Bonds - shaken not stirred. Photo / Supplied
They may not be as exciting as a suave Brit exploring far-flung corners of the world in the name of espionage, but bonds are experiencing a bit of fame recently for all the wrong reasons.
Typically used as a volatility dampener, bonds are a type of loan, an IOU, which can be issued by governments as well as companies – as opposed to shares, which are a form of ownership.
Essentially, bonds are a way for a company to raise capital where the payout for the investor is the loan interest, rather than owning shares. The income from typical bonds is usually a fixed rate of interest, paid regularly until the bond matures, at which point the bond holder receives the original amount back (the principal).
Still with me? Great.
Bonds can play an important role in your portfolio as a diversifier, a source of liquidity, a source of stability, as a hedge against inflation, and as a source of returns even in zero rate environments. When stocks zig, bonds tend to zag. That's what makes them appealing.
In recent times, bonds have become a little sexier – what was once only the stuff of die-hard enthusiasts is now being thrown around by talking heads and columnists.
While we love to see an interest in the area, it is odd to see bonds being discussed in much the same way as lithium or crypto when they're usually referred to as ballast in a portfolio – not worthy of much thought beyond the purpose they serve.i
Very recently we've seen articles popping up saying that long bull market run in bonds is coming to an end. When we're talking about markets, bulls are on the rise and bear markets exist in receding economies.
For the last 40 years, bonds have been in a bull market as interest rates sank from the double-digits of the 80s to the recently very low single digits.ii
And if you've been paying attention (or if you have any sort of debt), you'll likely be very aware that interest rates are beginning to rise again – spelling the end of this particular trend. For now, anyway.
What does this mean? Should we all be investing in bonds, or avoiding them?
Bonds can provide a more predictable income stream. For example, if you are supposed to receive $1000 on August 31, it is guaranteed you will receive this fixed income on that day.
Despite their reputation for relative stability, bonds nevertheless are still risky assets. As with equities, the premiums they offer – term and credit – are not constant. They vary based on market expectations and the information available.
Furthermore they are priced on a daily basis to reflect the value should you wish to buy or sell on the day, rather than hold to maturity and receive back your original investment sum.
At the moment the rising interest rates around the world could mean lower bond prices, which means those watching their portfolios like a hawk (which is a sure-fire way to raise your blood pressure, but not a great way to manage your investments) may observe an inverse movement.
Keep in mind, with all the red about in bond-land - it doesn't automatically mean that the underlying entity behind the bonds (Government or corporate) is in poor financial health.
In the case of God's Own country, we still hold our cherished S&P rating (a standardised measure of credit-worthiness) of AA+. This is just a fraction off the AAA rating still held by our Anzac cousins.
However, our Government bonds still tanked in recent times. In the calendar year ending 2021 the rate was -5.49 per cent, while the return in the last 12 months was even worse at -6.38 per cent.iii
But with their known fixed income, their lower volatility, and the fact they often move differently to shares – bonds can offer varied roles, allowing individual investors to tailor their respective portfolios to their own goals and risk appetites. As with any investment, you get to decide the amount of risk you are comfortable taking on.iv
So, in regards to what you might see in headlines about bonds no longer being lucrative … everything goes up and down, and a balanced portfolio will account for this in all areas. Reacting to news of the markets is like reacting to yesterday's rain by putting on a raincoat, only to find a sunny day outside – and bonds are no exception to this rule.
It's not so much that bonds have had a shakeup, as that we're seeing the usual cycle of things moving up and down. Sorry, Mr Bond – history tells us they are more likely to be stirred, and will come back to the mean at some point.
For advice specific to your circumstances and goals, sitting down for a chat with a trusted financial adviser is the best place to start.
And if you really want to watch bonds … you're better to queue up the latest Daniel Craig epic. It'll be infinitely more entertaining.
· Nick Stewart is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
· The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz i https://www.sfg.com.au/insights/shadforth_blog/bonds-just-bonds ii https://www.reuters.com/business/finance/us-bond-investors-worry-deep-slide-will-end-40-year-bull-market-2022-04-28/ iii Data from Dimensional Fund Advisors iv https://my.dimensional.com/why-bonds-are-like-ballast
