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Spreading Risk, Improving Quality

Gilts, bonds, and interest-bearing shares
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Spreading Risk, Improving Quality


Postby yieldhog » August 22nd, 2020, 11:21 am

I'm retired and draw an income from my SIPP. Currently, about 25% of my SIPP is invested in various types of fixed income securities, most of which were bought soon after the 2008 financial crisis. Most are irredeemable, illiquid, or subordinated.

At my book cost, most of the bonds are yielding around 8 - 10%. A typical example is the Halifax 9.375% Perpetual Subordinated Bonds (HALP) which I bought over ten years ago at a sub-par price. Today, an indicative price for HALP is 158.50 - 163 (Hargreaves Lansdown). At the bid side of this range the current/running yield would be 5.91%.

The question I'm asking myself is, should I be selling my current bond portfolio and reinvesting the proceeds in something that will preserve or improve the current yield, spread or reduce my risk, improve liquidity, and improve quality?

Using the HALP example, let's say I invested £10,000 at par 10-years ago and today I could sell them for 160 (just to keep the maths simple), then I would have £16,000 to reinvest. If I could reinvest at, say, 6% then I would get a small uplift in my dividend yield (from £937-50 to £960) but in itself this is hardly worth the bother. What may be more important is whether I could improve the portfolio quality, liquidity, risk profile etc.

One idea might be to reinvest in a fixed-income type Investment Trust. This would certainly spread the risk from a single company to a portfolio of bonds and most likely improve liquidity. It might also improve the quality. It could also help to reduce the number of holdings in my portfolio and simplify the administration.

Has anyone else on this board gone through a similar process and/or does anyone have any ideas on suitable alternative investments?

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Re: Spreading Risk, Improving Quality


Postby Laughton » August 22nd, 2020, 12:56 pm

I don't have the answer so excuse me for commenting. I'm in a similar situation to you although I don't really ask myself the same questions because:

1/ I don't really understand the common preoccupation with the book cost and therefore the yield on purchase price. Surely the only thing that matters as you are living on the yield is what the current and possibly yields to maturity are?

2/ As you have a portfolio, do you not already have a spread (of risk)? Or maybe your portfolio is concentrated in banks?

3/ I could well be wrong but the spread (in bid offer prices) makes it very hard to sell an existing bond yielding 5.91% to purchase something else, certainly at better quality and liquidity, that yields more. It's the quality and liquidity that dictate the yield.

But, as I say, I could well be wrong and I'll be interested in hearing from many on here far better informed than me.

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Re: Spreading Risk, Improving Quality


Postby yieldhog » August 22nd, 2020, 4:14 pm

Fair points Laughton.
1. In my case the book cost does have some relevence. When I bought most of my bonds they were trading below or not very far above par. I've always tried to err on the side of caution when buying bonds that are a long way over par, just in case an event occurs that allows the issuer to call the bonds at par. You may remember the situation a few years ago with some of the Lloyds ECNs, where Lloyds found a way to buy high coupon bonds back at par. The case went all the way to the High Court before Lloyds got it's way by a very narrow split decision in it's favour. The Yorkshire Building Society 13.5% convertible was another case where the issuer managed to buy back a lot of it's issue on the back of some veiled threats against anyone who decided to hang on to their bonds. It certainly wasn't clear in the Lloyds prospectus that the bonds could be called at par and that's why it had to go all the way to the High Court to get resolved.
2. I have eight high yield issues left in the portfolio, having recently sold 1SBA and 1SBB. Seven of them are bank names, one insurance company (General Accident 7.875% prefs.). When it was recently announced that ordinary dividends on bank shares would be suspended, I was relieved to hear that no other classes of shares, such as prefs, would be affected, since several of my holdings are prefs. However, it does underline the political risk that goes with bank debt and although I've enjoyed good returns over the past ten plus years from this sector, I feel it may be prudent to look for alternatives.
3. My SIPP is with EQi (Selftrade) and I've always found their bond traders quite helpful in getting trades done inside the wide price indications that go with most of the high yield bonds, but you are certainly right in saying it's very difficult to sell anything on 6 -7% yields and expect to reinvest for better quality without sacrificing yield. I do already own a few debt ITs (SMIF, NCYF and IPE) that yield over 6% but I'm under no illusions that their portfolios are any better quality than my existing bonds, indeed I think they are probably much worse. However, they do have more diverse holdings which may well mitigate some of the risk.

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Re: Spreading Risk, Improving Quality


Postby 88V8 » August 22nd, 2020, 8:43 pm

yieldhog wrote:I...should I be selling my current bond portfolio and reinvesting the proceeds in something that will preserve or improve the current yield, spread or reduce my risk, improve liquidity, and improve quality? One idea might be to reinvest in a fixed-income type Investment Trust.

On HYPP and HYSS, Itsallaguess has been making the case for moving out of individual HYP stocks into income ITs.
Not sure the same case can be made for Fixed Interest.

As you commented, most FI is still paying its coupon or divi, whereas many ords are not. The reserves in Income ITs will hopefully bridge the ords dividend drought, but in FI there is no drought to bridge. ITs have of course the merit of less admin and unless one views investment as a hobby, as time goes by this may become more attractive.

Your purchases were well-timed, although as Laughton commented, yield at time of purchase has no relevance now unless one is bothered about the capital, which I am not.

I do not presently see any compelling case for moving out of my directly-held FI. As an income investor, I am happy with any capital risk, so long as they continue paying.
There is however a cloud on our horizon, which is that in 2026, UK Prefs will no longer count as regulatory capital, and so there will be a temptation for issuers to retire them. Aviva for instance have said that they will review the status of their Prefs at that time.
One hopes that this would be dealt with honourably by retiring them at a fair market price, but having seen Lloyds' behaviour, one does wonder. Perhaps this situation will be better handled by a professional manager, rather than ourselves as private investors. So I am keeping a weather eye on this aspect.

Recently I bought some Shires Income SHRS, an Income IT with about 30% in UK Prefs, suggested here although I was surprised when I looked at their top ten holdings that they largely duplicate the retail issues that I already hold, and for that matter their ords are the usual income suspects. Never mind, at a 6% yield I'm not really bothered about the duplication.

Other than Shires, provided that inflation and interest rates remain low, I'm happy to hang onto my individual FI. I'm of an age where the erosive effects of inflation will not have too much time to gnaw at the real income, So I shall sit tight.

My portfolio btw:

Bit of a stamp collection. Never mind, it pays the bills.


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Re: Spreading Risk, Improving Quality


Postby yieldhog » August 24th, 2020, 11:34 am

Good comments V8, thank you.
Coincidentally, before I read your post I bought some SHRS at an all-in cost of 217.8 which gives me a prospective yield of 6.06% on a discount of 6.50%. This was a good match for what I was looking for.
I haven't yet sold any of the fixed income bonds I hold but am considering POB and/or STAB.
I think POB refixes next year at 5-yr Gilts + 3.9% but although I like the idea of some floating rate debt in the portfolio, I'm not sure a 5-yr refix period is the best way to go. In a rising rate environment a 3-month LIBOR link might be better. Besides it could be quite a long wait before we get into that situation.

Like you, I am of an age where the long-term portfolio characteristics may be of less importance than immediate income, but I hope to be able to pass my SIPP on to my wife and then to my two sons, so longer term factors are a consideration.

SHRS is certainly quite an unusual mix and in my case, as for you, it has holdings that duplicate some of my portfolio. GSK for example, I hold as an individual stock, and BHP is prominent in several of my ITs, but I like both of these stocks and so don't mind a bit of extra exposure.
The top holding (Aberdeen Smaller Companies Income Trust) in SHRS seems to me a bit odd, but it's a sector where I don't have any existing exposure and so am happy to gain some. At the same time, in the short term it may be a higher risk sector.

I recognise several of your holdings that are also in, or were until recently in, my portfolio.

Here's my current portfolio:


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Re: Spreading Risk, Improving Quality


Postby scrumpyjack » August 24th, 2020, 11:46 am

On the 'cost is irrelevant' bit, I would just say that it is of some interest to know whether the historic decisions one made were good ones as compared with the other things one could have done.

One could take the view that XIRR, which many posters seem interested in, is just as 'irrelevant' as cost. One is similarly looking at comparisons to historic prices whereas, apparently, all one should be doing is deciding what to do now.

Others may have a different view, but surely it is human nature to get a mildly warm feeling to see that the value of one's investment is significantly higher than its cost?

Perhaps there are fools who have rather more 'sangfroid' than me

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Re: Spreading Risk, Improving Quality


Postby yieldhog » August 25th, 2020, 11:05 am

That's quite a stamp collection you have there. Thanks for sharing it. I'm guessing you may have, or had, some links with the City to accumulate it. Unfortunately, almost all my contacts from City days have now retired or moved on, so I'm left to do my own research. I was unaware of the upcoming rule change on prefs, so appreciate the heads up on that.
Going forward, I will look for opportunities to sell some of my direct fixed income holdings and search for IT/ETF-type alternatives. With very little liquidity in some of the holdings there will probably be times when dealer short positions bump up the prices to give me a good selling opportunity.

I'm not really into the technical stuff like XIRR and IRR etc. As far as fixed income is concerned I just look at the quality of the issuer, outlook for the sector, chart history, yield, and liquidity.


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