Q: When to move your cash to bonds depending on yields and inflation? A: Always

As part of my buy-and-hold strategy, I want 25% of my portfolio to be in a safer asset, because 1. it helps buy when this asset is cheap every time I rebalance, and 2. because to hedge the risk that stocks sometimes perform poorly – see for example the 30ies, 70ies, 00ies Returns By Decade (NYSEARCA:SPY) | Seeking Alpha. Let’s not discuss the 25% here - my retirement situation is complicated, across countries. The question is whether to hold these 25% as govt bonds or in cash? How should this decision depend on current yields and the rate of inflation?

I’m confused about this issue at the moment, with several seemingly reasonable ways to think about this. I’d love your feedback on my reasoning below:

  1. When I started investing in 2018-2019, yields on government bonds were negative and inflation low. Thus, I reasoned that if I bought a bond at 100 CHF with a -1% yield, I’d get get 99 CHF back when the bond matures. Holding the position in cash beats this. Thus I kept my 25% bond allocation in cash. Makes sense?

  2. Now, yields are positive again, and inflation has increased. While inflation makes it a bad time to hold 10-year govt bonds at a fix rate — because the money will be worth less once the bond matures — it still beats getting 0% return on the cash. Thus, now is the time to move cash into govt bonds. Right?

  3. One should definitely hold the 25% of the portfolio as government bonds because we don’t buy these bonds directly but as ETFs whose price fluctuates depending on expected future gains: these ETFs are cheap when yields are low/negative and more expensive when yields are higher. So even when yields were negative back in 2018-2019, I should have bought bonds rather than hold cash. Sure, the fund manager may have charged an extra ~1% on top of the TER to cover negative yields. But the prices per share in the ETF were low, so I could have bought tons of them. A few years later, yields go up again, govt bond ETFs prices go up as a consequence, and guess who now holds tons of high-yielding govt bond ETF shares.
    Also, holding ETF shares whose price will increase with inflation is a better inflation hedge than holding cash.

Conclusion: Reasoning #3 is most accurate. Hold the course. As a buy-and-hold investor, just buy govt bond ETFs like you’d buy stocks ETFs, independently of what yields and inflation may be doing at the moment. Correct?

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Regarding #3: the short term reaction is: yields go up when prices go down, yields go down when prices go up. Now, if the coupons are positive and are reinvested in the ETF, they will contribute to the value of the fund.

Regarding the strategy: a question you may want to ask yourself is: what is the pain level in terms of inflation? At some point the SNB could be forced to stabilize the exchange rate with the Euro and import more inflation from the Euro Zone (currently 8.9%).

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If you are talking about “normal” bond ETFs, then it is other way around. How it works with inflation pegged bonds I don’t know and I don’t think there are some in CHF. Probably some corporate floaters, Swiss government has 20 something bonds all together anyway.

So I am definitely not buying bonds with negative yield even if their price can go up if rates and yield become even more negative.

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It also heavily depends on which bonds. Short term? Less fluctuation but negative or close to zero (might not beat cash).

Longer term duration, might have positive yields but much bigger exposure to interest rate risk. This might be ok for long investment horizon where having somewhat uncorrelated asset class is what you’re after rather than low volatility.

For example check:
https://www.ishares.com/ch/individual/en/products/261156/ishares-swiss-domestic-government-bond-13-ch-fund

https://www.ishares.com/ch/individual/en/products/261157/ishares-swiss-domestic-government-bond-37-ch-fund

https://www.ishares.com/ch/individual/en/products/261158/ishares-swiss-domestic-government-bond-7-ch-fund

They have increasing duration and increasing volatility.

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Nice that you mention these specific Swiss bond ETFs from iShares as I was just looking into them due to the fact that the might be interesting again because of interests rates going back up. What I wanted to share and what I found very special with these 3 ETFs is that the short term and less risky one (0-3y) has a coupon of 2.82%, the intermediate (3-7y) a coupon of 2.09% and the more risky long term one a coupon 1.61%. Based on what I have read I would have expected the exact opposite (the less risk and short term should have a very small coupon and the more risky long term should have a higher coupon). Does anyone know why this is the case with these Swiss bond ETFs from iShares? If I compare with government US treasuries ETFs from Vanguard (VGSH, VGIT, VGLT) it is exactly the opposite.

Is it maybe because the special economic situation we have or is this something specific to Swiss bonds? Because if it is always like that that the coupon is higher for Swiss government short term bonds then the choice is easy, I would go for the 0-3y short term bonds ETF which has a higher coupon and less risk… But yeah maybe I am missing something here…

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You shouldn’t look at the coupon. Longer term bonds (before 2015) had a bigger coupon and shorter term ones (very recent ones) might have a bigger one too.

I’d look at the yield to maturity (YTM), which is:

  • 0.04% for a weighted average maturity of 1.1y for the short term bond fund (with 2 holdings… not sure it’s worth using a fund for that).

  • 0.1% for a weighted average maturity of 5.04y for the intermediate term bond fund (5 holdings…).

  • 0.53% for a weighted average maturity of 11.5y for the long term bond fund (8 holdings…)

Coupons are set when the bond is emitted but the price is corrected by market participants to reflect their expectations, which should lead bonds with similar credit risk and duration to have similar yields, independently of the coupon they pay.

That gives a normal curve (the longer term bond funds have higher yields), which would mean the market doesn’t expect yields to be lower in 5 or 10y than they are now.

Given the very few holdings these funds have, I’d rather use individual bonds, adding cantonal and cantonal banks, rather than these funds, which leads to the #1 and #2 thoughts process in the OP (don’t buy bonds with a lower yield than what you can get on a similar duration term deposit/CD).

For bond funds, a case could be made for diversifying credit risk and using a broadly diversified investment grade fund hedged in CHF, of which AGGS seemed like the best last time I checked: https://www.ishares.com/ch/individual/en/products/295830/ishares-core-global-aggregate-bond-ucits-etf-fund

What’s important with bond funds is to match their duration with your time horizon. They are somewhat self compensating interest rate risk on their duration (their holdings are loosing value when interest rates increase, but the bonds they purchase later on have a bigger yield and will compensate for that on the duration of the fund - but not earlier).

I’d personally rather go with a ladder of individual bonds/CD/term deposits, so I would be subject to the considerations #1 and #2.

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I think you could be confusing coupons and yields. Coupons are the nominal interests received each year from the bond. Yields are the computed return that also takes into account the current price of the bond, which depends on current interest rates.

The yield is normally higher for longer durations and lower for smaller durations in normal market conditions. Otherwise this is an inverted yield curve.

But coupons don’t have to. I think the explanation is that the Swiss government issues bonds with interest rates close to the current yields so as to have an initial price close to 100%. Since yields were recently low, it also means that recently emitted bonds have lower coupons. And the most recently emitted bonds are also the ones with maturity farther in the future than older bonds.

That’s why long term bonds have lower coupons.

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And there’s not a lot of choice in duration (unlike US for instance), so you have a high coupon and low yield, pretty bad tax wise.

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Thanks Wolverwine (and others of course) for the great explanation. I of course got both terms coupon and yield mixed up…

To conclude o these specific Swiss bonds ETFs from iShares they finally do not look interesting anymore and on top of that there is hardly anything inside these ETFs (2 bonds for the short term duration ETF). So a no go.

I got this one in my watching list too as it already got mentioned a few times and this forum and probably the best diversified and cheapest one can get based in Ireland and with CHF hedging. Another alternative ETF I’ve been looking at is Vanguard Global Aggregate (VAGE, VAGF, VAGS, VAGP) for the same TER of 0.10% as AGGS but Vanguard’s ETF is not available on the Swiss stock exchange and is not available as hedged CHF. Maybe one day they will also have such a version available.

I also was taking a look at these iShare ETFs and actually found them useful, especially long term one. It has a higher volatility then the shorter term ones, but higher volatility is better if an asset is anticorrelated with other assets in the portfolio. I need to check though what is their correlation with the stocks market.

Yes, there are a handful of holdings, yes, there is TER, but: you can buy it at IB. I was not able to find a way to buy individual Swiss government bonds at IB. And I don’t want to have another broker account in the first place, and if it is a Swiss one, then with my amounts that I want to invest in Swiss government bonds, I am quickly having much higher trading fees then the TER of the iShare ETFs.

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VAGX is the one you’re looking for.

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Totally right and I know that you don’t want to open another brokerage account but I guess your best or only option here right now would be to go with DEGIRO for the cheap fees. In case one day you change mind…

Fantastic, now that you mention it I can remember but just did not have it on my to watch list and at that time when I found it bonds were so uninteresting that I had totally forgotten about it.