So, we are in the midst of a global pandemic. The
markets have become volatile so now is a good time to re-evaluate my attitude to
risk and make the necessary adjustments to my portfolio. We small investors have had a good run over the past decade but I sense this could be coming to an abrupt end and it could be more problematic over the coming year or two.
We have been in lockdown for several weeks and we don't know when it will be relaxed. When we start to come out of isolation there could be a second wave of coronavirus. A vaccine is the answer but it will likely be another year before one is available. In the meantime, the government is borrowing huge amounts to deal
with the lockdown emergency - latest figure was £225 billion to cover the next
three months! I suspect that may need to increase later in the year.
The Bank of England has reduced the bank rate to an all-time low of 0.1% and savings rates have just been slashed by the banks and building societies. I've just been informed by the Coventry that my
variable rate savings account will drop by over 50% to well under 1.0%.
Over the past year or so I have been moving toward
more climate-friendly investing. This has involved ditching my global
multi-asset index funds such as Vanguard Lifestrategy and HSBC Global Strategy
and replacing them with a mix of renewable energy trusts and individual shares.
This seems to be the right way to go as the world must embrace policies to
address the climate crisis. However the shift away from VLS 60 for example with
its 40% weighting of government bonds has increased the volatility of my
portfolio. The sudden market downturn in early March when the FTSE 100 dived
30% in the space of a couple of weeks - 10% in a single day - has reminded me
to pay more attention to asset allocation and restore a little more balance to
the portfolio.
In early March I was thinking that after a sharp
sell-off the markets would bounce back quickly and we would be back to business
as usual by June/July. I think it is clear this is now very unlikely and the
aftermath could be much worse than the financial crisis of 2008...maybe
equivalent to the depression of 1929. On Wall Street the Dow Jones dropped by
35% in the October 1929, bounced back by 20% over the next couple of months before
falling away a further 30% over the following year.
Asset Allocation
Earlier this year I took a little time to update
my thoughts on Asset Allocation
As can be seen from this visual 'Asset Quilt' from the
Blackrock website, any single class of asset is rarely at the top for two years
running - some years equities do well and other years bonds are topping the
chart, occasionally cash is king. I doubt equities will be topping the table in 2020.
According to the Barclays Equity Gilt study, over
the longer term of the past 120 years, equities have delivered a return of 5%
p.a. after inflation compared to 2% for gilts and 1% for cash. As should be
clear from the asset quilt, this trend is not so clear over the shorter periods
of a few years. As ever, it's all about time in the market and therefore the
asset mix which matches the temperament and appetite for risk of each
individual investor...which changes over time!
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| Barclays Equity Gilt Study 2019 |
So it's usually a good idea to have a mix of
assets, if for no other reason than to reduce portfolio volatility associated
with a large percentage of equities. Of course, a large proportion of my
'green' portfolio is made up of renewable energy infrastructure trusts which I
regard as a hybrid between equities and property and they have performed well
during the sell-off compared to conventional energy stocks such as Shell and
BP.
With interest rates back to rock bottom on cash
savings, it's tempting to load up on equities during the 'dip' but in the
present circumstances I am thinking this would be a mistake so I feel the
correct action is to be more circumspect and move towards a more defensive
position. Currently I am a little too exposed to equities, I hold some property
in the form of TR Property trust (and my house) but currently hold no bonds. So
I think a reasonable move at this point would be allocate maybe 20% of my portfolio
to bonds and gradually build this to 40% when we see more clarity on the
Covid-19 situation.
The Options
Fortunately I do not require income so that makes
the choice easier. Also I obviously want to maintain the fossil-free approach
so I do not want a corporate bond fund as they will inevitable contain holdings
such as fossil fuel companies and banks which I wish to avoid.
Therefore I will look at government bonds - gilts.
A simple low-cost index fund from the likes of Vanguard, iShares or L&G
will get the job done. So, what's on offer?
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| (click to enlarge) |
The table above covers some of the more popular
funds and ETFs from the largest providers. Of course there are many more index
providers and lots of managed funds with higher charges but I will keep things
fairly simple and select two or three options from these. I do not expect
inflation to be a problem in the foreseeable future so will probably pass on
index-linked gilts and stick to the low cost UK and Global gilts.
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| 3 Yr Comparison VGOV v IGLT...almost identical (click to enlarge) |
I think the main point of this is to try to protect some of the gains of the past few years and also find a way to
stay in the game for the coming few years if the markets slump. Obviously equities provide the better
returns but they are also the most volatile asset class. Bonds provide lower
rewards over the long term but offer stability and help small investors to ride
out the storms.
Finally, thanks to 'The Accumulator' for this article on the subject. I note that for their 'Slow & Steady' ongoing demonstration portfolio, the UK gilts element of the portfolio is represented by Vanguard UK Government Bond Index with OCF of 0.12% and this accounts for around one third of the total portfolio weighting. It's likely this is one I will go for also or possibly the ETF version (VGOV) which has slightly lower charges and may work out better with my broker on portfolio charges which are capped in my ISA for shares and ETFs.
As ever, this article is merely a record of my personal investment decisions and should not be regarded as an endorsement or recommendation - always DYOR!
Hi DIY
ReplyDeleteHope you are keeping well.
I'm glad that I had a portion of my portfolio in bonds as they did reduce the losses somewhat. At some point however, I think I will increase my noldings in bonds but for now, I will continue to scoop up more equities at a cheaper price.
When I started reading this post, I wondered if you would return to Vanguard after you had removed their equity ETFs from your portfolio due to their stance on fossil-fuels. I guess there's not a lot of choice and VGOV provides all you that you need for a defensive strategy.
Hi weenie,
DeleteYes, I think you have been wise to maintain a good percentage in government bonds and at times like this they certainly help to cushion the blow from the equity slump.
Interesting that you raise the point of Vanguard. I have not been so impressed with their record on climate issues. Having regard to the almost identical performance with the iShares fund (IGLT) I decided this morning to make my initial purchase with them and pass on the Vanguard (VGOV).
Stay safe and let's hope the restrictions can be relaxed before too long and you can get back to your work and gym! (or have you adjusted to home work?)
Interesting post. Any thoughts about the transparency of gilts? Investment in them could be going to undesirable areas? I'm not adverse to them, just food for thought.
ReplyDeletehttps://www.morningstar.co.uk/uk/news/197072/bond-funds-for-ethical-investors.aspx
Thanks Greg.
DeleteI had a quick look at the link but just had the headlines as you have to register but yes, like most things, government bonds are only as ethical as the country that issues them and although the UK is investing in 'green' infrastructure, there are many areas where it falls short on ethical grounds. I did look at the Lyxor Green bonds last year but I think there is a lack of transparency there also and funds are channeled into some really dodgy 'green' schemes.
Cash deposits with the Ecology BS are one solution but like everyone else, they have slashed their rates to around 0.5% in the past week so I guess it's not going to be so easy for the foreseeable for savers and investors.
Ciao DYI,
ReplyDeleteI used to be a major bond investors, at the beginning of the century I used to own "bond ladders" which I found perfect for income generation and stability. Unfortunately now bonds yield very little and in this phase of my investing there is little use for something that yields below 2% net... Having said this I might consider adding some more, but after the covid measures are decided by the EU, as there might be some opportunities with the recovery funds at that time...
ciao ciao,
Stal
Hello Stal,
DeleteYes, the yield on bonds has dropped to low levels - currently just 1.2% for gilts - however I am fortunate that I do not require income so it's just a matter of stability during this uncertain period and trying to preserve some capital.
It will be interesting to see how the EU handles lifting the restrictions - some countries like Italy and Spain have been far more impacted than others like Germany and Sweden. It will also be interesting to see how the UK moves now we have decided to leave the EU at the end of this year. Lots of uncertainty and yes, of course, some opportunities.
I think human nature and psychology is fascinating. It's interesting to see the decision making process that leads someone to justify moving allocation away from equities when equities are cheap, and towards gilts when gilts are relatively more expensive. Thank you for sharing!
ReplyDeleteI think that sums it up Bob...some think equities are cheap and others are not so sure. Time will tell no doubt!
DeleteHey DIY,
ReplyDeleteGreat post!
I actually just changed part of my bonds allocation from Vanguard Global Bond (and some short term bonds) to VGOV and Vanguard US Gov Bond Index fund. I am just looking for more quality right now in my bonds allocation.
The thing that bothers me about both VGOV and IGLT is their effective duration. Right now both funds duration is something like 13-14%, which I think is a bit too much and I don't feel great about it. I know inflation doesn't look likely in the short term, but who knows in a couple of years? And I am not looking for returns in my bonds, I want diversification :)))
What do you think about the IGLT duration? Does it bother you?
Thanks Fintech. Like you, I basically want to take a little more risk out of my portfolio and these bonds seem like a good idea in the current climate.
DeleteI am not too concerned about the duration % you quote but prefer the medium and longer term government bonds. So far I have added IGLT and also the L&G All Stocks fund and a couple of the iShares US Treasury Bonds - IGTM and IDTG.
Good luck with your bonds!
Ah, I'm sorry, I meant duration of 13-4 years. Not sure how I typed %.
DeleteI would prefer to be more like 7-9 years, but I do only have an ISA with Vanguard for now, so not really any other option to get a Gilts fund.
Good luck to you too!