UK Bond Funds & Duration

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UK Bond Funds & Duration

Postby Carpe » Wed Mar 13, 2013 3:22 pm

If you look at the UK Investing wiki, you will see the Vangaurd UK Government Bond Index Fund listed as a possible intermediate term bond index fund. As of Jan 2013, its duration was listed at 9.1 years. It may be the closest there is to intermediate, but 9.1 years?

http://www.bogleheads.org/wiki/UK_Investing

Vanguard does not appear to offer a "short-term" UK government bond index fund, or anything labeled as "intermediate". This is also consistent with one other major provider in the UK that I have experience with.

Can anyone provide input on typical UK bond-portfolio construction, UK perspective on duration, and specifically if approaching 10 years is what one would expect to use for a bond allocation?
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Re: UK Bond Funds & Duration

Postby Valuethinker » Wed Mar 13, 2013 5:10 pm

I think this is simply structural.

The UK has one of (the?) longest maturity profiles of any government in the world. A deliberate policy by the Debt Management Office (www.dmo.gov.uk) to 'fund long' -- trading off higher interest payments (yield curve is normally upward sloping) for less of a liquidity/ 'roll' problem when debt comes due.

This may have been driven by the actuarial requirement that UK pension funds hold risk free long bonds to match their liabilities. So they pressured the government into issuing a 50 year bond in 2005 for example, the longest Treasury security in the world I believe.

Hence the long duration.

Note c. 25% of all outstanding UK government bonds are inflation linked ie indexed linked gilts. They would not, however, be in this fund.
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Re: UK Bond Funds & Duration

Postby Carpe » Sat Mar 23, 2013 12:03 pm

Valuethinker wrote:I think this is simply structural.

The UK has one of (the?) longest maturity profiles of any government in the world. A deliberate policy by the Debt Management Office (http://www.dmo.gov.uk) to 'fund long' -- trading off higher interest payments (yield curve is normally upward sloping) for less of a liquidity/ 'roll' problem when debt comes due.

This may have been driven by the actuarial requirement that UK pension funds hold risk free long bonds to match their liabilities. So they pressured the government into issuing a 50 year bond in 2005 for example, the longest Treasury security in the world I believe.

Hence the long duration.

Note c. 25% of all outstanding UK government bonds are inflation linked ie indexed linked gilts. They would not, however, be in this fund.


Thanks for this, and yes, I am familiar with the UKs longer involement with index linking - I grew up with National Savings Certificates. I haven't looked recently, but I was dissapointed that the UK Gov't had not introduced any new issues of the Index Linked Savings Certificates. Hopefully IBonds won't go the same way.

Still trying to digest the 9.1 year duration issue, and how to incorporate this into my investement plan (my US nominal bond investments have an average duration a little over 5 years). Options include: (1) don't care about UK interest rate risk, and establish a consistent bond/equity allocation split for UK investements; (2) use a UK bar-bell, splitting the UK bond holding with UK cash to lower combined duration to circa 5 years, and a consequential loss of yield; (3) use a UK/US bar-bell, using combined/average duration of everything. All have pros and cons, expecially if you start caring about UK/US diversification and wanting location risk to be roughly the same. Thoughts?
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Re: UK Bond Funds & Duration

Postby helfordpirate » Sat Mar 23, 2013 1:13 pm

FWIW I use iShares II Plc FTSE Gilts UK 0-5 (IGLS) to reduce the overall duration in my UK fixed interest. I think its duration is less than 3 years if I recall.

However, I dont otherwise hold UK nominal gilts - I have UK index linked (I live in the UK and want protection against unexpected inflation) and Citigroup G7 Global Government Nominal (I think international diversification is handy for a European!). I shorten the whole lot with a dose of IGLS - the index linked in particular are very long duration and so pretty volatile.
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Re: UK Bond Funds & Duration

Postby Valuethinker » Sat Mar 23, 2013 6:21 pm

Carpe wrote:
Valuethinker wrote:I think this is simply structural.

The UK has one of (the?) longest maturity profiles of any government in the world. A deliberate policy by the Debt Management Office (http://www.dmo.gov.uk) to 'fund long' -- trading off higher interest payments (yield curve is normally upward sloping) for less of a liquidity/ 'roll' problem when debt comes due.

This may have been driven by the actuarial requirement that UK pension funds hold risk free long bonds to match their liabilities. So they pressured the government into issuing a 50 year bond in 2005 for example, the longest Treasury security in the world I believe.

Hence the long duration.

Note c. 25% of all outstanding UK government bonds are inflation linked ie indexed linked gilts. They would not, however, be in this fund.


Thanks for this, and yes, I am familiar with the UKs longer involement with index linking - I grew up with National Savings Certificates. I haven't looked recently, but I was dissapointed that the UK Gov't had not introduced any new issues of the Index Linked Savings Certificates. Hopefully IBonds won't go the same way.


There was an inflation +1% issue about 2 years ago. Not surprisingly it was snapped up.

Still trying to digest the 9.1 year duration issue, and how to incorporate this into my investement plan (my US nominal bond investments have an average duration a little over 5 years). Options include: (1) don't care about UK interest rate risk, and establish a consistent bond/equity allocation split for UK investements; (2) use a UK bar-bell, splitting the UK bond holding with UK cash to lower combined duration to circa 5 years, and a consequential loss of yield; (3) use a UK/US bar-bell, using combined/average duration of everything. All have pros and cons, expecially if you start caring about UK/US diversification and wanting location risk to be roughly the same. Thoughts?


As per the other poster, add a ST gilt ETF?

Directly own 5-10 year gilts?

The yield curve is not that steep except at the short end (ie a 5 year gilt and a 10 year have pretty similar yields? Without checking my FT).
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Re: UK Bond Funds & Duration

Postby Carpe » Sun Mar 24, 2013 5:35 pm

helfordpirate wrote:FWIW I use iShares II Plc FTSE Gilts UK 0-5 (IGLS) to reduce the overall duration in my UK fixed interest. I think its duration is less than 3 years if I recall.

However, I dont otherwise hold UK nominal gilts - I have UK index linked (I live in the UK and want protection against unexpected inflation) and Citigroup G7 Global Government Nominal (I think international diversification is handy for a European!). I shorten the whole lot with a dose of IGLS - the index linked in particular are very long duration and so pretty volatile.


Thank you for this suggestion. IGLS would be a good solution if it was accessible. Unfortunately, I have no access from within my UK pension, and since it doesn't trade on a US exchange, access via Vanguard brokerage doesn't look like an option.

Cheers!
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Re: UK Bond Funds & Duration

Postby Valuethinker » Sun Mar 24, 2013 5:46 pm

Carpe

If you have more than 9 years to retirement then a fall in bond prices (rise in yields) will be compensated for by reinvestment of coupons at a higher yield (roughly, rule of thumb, not as gospel).

Otherwise then hold some cash or cash like investments of shorter duration. For example an investment grade corporate bond fund should have shorter duration (albeit equity risk).

Although at a 3.3% breakeven inflation rate Indexed Linked Gilts are not particularly attractive right now, they could form a substitute investment as well.
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Re: UK Bond Funds & Duration

Postby Carpe » Sun Mar 24, 2013 6:15 pm

Valuethinker wrote:
As per the other poster, add a ST gilt ETF?

Directly own 5-10 year gilts?


In principle, yes, but since I don't have/use brokerage services in the UK, it is not an option for me at this time.

Also, for some reason, UK Gilt ETFs are just not part of what is accessible in the US. Pity!

The yield curve is not that steep except at the short end (ie a 5 year gilt and a 10 year have pretty similar yields? Without checking my FT).


Well, according to Bloomberg, the 5yr gilt is currently yielding 0.75%, whereas a 10yr is currently yielding 1.85%.

http://www.bloomberg.com/markets/rates-bonds/government-bonds/uk/

This being the case, using cash to shorten the duration is looking like the most straight forward path, at least for me:

Given than the Vanguard UK Government Bond Index has a duration of 9.3 years and is yielding 1.75%, diluting with 45% cash would bring down the combined duration to 5.1 years for a yield of 0.96%.

I chose 5.1 years here, since it is the duration of the Vanguard Intermediate-Term Government Bond ETF, which is essentially 100% Treasuries and has a current SEC yield of 8.2%. Not too different really.

I guess I just have to get used to having a cash holding :annoyed

Please feel free to throw stones at this approach if you disagree.
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