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VGOV as minimum risk asset

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AppleCrumble
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VGOV as minimum risk asset

#275355

Postby AppleCrumble » January 5th, 2020, 6:48 pm

In the book Investing Demystified by Lars Kroijer he suggests using short-dated government bonds in your home currency as your minimum risk asset and in chapter 12 - Products and implementation, gives the example of Vanguard UK Gov Bond ETF (VGOV).

Looking on the Vanguard site VGOV is U.K. Gilt UCITS ETF which has a risk factor of 4 so almost as much as most equities investments and doesn't neccessarily seem to be short-dated.

Can anyone make sense of this?

JoyofBricks8
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Re: VGOV as minimum risk asset

#275424

Postby JoyofBricks8 » January 6th, 2020, 2:04 am

Where the counter party in the bond is a sovereign government with the ability into mint its own currency, and the bond is denominated in that currency, the chance of default is pretty minimal, ie you will probably get your capital back at the end of the term plus the coupon payments will be paid according to the schedule laid down by the instrument.

Whether you will make an inflation-beating return is moot: bond yields for stable Western governments are really very low and the risk of inflation outpacing the return available from the coupon payments would be a concern.

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Re: VGOV as minimum risk asset

#275470

Postby Bathonian » January 6th, 2020, 10:43 am

The link you posted there is for an ETF which holds bonds which have quite long durations, with over a third of the portfolio in bonds with 25+ years left to run.

So if you are looking for a cash proxy, I would say look elsewhere.

Given that the counter-party is the UK govt, you are essentially guaranteed to receive back what they promise to pay you i.e. the coupons, plus your principal at the end of the bond term. However, bonds can change in price between the issue date, and when they get redeemed, depending on what interest rates are doing.

If interest rate expectations rise then bond values fall and vice versa. Long dated bond values are far more sensitive to changes in interest rates. If you look at the Vanguard chart, if you had bought in Sept 2019 you would have lost 5% of your capital between then and now.

So it depends a bit on what you are looking for the investment to do, and how long you are wanting to hold it for.

GeoffF100
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Re: VGOV as minimum risk asset

#275591

Postby GeoffF100 » January 6th, 2020, 7:16 pm

I have had a look at the book. Kroijer's minimal risk asset is a highly rated government bond in your own currency with maturity matching the investor's time horizon.

First you have to decide your time horizon. He has not offered any clear definition. Relevant questions might be: "when will you retire" or "how long do you expect to live?".

Then you have to pick a suitable investment. Funds will have a range of maturities. Directly held gilts (usually) have a single maturity. Five year fixed interest savings accounts protected by the FSCS offer much better interest than gilts with five years to maturity. Kroijer accepted that on Monevator.

Kroijer later says that VGOV is the equivalent of a 1-3 year bond. That is a mistake. An investment horizon of 1-3 years? That is very odd.

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Re: VGOV as minimum risk asset

#275870

Postby 1nvest » January 7th, 2020, 10:58 pm

Kroijer suggests for minimum risk seek out ...

Code: Select all

lowest risk asset you can possibly get your hands on, typically government bonds that are highly rated in your local currency, with a maturity that suits your investment horizons.

GeoffF100 wrote:An investment horizon of 1-3 years? That is very odd.

Rolling a three year ladder has a bond mature each year for three years, but that needn't be the final investment horizon - roll the maturing bonds proceeds each year into another 3 year bond (where if yields had risen so the newly purchased bond would pay higher interest) and that can be repeated/sustained to whatever mid to longer term horizon you desire. For instance held/rolled for 30 years/whatever and that likely would fair better (be safer) than buying the likes of a current 30 year index linked gilt, that with recent -1.86% real yields is destined to lose you 43% real - which is far from low risk.

A problem with UK index linked gilts is that demand isn't matched by supply. Around £500Bn value in issue, £30Bn - £40Bn new issues/year falls short relative to £1Tn of pension liabilities (or whatever the figures). Pension fund regulation forces pension funds to value holdings using the yield curve (have to buy Index Linked Gilts), which in turn pushes prices up, yields down, inducing pension funds having to buy even more, until we're at the present situation where a 30 year ILG will lose 43% of its value when held to maturity (pension funds have to pay 1.75 times present day money to match a liability to be paid in 30 years).

If pension regulations are changed or the Treasury up the production of new issues then that could see massive/rapid flight from Index Linked Gilts, and where a return to positive real yields would result in large price declines (that in turn might amplify the flight of money). Again not a small risk. Staying at and rolling the short dated end to whatever horizon using non government is potentially lower risk.

Kroijer's use of "typically government" - as being 'safe' increasingly is a historic relic of being low risk. Nowadays its higher risk. Since Obama also set a president to not always honour bond investors first, and permitted unions to have the first slice, so also have bonds in general become higher risk. Similarly in bailing out the bankers so their 'legal robbery' moved the liabilities for that over to states - such that historic security for savers/investors is no longer available. So where now in a daft situation of where corporate bonds are in effect perceived as being safer than Gilts.

Bankers should have been hung-drawn-quartered and their heads mounted on the Towers spikes as examples. Instead they were given golden handshakes for having set a president for future bankers to repeat the heads they win, tails the taxpayers bail them out win/win game-play. Gilts are far from low risk, the state can always 'tweak' inflation figures, or impose punitive taxation rates, or simply print more money (drive actual inflation). Currency (Pound, US$ which are in effect zero coupon instant redeemable Gilts/Treasuries) are equally highly unstable - no longer backed by anything finite and physical (such as gold), purely sustained via trust/faith (that could evaporate in a instant). The West is in effect bankrupt having lived the high life off Eastern debts. One day that debt may very well be called-in.

GeoffF100
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Re: VGOV as minimum risk asset

#275895

Postby GeoffF100 » January 8th, 2020, 8:05 am

The words that Kroijer used imply that if your liability is in X years time, choose a bond that matures in X years time, but he is not explicit. Nonetheless, his low risk asset is clearly meant to be the lowest risk asset available to you in your currency. I found Kroijer's book disappointing. It did not add much of substance to his Monevator contributions.

What you seem to be saying is that bonds have poor yields, and are not as safe as they were. That is true. Nonetheless, equities are on high valuations, and are likely to have correspondingly low returns. Future returns are likely to be lower than historically, and risk is likely to be higher.

MartynC27
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Re: VGOV as minimum risk asset

#277384

Postby MartynC27 » January 14th, 2020, 2:46 pm

AppleCrumble wrote:In the book Investing Demystified by Lars Kroijer he suggests using short-dated government bonds in your home currency as your minimum risk asset and in chapter 12 - Products and implementation, gives the example of Vanguard UK Gov Bond ETF (VGOV).

Looking on the Vanguard site VGOV is U.K. Gilt UCITS ETF which has a risk factor of 4 so almost as much as most equities investments and doesn't neccessarily seem to be short-dated.

Can anyone make sense of this?


I would have thought the Vanguard Global Bond ETF (VAGP) which contains a range of over 4200 Global Government and Investment grade Corporate Bonds, average quality AA-, Average Duration 7.2 years Hedged to GBP would be a good minimum risk asset. I suppose you could tweak the average duration shorter by add in a chunk of shorter duration Gov Bond etf (IGLS) or longer by adding a chunk of longer duration etf VGOV ?

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Re: VGOV as minimum risk asset

#277405

Postby TUK020 » January 14th, 2020, 3:49 pm

How does this compare in terms of risk with a 1-5 year corporate bond ladder such as IS15?

GeoffF100
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Re: VGOV as minimum risk asset

#277456

Postby GeoffF100 » January 14th, 2020, 7:05 pm

TUK020 wrote:How does this compare in terms of risk with a 1-5 year corporate bond ladder such as IS15?

I have had a quick look:

https://www.ishares.com/uk/individual/e ... rough=true

IS15 costs twice as much as VAGP. It has a much shorter duration. It is less vulnerable to interest rate rises, but provides less protection against interest rate falls.

It looks as though the bonds held are more risky on average.

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Re: VGOV as minimum risk asset

#277601

Postby MartynC27 » January 15th, 2020, 12:47 pm

TUK020 wrote:How does this compare in terms of risk with a 1-5 year corporate bond ladder such as IS15?


The risk levels from the KID Docs are :-
IGLS - 2
IS15 - 2
VAGP - 3
VGov - 4

But I think these Risk scores may be more of a measure of the volatility ?

GeoffF100
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Re: VGOV as minimum risk asset

#277714

Postby GeoffF100 » January 15th, 2020, 8:16 pm

Yes, the KIID risk levels are based on volatility:

https://www.rl360.com/row/news/download ... nation.pdf

What is a KIID risk rating?

The ‘Risk reward profile’ section of the KIID provides information and warnings about the risks of the fund. It also includes a synthetic risk and reward indicator (SRRI) for the fund. This is illustrated by using a rating scale of between 1 and 7 (1 being low risk, 7 being high risk).

The rating is based on the volatility of the fund over the past five years, so the more volatile the fund, the higher the risk rating will be. For funds that do not have a 5 year history ESMA lay down what alternative methodologies can be used to create the risk rating.

Investors can use this rating scale when selecting their investment options as a guide for which funds are in the cautious, medium or higher risk category.

Short term bonds usually have low volatility. There is also a credit default risk, which is reflected in the bond quality rating.


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