benefits.

The level of hostility towards Liz Truss' supply-side reforms has convinced me that the UK is heading the way of Italy; turning into a low growth high regulation country with an increasingly elderly population and an entrenched bureaucracy which pursues its own interests (job security, expanding the size of the bureaucracy and having a cushy life).

Solution: diversify away from the UK big time. The Far East, America, Canada, India and even South America. That said there are going to be some British businesses which benefit from more regulation and less growth as it entrenches their position by creating barriers to entry (which drive away competitors and thus allow them to earn supernormal profits).

In recent months I've been buying American REITs (a bombed out sector IMHO, especially residential and industrial), Agriculture (Farmland Partners for American farmland, Nutrien for Canadian fertiliser), Consumer Snacks (Mondelez), South America (Patria Investments for asset manager and Ocean Wilsons for an investment company (6.2% yield, 50% discount to NAV)) and India (investment trusts).

I've long been a bull for India over China and not just because I'm a big fan of cricket and have the Indian Premier League on all the time India is less corrupt, widespread use of English, stronger property rights, is not a dictatorship and has a much younger population (demographics is destiny).

[Walkeia]

Thanks all for feedback & discussion. To follow up on a couple of points - I obviously fall into 1invest's camp that government debt will not be losing its benchmark status as the risk-free return (ex-duration risk of course) soon. I agree that investing outside of the UK makes a lot of sense however I stick to Western capitalist countries - and try not to have too much exposure beyond this. Lastly, I think a view point difference here arises where one is happy to protect one's pile and feel comfortable that sufficient headroom is available to accept a lower return (perhaps with lower associated portfolio management hours) rather than push to maximise return

[1nvest]

Pushing sloth to the extreme, end of October 2000 and opting for thirds each FT250, Gold, Cash/Gilts, initially dividing your stack into three equal piles, but where instead of having to bother with rate-tarting cash around, chasing higher yields from high street banks or gilts you instead opted to divide the 'cash' pile in half, and add one half to the stock pile, leaving the other half in hard £20 notes (shifted 'bond' risk over to the stock side). A initial allocation of 50% FT250 total return index tracker, 33.3% gold, perhaps Sovereign gold coins, 16.67% in hard Pound note currency. 50% initially stuffed under your mattress (gold and cash).

12 days later HYP1 is published (12th November yearly review dates), where the most recent yearly review of that is here -> viewtopic.php?p=548145#p548145 Had your managed that HYP, re-investing all of the dividends at the ongoing portfolio growth rate, then at the 12th November 2022 review you would have seen the original £75,000 investment standing at £402,750 value (total accumulation return), ignoring costs and taxes. In contrast the gold/money under your mattress at the end of October 2022 was still close to 50% of the total portfolio value, 53%, with the other 47% in the FT250 accumulation index fund, combined value £394,000 relative to the £75,000 end of October 2000 initial value. Near-as comparable to HYP1. TJH (Terry's) HYP accumulation had slightly lower total return results than HYP1 over a similar period.

I think a view point difference here arises where one is happy to protect one's pile and feel comfortable that sufficient headroom is available to accept a lower return (perhaps with lower associated portfolio management hours) rather than push to maximise return

Whilst stock-heavy/all-stock broadly averages a higher reward that comes with higher volatility. Better good/great case outcomes (that more usually follow start dates after large declines), deeper worst case outcomes. Individual investors are single samples with the broad average and for some that entails being the worst case single sample, as another will be the best/greatest case sample. Those that push for the max risk doing significantly worse than the average, and are only inclined to achieve a max if they start at a time after stocks have dived deeply. In the median case, all-stock often achieves little different outcome to that of less aggressive asset allocations, but where the less aggressive is inclined to be closer to the broad average, has less variance of individual samples around that average.

An attraction into stock-heavy is that of the rear-view mirror. Investors might look back over the last 30/whatever years and see great returns, and be enticed into such in anticipation of those rewards continuing into the future, only to be disappointed, as the great case arose out of the likes of high interest rates/low prices in the 1970's/1980's, that had transitioned to low interest rates/high prices of recent.

Generally you want some stock, Benjamin Graham advocated 50/50 stock/bonds, with possible variance between no less than 25/75, no more than 75/25 subject to valuations. Many US retirees are content with the likes of Wellesley that holds around 33/67 stock/bonds, as that has a long history of providing 'satisfactory' rewards, but tending to do so with relatively low volatility (high 'comfort'). Only with hindsight is one choice better than others, so there's a high probability of regret-risk, wishing you'd opted for x rather than y asset allocation as that would have yielded a 'better' outcome.

US data PV comparing a number of different choices. Within that you can select individual cases of where one was much better (worse) than another. A key factor is to decide on one choice and stick with it rather than being tempted to 'profit chase'. Sloth/indolence can be a good quality - as you're less inclined to look/compare and be exposed to temptations to profit chase or sell at bad times.

Come bank runs, 'stocks crash' news headlines ...etc. if you're more inclined to just shrug rather than panic, then you've discovered the better asset allocation for your temperament. Some for instance can ride all-stock portfolios deeply down without concern/fear, others can't, but perhaps believe they could until the event actually occurs and where they sell out at the lows in fear. Quite a common outcome and where a large chunk of investors end up with worse actual outcome than had they just held their money within cash deposits.

[1nvest]

Thanks all for feedback & discussion. To follow up on a couple of points - I obviously fall into 1invest's camp that government debt will not be losing its benchmark status as the risk-free return (ex-duration risk of course) soon.

QE was to a large extent the BoE printing money to buy up much of older 2007 £500Bn type debt that was paying (costing) 5%/year, whilst the treasury issued £1Tn of new debt that paid (costs) 2.5%/year. In effect costs the treasury no more to service and where the debt was extended out over more years. The BoE return all of the interest they earn on the gilts they bought, back to the treasury.

Of greater concern is that Sunak has and continues to be a great liability for the UK, has cost/lost/wasted hundreds of billions. Whilst his wife might bail him out in regard to their private spending, unfortunately taxpayers bailing out his public wastage is a increasing burden. High taxation and flight of capital, inconsistencies etc. and like others there is appeal to switch to alternatives. For the time being however I'm still content with the FT250 as my stock exposure as around half of its earnings are from foreign anyway, and it includes a bunch of Investment Trusts that diversify widely. It is also more cost/tax efficient, as broadly foreign dividend withholding taxes average around 20%, a internal drag factor against funds that hold such foreign stocks (or funds of funds multiple layers of costs/drag). It's also more equal weighted, less prone to hold even 2% in a single stock whereas the FT100 can at times hold 10% in single stocks, and maybe 30% or more exposure to single sectors, a large part of its >2000 relative lag.

[Urbandreamer]

Come bank runs, 'stocks crash' news headlines ...etc. if you're more inclined to just shrug rather than panic, then you've discovered the better asset allocation for your temperament. Some for instance can ride all-stock portfolios deeply down without concern/fear, others can't, but perhaps believe they could until the event actually occurs and where they sell out at the lows in fear. Quite a common outcome and where a large chunk of investors end up with worse actual outcome than had they just held their money within cash deposits.

I was one who held during the covid stock market collapse. Before that the financial crisis. I suspect that other who have posted on this thread did likewise. Well in truth I actually continued to invest further funds.

I would dispute the contention by Walkeia that only those seeking maximal return avoid bonds (or in particular government bonds). I'm sure that there are many gold bugs who would disagree and one or two who are heavily invested in equities who would also claim that such is not their intention.

For example the second largest holding in my "equity" portfolio is Ruffer. They are clear that they are not trying to shoot the moon. Indeed I think that gold is their main investment at the moment.
BTW here is their stated aim.

We aim to deliver consistent positive returns – whatever happens in financial markets.

We can accept that they may or may not manage what they intend, but arguing that their intentions are different? Or that those who invest, don't pay attention to those intentions and choose based upon them?

No I really dispute Walkeia's contention about those of us who avoid or hold little in the way of bonds. Though I do confess to holding 2.3% in corporate bonds.

[Walkeia]

Hi Ubrandreamer;

‘I would dispute the contention by Walkeia that only those seeking maximal return avoid bonds (or in particular government bonds).’

Reading my comment back I certainly didn’t feel I said this - although I can see where you can imply it from. I believe there is lots of money to be made in bonds - one just needs to look at the price movements of bonds combined with the leverage available in this market and see it is a ripe market for trading. There is also large scope invest in bonds in certain economic conditions to PnL maximise if it is optimal to own them. BlueCrest HF up 150% last year for example betting on higher interest rates.

What I am discussing is at a personal level I am using government bonds because i. I continue to believe they are a safe haven asset and ii. owning a mix of maturities at current yield levels provides a large multiple of my income needs and I do not agree with the runaway debt / over-spending / inflation concerns raised above. When sh** hits the fan; interest rates go down and it’s nice knowing the government is my credit.

Therefore I have made a personal decision to allocate significantly to this asset class and I believe I’ll be happy with this decision even if it doesn’t result in maximising my returns. If we enter a recession / equities sell off and bond yields fall and I do end up PnL maximising - well that’d be lucky but isn’t the primary investment decision driver.

[GoSeigen]

Therefore I have made a personal decision to allocate significantly to this asset class and I believe I’ll be happy with this decision even if it doesn’t result in maximising my returns. If we enter a recession / equities sell off and bond yields fall and I do end up PnL maximising - well that’d be lucky but isn’t the primary investment decision driver.

FWIW, which is not much, I agree with your thoughts -- though my suspicion is that a large allocation to gilts/govt FI is a bit premature.

That's talking my own book since I bought a few gilts during the Liz Truss saga which I have now sold and am watching the development of the gilts price charts rather warily. I don't like the fact that corporate FI is also a bit depressed at the moment. To my mind gilts fall a bit more confirming the corp FI pricing or FI recovers and equities do well with them. So I'm holding my equity positions for now while the market endures its ongoing confusion and indecision.

The other thing I am doing is writing options against my long and short positions. The volatility curve is fairly steep given the uncertainty so there is a tailwind for taking option premium IMV.

However, further significant falls in gilts or rises in equities would certainly prompt me to start allocating to gilts and other FI. Whatever happens, I don't think yours is a losing strategy, I just wonder if it might take some time to play out, not least because I see corporate pricing power providing a boost to bottom lines that the market may be overlooking. And I can't help looking at that FTSE chart and seeing 23 years of consolidation (zero price gain) which in my mind looks hugely bullish.


GS