Like many investors, I have less fixed income in my portfolio than I should. Although I have some cash and property, so I am not completely at the mercy of the stock market, rock-bottom interest rates have long held me back from venturing too deeply into bonds.
Some of the investment trusts I own (Murray International, Acorn Income, and RIT Capital Partners) do hold fixed-income investments.
Even if I included these, which is dubious in the extreme, the resulting fixed-income element would only account for 3% of my overall portfolio.
I also have some renewables and infrastructure exposure within my portfolio, which I am hoping can provide some bond-like stability, but these are yet to be properly battle-tested.
But my lack of fixed income is definitely a weak spot, so it’s something I’m looking to address, albeit on a fairly gradual basis over the next decade or so. I like to plan ahead with these things as regular readers may have gathered.
Where investment trusts come up short
Unfortunately, for my purposes anyway, investment trusts don’t seem to cover this asset class that well. Most debt funds seem to specialise in niche and/or risky areas.
What’s more, many of them don’t have a particularly long track record and we’ve even seen a couple, namely Funding Circle SME Income and RDL Realisation, decide to call it a day. That doesn’t exactly inspire confidence.
My knowledge of the fixed-income market isn’t that great. I know some basics, but I feel much more inclined to go the passive investing route when it comes to this particular asset class.
A global bond index fund is certainly one option, but I’m also interested in Vanguard’s LifeStrategy and Target Retirement funds, so I decided to dig in to them a little more.
Both provide a mixture of both equities and bonds in one simple package. They are designed to automate your asset allocation, helping you resist the temptation of trying to time the market.
The LifeStrategy funds rebalance regularly, keeping a fixed proportion of equities and bonds.
The Target Retirement funds do much the same thing, but with the added feature of gradually moving more and more into bonds as you get older (as classic asset allocation theory dictates).
Why rebalancing works so well
The secret to a good asset allocation strategy is regularly rebalancing the proportion you have in each asset class.
Say you have 50% in equities and 50% in bonds. Let’s say that shares then have a good year, rising by 20%, but bonds produce a zero return.
This means your weighting would have shifted to 54.5% equities (60/110) and 45.5% bonds (50/110).
To rebalance, you would sell some shares and buy some bonds to restore your 50%/50% position.
The key point to note here is that you are (probably) selling shares when there are expensive. And you are (probably) buying bonds when they are cheap.
It’s all about taking advantage of reversion to the mean and the fact that shares, in particular, can produce wildly varying returns from year to year.
Of course, if you held fixed-income in an investment trust, there’s a decent chance the trust’s discount might widen considerably if the stock market had a major fall. Selling a little to rebalance your portfolio might not be nearly as effective in these circumstances.
Vanguard’s five LifeStrategy funds were launched in June 2011 here in the UK. They have a set percentage in equities with the balance in fixed income. You can have 20%, 40%, 60%, 80% or 100% in equities.
You can mix and match of course. For example, you could buy half LifeStrategy 40 and half LifeStrategy 60, if you wanted 50% in equities and 50% in bonds.
These funds have an ongoing cost figure of 0.22%. From a quick skim of the prospectus, there doesn’t seem to be a fixed rebalancing schedule. So, adjustments to keep the equity ratio at the correct level are made as and when required rather than, say, each quarter or year.
The Target Retirement funds aim to make your investing life even simpler.
Rather than sticking with a fixed ratio of equity to bonds, they start off with a ratio of 80% equity/20% bonds. Then they very gradually move towards 30% equity/70% bonds over the course of three decades.
There are several funds, with a range of retirement dates from 2015 to 2065, with five-year gaps in between. The idea is that you pick the retirement date that most closely matches your own. As that date approaches, the fund moves more and more into bonds.
The shift towards bonds starts when the typical investor is aged 43, that is 25 years before the target retirement date. It accelerates a little when you are in your 60s, before flattening off when you reach 75.
Here is the retirement glide path, as it is rather grandly called:
The Target Retirement funds for 2045, 2050, 2055, 2060 and 2065 are all still 80% equities. The remaining funds currently have the following equity allocations:
- 2040: 77%
- 2035: 72%
- 2030: 66%
- 2025: 61%
- 2020: 53%
- 2015: 40%
These funds all have an ongoing cost figure of 0.24% so the one extra step of automating your asset allocation makes it marginally more expensive than the LifeStrategy funds.
The 2015 to 2055 funds were launched in December 2015, and the 2060 and 2065 funds in December 2017.
Comparing the two
The Target Retirement and LifeStrategy funds invest in a very similar fashion and broadly use the same underlying funds.
What is a little surprising is the difference between how much is invested in each of them.
The LifeStrategy funds had £12.3bn of assets when I did the research for this article. LifeStrategy 60 is the most popular, no doubt due to the fact that 60% equities/40% bonds is typically the default recommendation for asset allocation.
The LifeStrategy funds have over 100 times more in assets than the Target Retirement funds. Combined, the eleven Target Retirement funds have collected just £122m.
I was amazed by how small these figures were. The Target Retirement funds haven’t been around as long, especially the 2060 and 2065 versions, but still.
In the US, Vanguard’s Target Retirement funds typically have tens of billions of dollars of assets and seem to be more popular than the LifeStrategy funds.
The bias to the UK
LifeStrategy 60 and Target Retirement 2025 both have 60% in equities at the moment, so they are fairly easy to compare.
While their holdings aren’t identical, the differences are quite small and largely cosmetic. For example, Target Retirement held both FTSE 100 and FTSE All-Share funds while LifeStrategy had just FTSE All-Share.
Both funds do have a significant bias to the UK, though, as this breakdown of LifeStrategy 60 by assets shows:
UK equities account for 15% (a quarter of the 60% held in equities) of this fund, whereas if a strict global weighting was applied this figure would be around 4%.
Likewise, UK fixed-income is 13% compared to around 3% under a strict global weighting.
According to Vanguard, “the allocation … is adjusted from a pure global market cap weighting to a heavier weighting in broadly diversified UK equities and bonds to reflect investors’ desire to hold more domestic assets, as well as to balance diversification requirements and investor costs”.
Now, that sort of UK bias is pretty close to my current portfolio but it’s definitely something to be aware of. Retirees may not be spending their cash in pounds, of course, depending on what plans they have.
According to a recent article in the Telegraph, it’s likely that both the UK weighting of these funds and their charges will come down in the coming years.
The US versions of the LifeStrategy funds have charges of 0.13%. I’m not sure the UK versions would ever get that low, but it would be good to see them reaching the high teens.
The DIY route is a little cheaper
If you were to create these funds yourself by buying all the sub-funds that Vanguard uses, then I calculate the average ongoing cost figure would be 0.15%.
Its equity funds range from 0.08% to 0.25% and the bond funds from 0.15% to 0.30%.
The key thing here is whether you trust yourself enough to rebalance any individual holdings you have when the need arises.
Another consideration could be whether you hold outside of an ISA or SIPP. Without the protection of these wrappers, rebalancing could incur some capital gains tax.
Of course, we shouldn’t pick funds like this on the basis of performance. But it’s useful to see just what the difference might be, as well as how much your returns might vary from year to year.
The income angle
Again, income probably isn’t something that should be top of your list when it comes to choosing these sort of funds.
For what’s it’s worth, the yield on the LifeStrategy funds goes from 2.0% (LS100) to 1.5% (L40).
The Target Retirement funds are 1.5%/1.6%, although Target Retirement 2020 is 1.3% and 2015 is 0.8%.
Therefore, if you are planning to live off these funds in retirement, you’d probably need to sell some units periodically to top-up the dividends paid out.
I still like the idea of these funds, and I think the marginal extra cost over bog-standard index funds is worth it to ensure your rebalancing needs are automated.
For me, ending up with 70% in bonds via the Target Retirement route seems rather too cautious, although I suspect I would still have other investments so the proportion of my total portfolio in fixed income would be a lot lower than that.
Of the two, I think I am more likely to take the LifeStrategy route, putting an increasing amount of my portfolio into it over a fairly long period of time as I sell out of other holdings. Hopefully, both the cost and the UK allocation will have been reduced by then.
Please note that I may own some of the investments mentioned above. You can see my current holdings on my portfolio page and the index page summarises my posts by category. Nothing in this article or on this website should be regarded as a buy or sell recommendation as this site is not authorised to give financial advice. I'm just a random person writing a blog in his spare time. Always do your own research and seek financial advice if necessary!
Subscribe to IT Investor
Get an alert every time I publish a new article. Your email address won't be used for anything else.