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High Quality Bonds in the Spotlight

There is an old adage in the investment world that ‘diversification is always having to say you are sorry’, as there is usually one (or more) parts of the portfolio that is a bit disappointing.  Every asset class has its day in the spotlight, for good or for bad, at some point.  

Over the past couple of years, shorter-dated, high-quality bonds that constitute strong defensive assets have delivered low returns and have had a finger pointed at them, by some.  Bond yields have been at historical lows, with yields on 5-year UK government gilts at or below 1% for the past three years.  Today they stand at around 0.2% and that is before the impact of inflation.  It is understandable that investors find low yields frustrating, but one needs to look at the bigger picture.  Bonds sit in long-term portfolios predominantly to provide some stability at times of equity market turmoil.

In the face of these low yields, investors have had two straight choices: accept the fact and stoically maintain the quality of their bonds; or go in search of yield by owning lower credit quality bonds and/or bonds of longer maturity.  We know that many have been tempted by the latter strategy.  We have stuck to the former to defend the portfolio at times of equity market turmoil such as this.  Remember that the lower the credit quality of bonds, the more they act like equities.

We think of yield-driven bond strategies – particularly high yield bonds – as akin to picking up pennies in front of a steamroller, which works nicely until you trip over.  The chart below looks at the performance of different types of bonds since the equity markets began to fall in February this year.  

It reveals that high-quality bonds have more or less held their value, doing the job asked of them.  As one moves down the credit spectrum to lower quality companies, returns become increasingly negative.  Owning these lower quality bonds, but with longer maturities, simply magnifies these falls (heading from left to right in the chart).  As it has always done, scared money runs from higher risks (including the possibility of default on bonds from less healthy companies) which drives yields up and prices down. It tends to move into high-quality, liquid assets driving bond yields down and prices up.

 

As Warren Buffet once said:

‘Only when the tide goes out do you discover who’s been swimming naked.’

Fortunately, your portfolio has kept its trunks on!  

 

Use of Morningstar Direct© data

© Morningstar 2020. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

Data set

Data label Market index used
Global Govts 1-5 Hdg Markit iBoxx GBP Gilts TR
Gilts 1-5 TR FTSE WGBI 1-5 Yr Hdg GBP
GBP Corp 1-5 TR Markit iBoxx GBP Gilts 1-5 TR
Global Corp TR Hdg GBP Markit iBoxx GBP Corporates 1-5 TR
GBP Corp TR BBgBarc Global Aggregate Corporates TR Hdg GBP
GBP Corp BBB TR Markit iBoxx GBP Corporates TR
Global High Yield TR Hdg GBP Markit iBoxx GBP Corp BBB TR
Emerging Equity BBgBarc Global High Yield TR Hdg GBP
Developed Equity MSCI EM NR USD
UK Equity MSCI World NR USD

 

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

 

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

 

It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

 

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

 

Your adviser’s role as your investment coach

ILP13_invtrstprvIt is always tempting to judge the value of your adviser on the recent performance of your investment portfolio.  That is unfair as it fails to understand both the true value that a good adviser delivers with respect to investments and the fact that no manager can control the returns that the market delivers.  A good adviser can earn their ongoing annual fee several times over, simply by helping clients to have patience, fortitude and discipline in their investing.  As the founder of Vanguard and legendary US investor, John Bogle points out:

 “If I have learned anything from my 52 years in this marvellous field, it is that, for a given individual or institution, the emotions of investing have destroyed far more potential investment returns than the economics of investing have ever dreamed of destroying.”

When it comes to investing, there are five key areas that your adviser provides significant value:

  1. Structure: The starting and critical step is getting your portfolio structure right for you. This must be based on your emotional and financial tolerance for, and need to take, risk. It involves selecting sensible risks to take and using high quality, low cost funds to capture the rewards that your earn for doing so.
  2. Governance: Making sure that your portfolio strategy and the funds that you own continue to deliver you with the greatest chance of a successful outcome and that you avoid fads and too-good-to-be-true products is important, yet much of this is behind the scenes and you may not see the work being done on your behalf.
  3. Hand-holding: The hardest part of investing is having the confidence and emotional fortitude to stick with the programme through thick and thin. When markets are either going up or down with great magnitude, as they inevitably do from time to time, an investor’s emotions will kick in either in the form of greed or fear often resulting in the destruction of wealth through a ‘buy high, sell low’ strategy.
  4. Rebalancing: Over time, portfolios drift in terms of their structure due to market movements resulting in either too much risk (equities have increased as part of the portfolio) or too little risk. Rebalancing seeks to ensure that the risk level of the portfolio remains where it was specifically designed to be. It takes stomach and discipline on behalf of your adviser to do this.
  5. Doing the boring stuff: The fifth level of value that an adviser delivers is undertaking some of the menial, yet highly valuable, administrative functions such as ensuring that ISA allocations are made use of and that capital gains are taken in a controlled manner, avoiding as little time out of the market as possible. We all hate paperwork, so let someone else take care of it!

Buy-high, sell-low strategy – favoured by many investors!

As an example of the hand-holding role of an advisor, take a look at the eye-opening chart below, which compares the flow of money into and out of equity mutual funds in the US to the year-on-year performance of the global equity markets.  Investors load up on equities at the top of the market and sell when the markets crash, time and time again.  The largest ever inflows into equity funds occurred almost exactly at the top of the tech boom in early 2000.  The biggest outflows occurred at the lowest point of both the ‘Tech Wreck’ and the ‘Credit Crisis.’  In short, positive market returns result in investors buying equities and negative market returns result in investors selling equities!

Figure 1: US investors – net new cash flows vs. equity market returns (1998 to 2013)

This is a picture of a graph showing the poor timing decisions that UK equity investors make over time

Source: Investment Company Institute. Copyright.  All rights reserved 2013

Research by Morningstar[1], reveals that the average difference on an annual basis between the returns of a fund and those that the average investor receives is -2.5% per annum to the detriment of investors, on account of their poor entry and exit timing.  Given that most advisors charge 1% as an ongoing fee, which should also include comprehensive financial planning and regular goal tracking, it is easy to see the value of employing a steady hand to guide an investor through choppy waters.

In conclusion

So next time you look at a portfolio valuation, spare a little time to consider the broader, longer-term role your adviser is playing.  What you are looking at is market noise, which risks tempting you into bad, emotional choices.  Your adviser is there to provide perspective, stop you from owning investments that should be avoided, help you to keep faith in the programme and make you rebalance, just when you don’t want to!  That’s what they are paid to do.

 

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services.

 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of a unit linked investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

 

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

 

 

[1] Mind the Gap 2014 by Russell Kinnel, Morningstar. http://news.morningstar.com/articlenet/article.aspx?id=637022

 

Smarter Insight – Asset class insight: equities

Our latest Smarter Insights briefing in now available. You can access this by clicking the link here.

Some people may be be uneasy about investing their money in equity markets.  This article provides a deeper insight into investing in equities, providing more information and commentary on this important asset class.  If you have any queries of questions relating to investing in equities do not hesitate to get in touch.