By BILL BLEVINS [email protected]
Bill Blevins is the Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK
There has been a notable increase in investor confidence in bonds over the last year. Despite the global credit crisis, independent financial advisers (IFAs) are convinced of the long-term benefits of investing in bonds.
At the Joint Investment Forum 2009, 83 per cent of 1,430 IFAs polled said that they would be recommending corporate bonds to their clients this year. The Virgin Money Investor Intension Index, which measures IFA confidence in various sectors, also reveals that bonds have seen a 15 per cent rise – to 83 per cent – in confidence since the index was launched last June.
Bonds are arguably now even more attractive following the latest Bank of England (BoE) interest rate and quantitative easing announcements.
With bank interest rates now so negligible, more people will move their money out of cash and into securities like bonds which provide higher returns.
Chancellor Alistair Darling gave the BoE permission to spend 150 billion pounds sterling on asset purchases. 75 billion pounds will be spent over three months to buy corporate and government bonds. This will increase the flow of credit available to business, thus helping them cope with the economic downturn. Extra demand for bonds and gilts from the Bank will drive down interest rates for business and consumer borrowers.
Corporate bonds are one of the main methods a company employs to raise money – the other two being issuing shares or borrowing from the bank. With share prices still very volatile and the credit crunch making it harder to obtain bank loans, companies may need to rely more on issuing bonds – and in the current economic climate have to offer higher interest rates than they normally would to attract investors.
When you buy a bond you lend money to a company or a government for a fixed term. In return the issuer pays you a fixed rate of interest each year and on maturity will repay the original capital back in full. If the company does not have the means to repay the capital and/or interest, it is possible that they may default on the loan.
Since bonds are traded on the open market their value can both fall and rise. If you sell a bond before maturity and it has fallen in price, you may receive back less than your original investment. If you sell before maturity and the price has gone up, you could make a profit. In the meantime you will receive steady interest payments either way – the interest does not fluctuate with the price of the bond as it is fixed on the issue date.
You can of course buy a few individual bonds on issue and just hold them to maturity – you will not have the opportunity to generate any capital growth but you will earn a fixed rate of interest for each bond each year. However if you buy some time after issue when its price has fallen, and then hold to maturity, you would generate both capital growth and the annual interest.
It is normal practice for investors to access bonds though professionally managed bond funds, rather than buying and selling individual securities, which takes experience and needs insight into the issuing companies and the potential for their credit worthiness to be upgraded or downgraded, or for them to default.
Bond fund managers actively buy and sell bonds before they mature where they see opportunities to make gains by doing so, rather than purely holding them to maturity. A bond fund also allows you to invest in a wide range of bonds to increase the potential for good returns.
Bonds, particularly high yield bonds, are currently priced at what many commentators are calling ‘once in a lifetime’ levels. Such prices were last seen in the 1930s.
Distressed sellers have pushed prices down – and yields up – to record levels. The market has also priced in a very high level of defaults, but while defaults may increase in these economic conditions, managers agree that they will not rise to the extent that has been priced in.
The apparent mis-pricing of risk provides an ideal time to lock in a high income and also to potentially make a capital gain once the economy is back on track.
Many bond issues are currently trading at half their original value, but once they reach maturity the original issue value will be repaid in full. It is therefore possible for fund managers to make significant gains on such a bond if they buy it today and hold to maturity, assuming that the company does not default.
These low prices are also reflected in prices of bond funds, so by investing now you will generate a very attractive income.
Corporate bond markets typically recover before equities after economic downturns. Their yields going into 2009 are exceptionally high, with equity type returns expected for 2010, without taking equity type risk. They are an attractive proposition for those looking for ways to increase their income in these days of low bank interest rates and a poor Sterling to Euro exchange rate.
As always, while bonds look attractive right now, it is not recommended that you pile all of your money into bonds. The tried and tested route of asset allocation remains as important as ever – probably more so in these difficult times. You should always discuss investment opportunities with a financial adviser to ensure they suit your objectives and circumstances and work well with your other assets.
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