Bond funds available to stocks and shares ISA

[Alaric]

Anyway cutting to the chase, do we calculate our running yield at purchase, like this:

running yield = 100 / market * PREF_RATE

e.g. AVIVA8.375

100/141 * 8.375 = 5.94%

You treat them as an income running for ever. The scare on Preference Shares is that there are possible legal interpretations that Aviva or any issuer could announce that they were repaying the Prefs at 100 and either no vote against this was possible or that holders of Ordinary Shares who might approve of this repayment could outvote the holders of Preference Shares who wouldn't. It's still a bit unresolved. The FCA have more or less said "you can't do that" and Aviva agreed to compensate those who panicked and sold when Aviva first made the threat. The legal loophole still seems to be there however.

[TheMotorcycleBoy]

Anyway cutting to the chase, do we calculate our running yield at purchase, like this:

running yield = 100 / market * PREF_RATE

e.g. AVIVA8.375

100/141 * 8.375 = 5.94%

You treat them as an income running for ever. The scare on Preference Shares is that there are possible legal interpretations that Aviva or any issuer could announce that they were repaying the Prefs at 100 and either no vote against this was possible or that holders of Ordinary Shares who might approve of this repayment could outvote the holders of Preference Shares who wouldn't. It's still a bit unresolved. The FCA have more or less said "you can't do that" and Aviva agreed to compensate those who panicked and sold when Aviva first made the threat. The legal loophole still seems to be there however.

Thanks Alaric,

But my main question was about whether my yield calculation was right. But looking at it I suppose it must be. I just got hung up on the concept of them having a par value. But I suppose if you are just looking at % then you only need to consider the purchase price and the annual div.

[hiriskpaul]

Thanks for the pref share links. To be honest we are going to stick to these names I think, mainly because I'm (slightly) more knowledgeable about these firms, than the others:

LLYD BKG9.75PREF
AVIVA8.375PREF
NAT.WEST 9%PF

I'm a little unsure about NW, and LLYD, since we are already umming and ahhing LLOY ord shares, and want to spread risk etc. And I'm already a tiny bit nervous about banks, though I've heard that Lloyds is sticking to vanilla banking (i.e. not investment banking). Perhaps I'm wrong, still v. green in all this.

Anyway cutting to the chase, do we calculate our running yield at purchase, like this:

running yield = 100 / market * PREF_RATE

e.g. AVIVA8.375

100/141 * 8.375 = 5.94%

thanks Matt

That is approximately right. To get a more precise figure you need to take account of stamp duty (if you are buying) and the value of any dividend that is included in the price. As an example of the latter, take NWBD, which pays 4.5p per share every 6 months. On each ex-div date the price can be expected to drop 4.5p as you will not be receiving the next coupon. Thereafter you can expect the price to rise a little bit each day (~ 4.5p/180) until the day before the next ex-div date. In practice you will not see the precise changes due to normal market trading, or lack of, but you need to take it into account if you want a reliable yield calculation. Essentially you need to use the "Clean" price in your yield calculation, which is the market price minus the amount of dividend accrued since the last ex-div date, approximately number of days/180 times 4.5p.

Strictly speaking, that is the yield for biannual payment. You might want to annualise that yield to compare with other returns. You can do that using (1+y/2)^2-1. So if the semi-annual yield comes out as 5%, the annualised yield would be 5.0625%.

Another, potentially simpler way to calculate the annualised yield which also takes some account of the time value of money and does not rely on knowing ex-div dates is to calculate the internal rate of return of the investment over one year, taking the sell price to be the same as the buy price less the stamp duty. You can use the excel XIRR function to do that for you. Simply lay out buy/sell cashflows and dates along with the 2 coupon payments and use XIRR to calculate the IRR.

[TheMotorcycleBoy]

Thanks for the pref share links. To be honest we are going to stick to these names I think, mainly because I'm (slightly) more knowledgeable about these firms, than the others:

LLYD BKG9.75PREF
AVIVA8.375PREF
NAT.WEST 9%PF

I'm a little unsure about NW, and LLYD, since we are already umming and ahhing LLOY ord shares, and want to spread risk etc. And I'm already a tiny bit nervous about banks, though I've heard that Lloyds is sticking to vanilla banking (i.e. not investment banking). Perhaps I'm wrong, still v. green in all this.

Anyway cutting to the chase, do we calculate our running yield at purchase, like this:

running yield = 100 / market * PREF_RATE

e.g. AVIVA8.375

100/141 * 8.375 = 5.94%

thanks Matt

That is approximately right. To get a more precise figure you need to take account of stamp duty (if you are buying) and the value of any dividend that is included in the price. As an example of the latter, take NWBD, which pays 4.5p per share every 6 months. On each ex-div date the price can be expected to drop 4.5p as you will not be receiving the next coupon. Thereafter you can expect the price to rise a little bit each day (~ 4.5p/180) until the day before the next ex-div date. In practice you will not see the precise changes due to normal market trading, or lack of, but you need to take it into account if you want a reliable yield calculation. Essentially you need to use the "Clean" price in your yield calculation, which is the market price minus the amount of dividend accrued since the last ex-div date, approximately number of days/180 times 4.5p.

Strictly speaking, that is the yield for biannual payment. You might want to annualise that yield to compare with other returns. You can do that using (1+y/2)^2-1. So if the semi-annual yield comes out as 5%, the annualised yield would be 5.0625%.

Another, potentially simpler way to calculate the annualised yield which also takes some account of the time value of money and does not rely on knowing ex-div dates is to calculate the internal rate of return of the investment over one year, taking the sell price to be the same as the buy price less the stamp duty. You can use the excel XIRR function to do that for you. Simply lay out buy/sell cashflows and dates along with the 2 coupon payments and use XIRR to calculate the IRR.

Thanks for this Paul,

Yes, Mel and I, with GoSeigen's help managed to get our heads around accrued interest and clean vs. dirty prices when we used to chat more about bonds in our early days here.

I'm cool with a lot of the calculations, and as I'm a computer nerd I wrote some python code, which I can bung in a bunch of numbers, and get a load of others out at the end (e.g. YTM, duration, and so on). (Sad, eh? )

What I'm wondering is whether to get that fund I mentioned here or a bunch of pref shares. The issue in my mind is that several of bigger issuers in the available pref. share world look to be like finance/banking firms (e.g. Aviva, Lloyds, etc) and so not as diverse (potentially) as bond fund, solely regarding sectors covered. And since the last big CC emanated from banking/finance (I suspect the next will do too, on reading about the large number of LBOs and M&As going on in the US lately) then perhaps that is a tad ill-informed? But having said that perhaps I'm just doing what another (GeoffF100) warned me about - trying to guess the market.

Matt

[Alaric]

What I'm wondering is whether to get that fund I mentioned here or a bunch of pref shares.

There is an added risk on Preference Shares that you would be buying them at a considerable premium to their face value. As the rules on capital requirements for banks and insurers are changing so Pref Shares will no longer count, a financial storm that caused yields to rise and thus prices to plummet could see Pref Share prices drop back towards 100 at which point issuers might attempt to invoke their rights to pay off the Pref holders. Those who bought at 150 say would then see a capital loss without being able to hold and see out the crisis as yields dropped back.

[TheMotorcycleBoy]

What I'm wondering is whether to get that fund I mentioned here or a bunch of pref shares.

There is an added risk on Preference Shares that you would be buying them at a considerable premium to their face value. As the rules on capital requirements for banks and insurers are changing so Pref Shares will no longer count, a financial storm that caused yields to rise and thus prices to plummet could see Pref Share prices drop back towards 100 at which point issuers might attempt to invoke their rights to pay off the Pref holders. Those who bought at 150 say would then see a capital loss without being able to hold and see out the crisis as yields dropped back.

Can all Pref share issues forcibly repurchase them then? Or is it just something that Aviva decided they might be able to get away with?

[Alaric]

Or is it just something that Aviva decided they might be able to get away with?

Probably the latter, although there do seem potential loopholes everywhere. The FCA read the riot act though about orderly markets to discourage others from making Aviva style announcements.

The problem is not so much that they offer 105 when the price is 105, but when they announce that they are paying back 100 when the price is 150 and the Pref holders are unable to vote to prevent it because there's nothing to compel a separate vote of just Pref holders.

[TheMotorcycleBoy]

While we are on the subject of pref. shares, and bonds, am I correct in assuming that the macroeconomic trends followed by corporate bonds i.e. the yields go up along with interest rates, generally speaking, are shared by pref. shares?

[Alaric]

While we are on the subject of pref. shares, and bonds, am I correct in assuming that the macroeconomic trends followed by corporate bonds i.e. the yields go up along with interest rates, generally speaking, are shared by pref. shares?

In mathematical terms, Preference Shares work the same way as Corporate Bonds. Mostly they are undated of course unlike Corporate Bonds. They differ in legal aspects which becomes important if defaults are in the air.

[TheMotorcycleBoy]

While we are on the subject of pref. shares, and bonds, am I correct in assuming that the macroeconomic trends followed by corporate bonds i.e. the yields go up along with interest rates, generally speaking, are shared by pref. shares?

In mathematical terms, Preference Shares work the same way as Corporate Bonds. Mostly they are undated of course unlike Corporate Bonds. They differ in legal aspects which becomes important if defaults are in the air.

You mean that except for the seniority level of the capital, their macroeconomic properties are similar, right?

i.e. if interest rates rise, then typically the yields on prefs. rise in a similar way that the yields on bonds do?

[TheMotorcycleBoy]

I'm just writing up a few of the bond funds which people (Alaric, Geoff, Hiriskpaul, I think) suggested over in viewtopic.php?f=55&t=13931&start=20 which are on iWeb

Vanguard Global Bond Index GBPH Acc (GBPH means hedged against sterling)
5 year annualised return=2.73%
12 month yield=0.28% (hmm...)
OCF=0.15%

iShares Core £ Corp Bond ETF GBP Dist (SLXX) (this distributes it's divs which I don't like, would rather have an ACC version etc)
Div yield= 2.73%
OCF=0.2%

Paul also mentioned that there's a Vanguard one, called VDET. Alas not on iWeb

I'm struggling to find something yielding/returning something in between the above low yields and the Schroeders high yld opportunities one, we looked at the other day.

[TheMotorcycleBoy]

So what happens if we buy i.e. from the UK a Bond fund listed as being USD or EUR? I suppose that there could always some losses bundled in due to exchange fees, but I guess if you choose an Acc fund, this doesn't really matter until the day you choose to cash it out into GBP?

But if it's a Inc fund, we currently do quite well since the $ and the E are strong against the £ ?

Correct?

[Alaric]

But if it's a Inc fund, we currently do quite well since the $ and the E are strong against the £ ?

It's the relative strength since you buy it that matters. If you buy when the pound is 1.1 to the Euro, then a 1.10 dividend in Euros is worth £ 1 (obviously). If the pound falls to parity, that dividend is now worth £ 1.10. If the pound climbs to 1.2 against the Euro, the dividend is now only worth about 90p.

There's complicated alchemy in some funds where currency fluctuations are ironed out. Look for the word "hedged" in some fund names.

[GoSeigen]

Can all Pref share issues forcibly repurchase them then? Or is it just something that Aviva decided they might be able to get away with?

Melanie,

Only redeemable shares give issuers the right to "forcibly" repurchase them.

Issuers of all other share classes, including Aviva's irredeemable preference shares, require the agreement of (usually) 50% of their shareholders to repurchase in the market, or 75% in a capital reduction.

GS

[GoSeigen]

You mean that except for the seniority level of the capital, their macroeconomic properties are similar, right?

i.e. if interest rates rise, then typically the yields on prefs. rise in a similar way that the yields on bonds do?

Well, this is not true of bonds in general, is it?

Bonds duration varies from zero to long. The shorter the bond duration the more like cash the bonds will behave, i.e. if bank interest rates rise their yield will follow. In contrast long-duration bond yields are relatively insensitive to interest-rate changes but instead track long-term inflation expectations (whatever that means!).

In my view preference (and other) shares behave just like bonds in those respects: redeemable shares with a nearby redemption date will have yields sensitive to interest rate changes, while irredeemable-share yields will be relatively insensitive to interest-rate changes -- unless rates are very high like in the 1970s in which case they again become increasingly linked to interest rates.

Other Fools have argued in the past that shares and bonds are entirely different, but I never understood their POV.


GS

[GoSeigen]

[...]

What? Who? Where has Melanie gone? I quite fancied her...




GS

[TheMotorcycleBoy]

[...]

What? Who? Where has Melanie gone? I quite fancied her...




GS

PMd

[TheMotorcycleBoy]

You mean that except for the seniority level of the capital, their macroeconomic properties are similar, right?

i.e. if interest rates rise, then typically the yields on prefs. rise in a similar way that the yields on bonds do?

Well, this is not true of bonds in general, is it?

Bonds duration varies from zero to long. The shorter the bond duration the more like cash the bonds will behave, i.e. if bank interest rates rise their yield will follow. In contrast long-duration bond yields are relatively insensitive to interest-rate changes but instead track long-term inflation expectations (whatever that means!).

In my view preference (and other) shares behave just like bonds in those respects: redeemable shares with a nearby redemption date will have yields sensitive to interest rate changes, while irredeemable-share yields will be relatively insensitive to interest-rate changes -- unless rates are very high like in the 1970s in which case they again become increasingly linked to interest rates.

Other Fools have argued in the past that shares and bonds are entirely different, but I never understood their POV.


GS

Hi GS, Sorry I phrased the question poorly. What I should have written was

i.e. if interest rates rise, then typically the yields on prefs. rise in a similar way that the yields on long-dated bonds do?

but now I've read your replies better, I guess what I'm now thinking, is the question really should have been:

do long-dated bonds and pref. shares have similar yield properties regards interest rates and inflation expectations?

thanks Matt

[everhopeful]

I am sorry I have been away staying at a lighthouse. Despite lighthouses being at the forefront of communication for 200 years there was neither a phone signal or wifi (bliss).
There has been a great deal of discussion about the riskiness of prefs elsewhere on the Fixed Income Investor boards. Without going into detail amongst the financial prefs ELLA and NWBD are considered to be at least risk of any cancellation at par. Having said that I do not personally share the concerns mentioned by Alaric about prefs in general. There are risks attached to everything we invest in and the reaction to Aviva's actions have IMHO made prefs even safer.

[Alaric]

There's a new investment trust being launched by M&G which is going to invest in the outer reaches of the quoted and unquoted fixed interest market. As might be anticipated it's likely to combine highish returns, the target is LIBOR + 3% with risk and highish charges. It's a closed end fund, so isn't going to be hit by the redemptions it might get where it structured as an OEIC and things went wrong.

https://www.investmentweek.co.uk/invest ... ment-trust

It's built around the expertise built up on managing private credit assets for the Pru and perhaps others.