We are living in remarkable times. Challenging, but remarkable. In the midst of the current global Coronavirus pandemic, along with the lack of clarity and uncertainty around Brexit negotiations, it is virtually impossible to read and predict what is going to happen to the financial markets, let alone your own investments.
This, in turn, has led many investors, both experienced and novice to look at their current investment portfolio and strategy with the view to best optimise their wealth. Traditional stocks and shares are showing greater volatility and interest rates have been cut, affecting long term savings.
One investment vehicle which has remained popular is bonds. However, even though bonds are generally considered less volatile than stocks, there are still many misconceptions around the risks involved. Some are justifiable and others are not. It is important to understand the general landscape, including bonds and the rewards they can offer investors.
Bonds carry risk – but it is relative
No investment is risk free. Regardless of whether you’re conservative or aggressive with your investments, bonds are often considered extremely important for diversification and should be a part of any well-diversified portfolio.
Unlike stock investments that can jump up and down, bonds are primarily designed to pay you a fixed interest no matter what the economic markets are doing, and at this juncture it is important to understand the nature & quality of the bonds you are buying.
Bonds which are tied into interest rates will have a varied return that is dependent on what the current national interest rate is, where that bond is listed and the timeframe for the bond. Alternatively, fixed rate bonds set an agreed annual return over a set period and are subject to the performance of the issuer.
With both fixed and variable bonds, the annual redemption may not be as high as potential stock returns, but on the flip side the risks are less influenced by overall investor/market intent. Only If the issuer becomes insolvent will the investor lose out. So, it is important to understand who that is and what their track record is – a great way to judge is to look at the underlying security, management team and previous track record of paying interest and matured bonds back to investors.
Bonds are boring
Another common misconception about bonds is that they are not overly exciting. Whilst it’s almost impossible to know the value of your stocks in the future, bonds ensure the issuer is obligated to pay you the rate and your capital back by the maturity date, otherwise the issuer will be in default.
However, like any good financial product, bonds offer choice, and it is this choice which makes the bond market more exciting than is immediately perceptible. You can choose from super-safe triple A-listed bonds with low returns such as short-term government securities, or you could go for some meatier options like high-grade corporate bonds. And maybe add on a side dish of mortgage or asset backed securities, high-yield bonds, or even emerging market bonds.
In addition, you can also spread your investments over bonds based on their redemption timeframes. There are 1-year bonds all the way to 30-year bonds, and the yield will vary depending; this enables you to plan your cashflow more accurately over a longer period of time, balancing it out between annual returns and redemption payments.
Bonds are not worth owning if interest rates rise
As mentioned earlier, the rate of return that bonds offer is often tied into interest rates. As these move up or down, so will the value of your investment.
Currently there is much speculation about holding bonds – especially government bonds. Due to the global Coronavirus pandemic, UK interest rates are extremely low, and this looks to remain so for the near future. In fact, many believe that we might soon end up with negative interest rates similar to Japan– meaning there is a fear that investors may end up paying the government for owning the bonds!
In addition, when interest rates rise, bond prices tend to fall, although some hold up better than others. However, given the length of time you can hold on to certain bonds, this may not be as bad as you think. A few years ago, Vanguard carried out some research into the performance of bonds against interest rates – specifically if there was a sudden rise from 2.1% to 5.1%
Vanguard found that on the whole bonds would lose around 13% in the first year. Not great. However, because the yield on bonds would now be higher due to the increased interest rate, the breakeven point would be on average just over three years. Thus, bonds which are held for several years would still potentially make money.
However, fixed asset bonds – based on security backed debt and mortgages are considered by some investors more secure if interest rates rise, as the yield on their loans will also increase -ensuring they are able to meet the fixed return to investors.
In conclusion, during a volatile market with low interest rates certain bonds, offering a fixed yield can be very appealing, regardless of your current position in life. However, each investor needs to understand the product and its risks. However, if you are building or amending a diverse investment portfolio, bonds should have a place within it.
For more information about the bond market or Astute Capital and their products please email us or call us on 0800 009 2988. Alternatively, feel free to create a non-obligatory account and view new investments as and when they become available.