VBND vs VAF vs VGB

We are retired and as mentioned in another thread we have a very small holding of bond etf's holding 2 years of compulsory payments from our SMSF. We do not have an offset account or anywhere else to park this money and the bond etf's have done much better than term deposits. They were bought in 2017 and 2018. They are not a long term hold and will be sold as soon as interest rates rise - one day they will

 

@Islay

They have done well of recent times with rates falling



With $1.4 billion moving into fixed income ETFs this year, it's now Australia's most popular asset

 

That they have @Redwing. We hold IAF and VGB - at least for now

 

But what if it had gone the other way and bond capital was lost? If one wanted to be sure that there was a “guaranteed” sum of Money there for Liability Matching (eg pension payments) a Bond Fund cannot do this. Cash / term deposits can! Off course there is also the option of selling equities if one is happy to accept whatever the market is doing at that point in time when the liability falls due.

I personally have never looked to the “safe / risk free” part of the portfolio for capital growth / equity like returns. That’s what our risk portfolio being equities is for. The safe part of the portfolio is exactly that, returns are sacrificed for a guaranteed return of capital to meet known shorter term liabilities. Buying a bond fund in the hope of short / medium term outperformance over term deposits would appear to be more of a timing / speculative bet than for Liability matching?

But all a bit academic though in your case given likely dividend income and the option to sell assets tax free in the Super fund.

But the great news is we are all correct if we apply @SatayKing ‘s infamous quote of “it’s all about me”.

 

This is true, its possible but not highly likely. Super is in pension phase with excess in accumulation. This means we have dividend income much greater than the 4% draw down requirement so it is very unlikely we will ever need the cash or need to sell down equities. We are just having a bet each way.

 

If bonds crashed and you had to re-balance, any new bonds purchased would have a higher interest yield

A quote from the interweb

 

Thanks for continuing to try to educate me. Though I’m likely a lost cause.

I read stuff like this occasionally generally from Bond Fund Mgrs including Vanguard trying to put a positive spin on Bonds in this low interest rate environment. So many conflicting views out there. It would be interesting to hear from @dunno on the your previous quote.

I admit to having limited knowledge on Bonds so tend to look to basic things like Duration. In the current environment I subscribe to the stay short and stay safe for the relatively small defensive allocation of our portfolios. Looking at VAF attributes shown below that duration albeit intermediate is still far too long for my comfort:


Besides it must be bad because it doesn’t fit with my confirmation bias.

 

I just keeping plugging away at the plan... invest, balance, repeat

Nice and easy as I know what to buy when the funds are available

 

Dividends without consumption of capital is easier albeit I appreciate not everyone will have this luxury. Although does investing in Bonds during the accumulation phase reduce one’s chance of reaching that ultimate goal of living off dividends or even living off equities utilising applicable Safe Withdrawal Rate? Refer to @dunno ‘s many excellent posts with supportive data analysis. Decisions, decisions.

 

@Nodrog we have the luxury of dividends and investments outside super. During accumulation we never considered bonds or cash - always 100% equities. The plan is to have some cash and bond ETF's for a 5 year period in the superfund as we transition from accumulation to pension phase. After 65 we will move back to 100% equities. @dunno has posted some excellent and well researched information. I believe 100% equities all the way! Except just for this period of transition we will have a small holding of cash and bonds. Its each to their own I guess

 

Hi Redwing, very interesting discussion regarding bonds, out of curiosity what percentage of bonds are you targeting in your portfolio?

 

Thanks for the response. I hope my posts don’t come across as suggesting others are wrong. I’m just putting forward my own crazy beliefs and hoping it generates discussion. I’ve been proven wrong and made a dill of myself plenty of times so I learn things myself in the process of hearing alternate view points.

Your approach it appears is very similar to ours albeit I’ve been reducing the SORR cash buffer. Our intention is to always have at least 2 - 3 years SMSF pension payments in cash / term deposits. Outside of Super we hold very little cash.

Curious in that I thought you had already transitioned from accumulation to pension mode in the SMSF? Are you meaning this from a SORR general sense rather than actual admin in the SMSF?

 

I enjoy your posts and was just putting our approach as yet another way of doing things. As you say, just adding to the discussion.

Our approaches do seem similar. We have little cash outside super too.

Yes the super has transitioned to pension phase now. One of us only May last year. We both still have funds in accumulation too because of the cap. Yes, in a general sense it is a period of transition for us in a number of ways as we windup and/or withdraw from other activities and investments. The admin of the SMSF is organised for now.

 

I always enjoy your posts, specially about bonds, makes me look at the overall strategy in more detail

Not trying to convince anyone other than myself on its merit

 

To be honest I sometimes think I’m a bit of a nutter with all this stuff. No one really has a clue about the future whether it’s equity or bonds. Given this unknown future, from a risk management perspective having the likes of Bonds in the portfolio which generally are more likely to behave very differently to equities would seem to make sense. But I love equities and just want to keep collecting more and more of them. Hence I’ll find any excuse I can to favour equities over any other asset class. Confirmation Bias I think they call it.

 

Redwings referenced quote is not wrong. Just like shares your re-investment rate is the most important thing when you are accumulating, so you want prices to go down (yields to go up on bonds) so you can buy future cash flows cheaper. But what it sort of glosses over is the non-speculative return on your current ownership of bonds is a ‘sunk’ return locked at the yield to maturity for the effective duration period. Yep your future purchases are going to provided better returns, but your existing holdings will hurt. The breakeven depends a lot on how much you currently own vs how much you will accumulate at higher yields.

Using your VAF data to make some calculations.

Yield to maturity is 1.39%

RBA rate is 0.75%, therefor the remaining 0.64% of YTM return is for the credit spread risk (AA+) and for duration risk on both the risk free rate and credit spread. Locking your funds up at 1.39% (non-speculative) return for 5.5 year does not appeal to me. And 1.39% is the max non-speculative return, any actual defaults over the 5.5 Years will reduce that return.

I can understand why you would do it though if you were committed to a Static Asset Allocation that includes bonds. Sometimes you have to hold your nose and pay up because it’s part of a bigger plan that makes sense for you.


RBA has indicated 0.25% is lower bound before they start quantitive easing. That means 0.75% risk free rate could come down to 0.25%. the upside for VAF of that would be a speculative capital gain of 2.56%. Quantitative easing could compress the 0.64% part of the existing return as return on duration is reduced and people’s fear of credit risk diminishes. – maybe another 0.39% there, the two combined would leave VAF with a YTM of 0.50% and produce a one-off capital gain of 4.61%. Unless people are going to start paying to hold bonds, future upside is limited.

Other way Bonds could prove valuable is if we get entrenched deflation. They will still earn next to nothing on a non-speculative basis but everything they can purchase will be getting cheaper.


The potential down sides of bonds.

Risk free rate rising:

Returning to a 5% risk free rate would cause a speculative capital loss in VAF of 21.67% over the duration of time it takes to rise. it would probably actually be more because if the risk free rate does start to move upward, the duration risk part of bond pricing (part of the current 0.64%) will probably also increase.

Credit spreads widening:


This doesn't relate explicitly to VAF as its mostly high quality bonds, but it could still be subject to some credit widening.

But I sense people are chasing yield in lesser quality bond and hybrid's and probably don't even understand the first thing about credit spread risk. A lot of stuff people are buying and thinking is safe could easily spike a couple of % in spread even as the RBA lowers the risk free rate by 0.5% leaving them with an unexpected loss on their "safe" investments. the scenario of RBA lowering .5% and credit spreads widening 1% leaves VAF with a 2.48% capital loss.

Bonds are not part of my overall Asset Allocation - I don't need or want their volatility dampening attributes, Just as I don't want gold or other assets that could sort of do a similar job, offering low non-speculative returns over the long term, but are sometimes lowly-correlated to equity. That's a personal decision based on my temperament for volatility and circumstances.

As for bonds now for speculative purposes - they seem on balance of probabilities to me to be a lot of risk with little reward, so again a no thanks. My main interest in bonds is because I reckon there's a fair chance that when people who think they are making low risk investments are faced with speculative losses, they all try to bolt for the door at once. I suspect very few of them look at the yield to maturity and effective duration and say yep happy with that I'll stay the course to maturity. At least people buying equities generally know they are taking on high risk and are getting better compensated for it.

ps.

Bonds had a good year last year, but equity had better, so the rebalancing would be out of somewhat expensive equity into very expensive bonds. Not a rebalancing outcome that appeals to me. In theory rebalancing is from expensive to cheap, sometimes in reality.....

 

Yep, 2018 was a better year for the bonds (price chart only below)

 

These have been betterer for many years up to and including 2018.

 

Geez @dunno you never fail to impress. It’s this bit from you that is my concern with the piece quoted by @Redwing:

From what I understand there’s a time factor involved here with the longer the duration potentially the greater the pain. But as mentioned the amount currently owned vs future accumulation need to be factored in.

Thankfully equity volatility is not a concern for me. Seems to me that investors are paying for very high price for Bonds in an attempt (with no guarantee) to counter volatility. I sleep like a baby when it comes to our equity portfolio but the thought of investing in a Bond Fund terrifies me.

 

I remember this old quote from @SatayKing albeit in relation to speculative stocks but the same applies to many Bonds in this low interest rate environment.

@SatayKing said: