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Beagle
12-08-2017, 10:48 AM
Watching CNBC this morning and Jim Cramers mad money and he got talking about investing for your age.
Zero bonds under 25
In your 30's 10-20%
In your 40's 20-30%
In your 50's 30-40%
In your 60's 40-50%
When retired approx. 60-70%

Bond yields are pretty low but even so this approach seems to make prudent common sense to me.
He has a book out called Get Rich Carefully - pretty smart guy - anyone know where I can get a copy ?

To be honest this weeks political and geopolitical events have sharpened my focus on risk management.
Who knows what sort of Government we have coming soon or quite how things will play out with North Korea ?

Your thoughts on the above allocation strategy, make sense ?, what do you think Peat ?

peat
12-08-2017, 01:49 PM
yes that approximately what the textbook says Beagle. Bonds, NB True Bonds (not junk) are seen as a smoother of ones portfolio returns as they tend to, or at least have in the past, operated countercyclically to equities. However QE and this era of very low interest rates hasnt panned out exactly like that in that interest rates have gone lower and lower (making bonds worth more) and equities have gone higher and higher meaning that we appear to be in a bull market for BOTH at the same time.

Traditionally interest rates fall during recessions and depressions etc when there is low demand for money and in that environment equities tend to perform poorly. But this time round its different huh :p
They still act to smooth out returns because of their relatively lower volatility and their fixed returns but just not counter-cyclically so much.

Gotta watch out for junk bonds though as they tend to act more like equities in testing times when the issuer's ability to pay interest and pay the capital back becomes more questionable. In that case the price of the bond will fall, and yields will become high (but maybe that coupon payment wont actually be received).

I recently sent out an article via a Sharechat mailout on this subject which said that (in a deep and liquid ) bond market , prices of the bonds were a good predictor of shareprice following an company profit result.
https://www.bloomberg.com/news/articles/2017-07-31/stock-investors-advised-to-watch-junk-after-earnings-reports

Its not in the textbooks but I think for many retail investors Term Deposits act as this smoother device and while there is opportunity cost risk with these if interest rates move there isnt any real capital value change because retailers dont have to mark to market like say a bond fund would have to.

NZ has a pretty good bond market these days. Thats actually the place where NZX has been growing its revenues - we all know how few new equity listings there have been.
Hopefully there will be some new bond issues in the next few months - I will of course keep everyone informed as these come through. ;+)

macduffy
12-08-2017, 02:18 PM
Bonds certainly have their place in portfolios but anyone newly retired 5-10 years ago would be wondering about that text-book advice if they had switched from equity-heavy to 60-70% bonds. It would probably be argued that the low interest rate environment of the last several years is abnormal - but then so is the low inflation environment - and retirees' spending patterns probably don't correlate with CPI weightings. Perhaps the "60-70%" theory needs a critical re-evaluation in the light of changing conditions.

percy
13-08-2017, 09:44 AM
Watching CNBC this morning and Jim Cramers mad money and he got talking about investing for your age.
Zero bonds under 25
In your 30's 10-20%
In your 40's 20-30%
In your 50's 30-40%
In your 60's 40-50%
When retired approx. 60-70%

Bond yields are pretty low but even so this approach seems to make prudent common sense to me.
He has a book out called Get Rich Carefully - pretty smart guy - anyone know where I can get a copy ?

To be honest this weeks political and geopolitical events have sharpened my focus on risk management.
Who knows what sort of Government we have coming soon or quite how things will play out with North Korea ?

Your thoughts on the above allocation strategy, make sense ?, what do you think Peat ?

Always interesting doing the opposite.Added to that, I recently decided I did not have enough of our portfolios in higher risk shares.These have been very rewarding to us over the years.So have increased to near 20%.
So a 68 year old's alternative portfolio....
.......................................My wife's............................Mine.
NZ shares...........................79.53%........... ..................52.82%
Aussie shares.......................0.26%................ ..............28.65%
Unlisted/via company.............14.56%........................ ....15.01%
Cash at broker.......................5.66%................ ..............3.52%
We also have enough money in our savings accounts to last us a couple or three years.
No bonds.
"well positioned".
NZ governments .All have been very kind to me over the years.No worries there.
..

..
The Book ,Get Rich Carefully $21.99 Bookdepository.com

Beagle
13-08-2017, 05:00 PM
Thanks for your thoughts folks. The theory appears to be sound but with the current abysmal returns I am not sure it presently works very well. To be honest with bond yields so low I have been using REIT"s as quassi bonds with PIE structures giving tax paid returns around 5%, 7.5% gross for taxpayers on a 33% rate, this to me gives an acceptable return for the risk involved, many REIT's have fairly well defined gearing parameters.

I look at the yields of longer dated bonds like Infratil at circa 5% gross before tax, 3.35% after tax, and I know their balance sheet carries very substantial debt and I struggle to get interested because they're unrated and probably more highly geared than most REIT's and quite probably more vulnerable to a major exogenous shock.
The other thing I don't think many investors consider with Banks capital note issues is that these are subject to the Reserve Bank's open banking resolution and some people may be investing in these ignorant of the fact that in a severe GFC Mk2 situation they could get a serious haircut. This risk obviously doesn't apply to corporate bonds or REIT's.

I would speculate I'm not the only one using REIT's to get a fair type of bond return by any means.

Term deposits at circa 3.7% for around 1 year also leave me fairly cold as by taking a little commercial risk in a well diversified good quality REIT you can get double the return. Further the term deposit is not without capital risk due to the above mentioned open banking resolution. Bank term deposits give a very poor return on a risk, tax and inflation adjusted basis in my opinion.

I have a number of clients who have done very well out of commercial property over the years and although the capitalisation rates on commercial property are at all time lows with consequent revaluations giving strong NTA increases I don't think they'll change much in the foreseeable future so I think on balance going forward I'll continue to use my strategy of REIT's.

The other thing is that the theory assumes one has to protect against volatility in one's portfolio as they age. In practice however people who've worked themselves into an extremely comfortable position are well positioned to withstand higher volatility and therefore well positioned to benefit from an ongoing higher portfolio allocation to shares.

I'll keep an eye out for new bond issues though Peat and thanks for sharing your thoughts but at this stage I think my strategy probably only needs a minor tweak.
Currently holding too much cash but this is not necessarily a bad thing going into an election and with current level's of geopolitical risk and the markets have run pretty hard.

stoploss
13-08-2017, 05:33 PM
"Currently holding too much cash" can never have too much cash :)

peat
13-08-2017, 10:13 PM
I wouldnt compare bonds with REITS myself. The risks are very different and comparing the current returns isnt valid either
The thing about a good bond is that its top of the pecking order and so capital loss is almost a zero probablity (well maybe not quite ) They should be better than bricks and mortar - they should be rock solid. Hence low returns are acceptable for that part of the portfolio because its actually more about capital preservation.
I agree that growth should be held longer and more of it in the investment lifecycle nowadays due to increasing longevity and low nominal returns but for those who arent - shall we say - extremely comfortable- capital preservation can still be very important in the later stages.

We're actually offering a REIT of REITS at the moment (shameless plug)

winner69
16-08-2017, 07:57 AM
I wouldnt compare bonds with REITS myself. The risks are very different and comparing the current returns isnt valid either
The thing about a good bond is that its top of the pecking order and so capital loss is almost a zero probablity (well maybe not quite ) They should be better than bricks and mortar - they should be rock solid. Hence low returns are acceptable for that part of the portfolio because its actually more about capital preservation.
I agree that growth should be held longer and more of it in the investment lifecycle nowadays due to increasing longevity and low nominal returns but for those who arent - shall we say - extremely comfortable- capital preservation can still be very important in the later stages.

We're actually offering a REIT of REITS at the moment (shameless plug)

Peat, whose the WE in your last sentence?

peat
16-08-2017, 08:41 AM
Peat, whose the WE in your last sentence?
replied via PM so as to keep the touting to a bare minimum ;+)

Bjauck
06-09-2017, 01:59 PM
Watching CNBC this morning and Jim Cramers mad money and he got talking about investing for your age.
Zero bonds under 25
In your 30's 10-20%
In your 40's 20-30%
In your 50's 30-40%
In your 60's 40-50%
When retired approx. 60-70%

Bond yields are pretty low but even so this approach seems to make prudent common sense to me.
He has a book out called Get Rich Carefully - pretty smart guy - anyone know where I can get a copy ?

To be honest this weeks political and geopolitical events have sharpened my focus on risk management.
Who knows what sort of Government we have coming soon or quite how things will play out with North Korea ?

Your thoughts on the above allocation strategy, make sense ?, what do you think Peat ?

The allocation you have for bonds must depend on whether or not you own your home and whether or not you still have an outstanding mortgage on your home.

If you have a home and still have a mortagage, I think it would make more sense to discharge your mortgage prior to accumulating a bond portfolio.

Most people, who are (fortunate enough to be able to buy a home in an Auckland context these days) in their 30's are often still owing a decent mortgage. So I doubt it would be prudent for them to own any bonds, which would probably be paying them a smaller gross interest rate than what they would have to pay (from their taxed income) on their mortgage.

Also, if you own your own home mortgage-free, as you already have a considerable asset which (in NZ in the past) tends not to drop as much as shares in a downturn, then you already have a conservative equity-type investment, so your allocation to property, retirement or conservative shares should be smaller than if you do not own a house.

We are increasingly in an era where real estate property ownership can no longer be assumed for all investors. Many commentators suggest that NZ real estate property ownership need no longer be a goal. (Mostly I suspect these commentators already own their own homes).

macduffy
06-09-2017, 02:53 PM
I'm not sure I'd agree 100%, Bj, in that I'd treat my mortgage-free home as just that, a home to live in and not an investment. Aside from that, I've never favoured the increased allocation to bonds advocated by many (most?) advisers. Retired folk still have to hedge their income against rising costs - rates, power, insurances etc - nothing seems to get cheaper except maybe electronics which don't figure much in a retiree's spending! - and equities have long been the best way to do this, at least in NZ.

Bjauck
06-09-2017, 05:34 PM
I'm not sure I'd agree 100%, Bj, in that I'd treat my mortgage-free home as just that, a home to live in and not an investment. Aside from that, I've never favoured the increased allocation to bonds advocated by many (most?) advisers. Retired folk still have to hedge their income against rising costs - rates, power, insurances etc - nothing seems to get cheaper except maybe electronics which don't figure much in a retiree's spending! - and equities have long been the best way to do this, at least in NZ. True...even for a retiree, you need to account that your assets should rise by inflation in addition to providing after tax income. The general CPI is a poor guide as to the inflation in items that retirees have to consume or consider too. Especially when many folks can spend decades in retirement. So a big ask for what bonds actually provide these days after tax.

We will have to dsagree on treating owner-occupied housing as an investment. While it is a home to live in, it as also an investment, in the past the best performing investment for many with mortgages as it leverages up their equity. It provides a valuable annual return in providing accomodation. It can be sold to provide many with a nice modern unit in a retirement village with an additional nest egg left over....(Disc: I hold listed retirement company shares)

If you cannot or choose not to buy a home, then you need more investments or an alternative or higher income to provide what an owner-occupied house provides.

Snoopy
07-09-2017, 02:15 PM
The thing about a good bond is that its top of the pecking order and so capital loss is almost a zero probability (well maybe not quite ) They should be better than bricks and mortar - they should be rock solid. Hence low returns are acceptable for that part of the portfolio because its actually more about capital preservation.


Peat, Contact 040 bonds are a BBB rated bond with a coupon rate of 4.63%. If I read the market price correctly you can buy them at a market coupon rate of 3.75%. IIRC a BBB rated company has a 1 in 30 chance of a severe capital stress event (going bust without a capital injection) each year. Let's say you are buying the bond in year zero for $10,000, are paying 30% tax, and want to hold for 30 years.

Your total expected income is: 30 x ( 0.0375 x 0.7 x $10,000 ) = $7,875m

After 30 years the chance your investment will still be intact is:

(29/30)^30 = 0.3617

This implies the chance of losing your investment is:

(1-0.3617) = 0.6383

Or in dollar terms your expected capital loss from business failure will be:

$10,000 x 0.6383 = $6383.00

I hope you can see that your expected after tax income barely covers your expected capital loss.

Can you see why I bought CEN shares yielding 6% gross return ahead of the bonds?

SNOOPY

Snow Leopard
07-09-2017, 02:36 PM
...IIRC a BBB rated company has a 1 in 30 chance of a severe capital stress event (going bust without a capital injection) each year....

If the Bond is rated BBB then I understand that it mean than there is a 1 in 30 possibility, over the 'life' of the bond, that there will be a default on paying the interest or repaying the capital.

But as I don't do Bonds I could be wrong.

Best Wishes
Paper Tiger

Snoopy
07-09-2017, 02:51 PM
If the Bond is rated BBB then I understand that it mean than there is a 1 in 30 possibility, over the 'life' of the bond, that there will be a default on paying the interest or repaying the capital.


Looking at the Reserve Bank published pdf on credit ratings above. This says:

https://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervision/banks/3498179.pdf?la=en

Approx. probability of default over 5 years (The approximate, median likelihood that an investor will not receive repayment on a five-year investment on time and in full
based upon historical default rates published by each agency.) is '1 in 30'.

So let's look at a 5 year time horizon for Contact 040 bonds.

Let's say you are buying the bond in 'year zero' for $10,000, and are paying 30% tax.

Your total expected income over five years is: 5 x ( 0.0375 x 0.7 x $10,000 ) = $1,312.50

The chance your investment will still be intact after 5 years is 29/30.

This implies the chance of losing part of your investment is 1/30:
The worst case here, should Contact Energy fail, is that you will lose all of your investment. Your 'expected' capital loss in this worst case situation is therefore:

(1/30) x $10,000 = $333.33

Some might call that pessimistic. But even if you don't lose all your investment, a partial recovery of what is left might take years. So I think 'total loss' is the real world scenario you should plan for. So I would argue the expected return over five years is:

$1,312.50 - $333.33 = $979.17

This represents an annual net rate of:

($979.17 /5) / ($10,000) = 2%

Compare that with

1/ Buying the Contact shares at a 6% gross yield ( 4.2% net) on market ( approximately true with a $5.50 share price ) and
2/ The possibility of a capital gain from the shares

then the bonds look very unattractive as an 'income generating investment' and an investment in general.

SNOOPY

Investor
07-09-2017, 03:27 PM
I don't think it's worthwhile relying on a rule of thumb. I intend to have 0% bonds at all age brackets.

FIsaver
07-09-2017, 03:55 PM
I don't think it's worthwhile relying on a rule of thumb. I intend to have 0% bonds at all age brackets.

I also intend to have 0% bonds at all ages and to have enough in the market to ride the rollercoaster.

peat
07-09-2017, 04:32 PM
the premise (1 in 30) is fully dubious in my opinion, I really dont see CEN falling over in half a decade. Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical.

And if you spend a good number of lines discounting the bond why is the equity investment not also risk adjusted

Snoopy it seems your analysis discounts the bond for an arbitrary risk factor but the equity return should even more heavily discounted because the bond and its interest will be paid as a priority over the share being worth anything or the dividend being dropped.

Snoopy
10-09-2017, 03:13 PM
the premise (1 in 30) is fully dubious in my opinion, I really dont see CEN falling over in half a decade. Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical.


It would be fascinating to know how Graeme Wheeler and the boffins at RBNZ equate a BBB rating with a one in thirty chance that "an investor will not receive repayment on a five-year investment on time and in full." The claim is that 1/30 is from 'historical data' (so not intuitive as you suggest Peat), but what data? Was it gathered in NZ only or is the data global? What industries made up the data?

I think there is a difference between Contact 'falling over' and the bond 'falling over'. In the worst case, a capital injection from shareholders would stop Contact 'falling over'. But probably dividends would be suspended at the same time, and interest on the bonds might be a 'delayed payment' or maybe the interest would not be paid at all? In those circumstances existing bonds might become close to unsalable, unless the bondholder was willing to take a huge haircut.

The problem with this 'probability of failure within five years' is that not all five year periods are equal. At the moment it does seem implausible. But I put it to you that if you think this, you are are probably being influenced by the bombardment of information on present day circumstances. Go back less than two years and Contact has its cash resources drained with a 50c special dividend. What if Tiwai point had announced its closure shortly after that? It didn't happen of course, but that is not the same as saying it could not have happened. Right now a 1 in 30 probability of failure looks ridiculous. But back then if my 'alternative fact' scenario had played out, the chance of failure could have been 1 in 10. Contact's relatively high debt load even today (high for companies in general, not high for power companies in particular) is deemed prudent because they have great security of cashflow. If the cashflow becomes less secure then there would rightly be more attention paid to overall debt levels.



And if you spend a good number of lines discounting the bond why is the equity investment not also risk adjusted

Snoopy it seems your analysis discounts the bond for an arbitrary risk factor but the equity return should even more heavily discounted because the bond and its interest will be paid as a priority over the share being worth anything or the dividend being dropped.


I agree the equity (Contact shares) are likely to be more volatile than the 'Contact Bonds'. I did not discount that return because half of the volatility is negative (the share price might go down) and half is positive (the share price might go up). It is only negative volatility that is of concern for shareholders. Positive volatility is what we all seek and why we are in the game. 'Discounting' a share value and/or dividend because you might get 'positive volatility' makes no sense at all. "Positive Volatility' is an investment objective, not a risk factor.

The big problem with bonds right now is that potential rising interest rates are a real threat to bond values and share values, but in a broad market sense probably more of a threat to bond values. Thus I see bonds right now as higher risk and lower return than shares, even though I acknowledge that shares are also high risk. Traditionally , when all those asset allocation text books were written, bonds and shares were more often than not 'out of sync'. I don't think this is so today, which is why I don't think the traditional textbook advice of the conservative investor weighting their portfolio towards bonds works in today's market.

SNOOPY

peat
10-09-2017, 08:02 PM
The claim is that 1/30 is from 'historical data' (so not intuitive as you suggest Peat), but what data? Was it gathered in NZ only or is the data global? What industries made up the data? SNOOPY

Good questions but I wasnt actually saying that the statistic was intuitive, I was saying that my view is intuitive. Sorry for that lack of clarity.

"Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical."



Thus I see bonds right now as higher risk and lower return than shares, even though I acknowledge that shares are also high risk. Traditionally , when all those asset allocation text books were written, bonds and shares were more often than not 'out of sync'. I don't think this is so today, which is why I don't think the traditional textbook advice of the conservative investor weighting their portfolio towards bonds works in today's market.SNOOPY

Its worked pretty well I would've thought , capital gains, no failures (that I can think of) .

Snoopy
12-09-2017, 04:26 PM
Its worked pretty well I would've thought , capital gains, no failures (that I can think of) .


With interest rates falling the capital value of any existing bond will rise. That is indisputable. It follows that in a climate of falling interest rates that most bondholders experiences will have been positive.

However, I think it is a false belief to rely on this 'experience' and suggest that in a future climbing interest rate market, that most bond holders experiences will be positive. Many companies that issue bonds know this and have built in a future 'reset to market rates' clause at some time in the medium term future. That will stop the value of those bonds absolutely tanking as interest rates go up.

SNOOPY