2020 will be remembered throughout the history of finance due to the COVID-19 pandemic. In times like this, should you keep on investing? So what are good investment strategies during a pandemic?
Bonds can be able to play an essential role in our investment profile, especially when a financier aims for an investment that could help him/her with his/her long-term financial goals. Bonds are characterized due to their predictability devoid of complex strategies which shall be beneficial to active buyers. Even casual and non-investors could benefit from this kind of security.
It is a prominent as well as well-known security for capitalists who are saving funds for lasting needs. For instance, in your prime period (the early 20s or 30s), you might consider buying securities for you to secure yourself in your retirement years. Or, it also a viable option to purchase securities through bonds in support of your children’s future education, especially when they reach college since college education very costly. Or you may desire to secure enough funding for the construction of your dream house. Whatever your objectives are, if it is something you may require in the forthcoming, then bonds will help you.
So returning to the query, if bonds are worthy of investiture or not, well, before anything else, we must review and grasp the fundamentals of capitalizing in bonds.
Formally Defining Bonds
Bonds refer to an instrument generating fixed income that is delineated by a credit transacted between a borrower (usually a government authority or corporation) and an investor. Further, it is deemed as an “I Owe You” established amongst a borrower and a moneylender; inclusions are remuneration timetable and credit info. Usually, towns, countries, authorities, and enterprises maximize bonds so that they can provide enough financing to their enterprise activities or big schemes. Bond bearers are also well-known as loaners or ‘debt-holders’ of the issuer. Particulars of the bond will list down the termination date once the credit is already due for settlement to the bond possessor, furthermore, the circumstances for rigid interest payments done by the scrounger himself.
Finding the Antiquity of Bonds: Starting from Mesopotamia to the US
Archives had revealed that factually, bonds had been prominent way back 2400 B.C., as understood in a rock discovered at Nippur, Mesopotamia which now present-day Iraq. In that the first-ever bond, corn functioned as the coinage.
The investments in the bond market became a global trend, with a lot of countries following the lead of England, and across the globe, governments had been engaging in ‘fund wars’. Fund wars became a common case in the United States.
In the US, the government engaging in bonds started during the Revolutionary war. It is during that time that the US issued its first bonds ever in order to gather enough funds to fight the war. It can be remembered that during those times, the government Treasure was offering loan certificates, which corresponds to bonds. Due to that, a lot of private investors purchased bonds amounting to 26 million to help fund the war.
The Good of Investing in Bonds
As associated with diverse kinds of securities, bonds offer financiers stronger gains. They are branded to have lesser unpredictability, not like other investment equities. For this, it can be presumed that they are much more untroubled and more safeguarded over stocks. In most instances, the interest disbursements of bonds are greater compare to dividend outlays.
Another feature is that it is fluid. It is simpler for any business enterprise to retail to other companies or investors bonds in a greater volume less the fear that it can influence the value of bonds, which is relatively different in stocks. It is undeniable that bonds can entice more investors because elicits a definite rigid interest remuneration semi-annually, and when the bond matures, investors can expect a settled flat rate.
More importantly, bondholders could be free from anxiety since they are protected by laws. Almost all countries provide bondholders with legal protection. To illustrate, if ever one corporation experiences bankruptcy, its bondholders can still be released with their money back (based on the recovery amount). This is not the case for stocks; when a company goes bankrupt, the stocks will lose their value.
When investing in bonds, be familiar with covenants and indentures. Covenants are clauses on the agreement between the bondholder and the bond owner. These contain the duties of the issuers, as well as the rights of the bondholders. Additionally, covenants list down the obligations of the issuers as well as the prohibitions. Whereas, indentures are a formal agreement pertaining to debt and its payment terms.
Depending on the investor’s financial goals, there are a lot of bonds to choose from. There are zero-coupon bonds, inflation-linked bonds, convertible bonds, floating-rate bonds, and fixed rated bonds.
The Bad of Investing in Bonds
There exist handicaps in bonds which encompass unpredictability of the marketplace, loan hazard, and increasing interest tariff. The cost of bonds may climb when its rate drips, contrarily, the value will decline once their rate increments. hence, an investor’s bond portfolio is at risk whenever the market price losses in a competitive and rising-rate market environment. It is the volatility of the bond market that impacts the bond prices.
The second drawback is credit risk which pertains to the default on interest and principal repayment obligations the issuers can result in if they are experiencing problems with the company cash-flow. However, there are several bonds that included in their provisions the right of issuers to be able to purchase back the bonds prior to their maturity. Therefore, issuers have the opportunity to redeem their right early on when they already perceive the interest rates to be shopping. In this case, the investors end up reinvesting the principal at rates lower than expected.
Diverse Varieties To Pick From
If you are already decided on spending on bonds, then you have to first figure out the variety of bond suited for your financial goals. Most investors are unaware that the bond marketplace can provide a lot of bond kinds to select from, unlike the limited offerings of the stock marketplace.
The bond investiture choices are international, municipal, corporate, government, asset-backed, and or mortgage-backed securities. Your pick must reckon on your threat appetite, your levy condition, and your financial objectives. Since there are various sorts of bonds, there are also different kinds of issuers, voucher rates, falling due, rates of return, credit ratings, and more countenance embedded in each bond variety. More importantly, various bonds mean distinct levels of threat, and chances of advantage.
1) Municipal Bonds
These are the type of securities that are being released by the states, cities, countries, and many more agencies of the government. Most often than not, these bonds are spent to finance government programs such as hospital construction, the building of schools, the renovation of highways, and many other relevant projects for the masses.
By buying a municipal bond, a financier is already lending funds to the local or state authorities in the completion of their projects. This, in turn, will repay the investors with a specific amount of interest, and of course, the settlement of the capital once it attains maturity.
However, not all municipal bonds have levy exemptions. There is, however, a different marketplace where they are taxable at the federal nation yet still has state- tax exemption on interest settled to the country inhabitants.
2) Government Bonds
A variety of bond that is issued by the authorities in the government. These are loan-based kinds of holdings. Here, investors are allowed to credit funding to the authorities, and in return, they are guaranteed a specific interest. Authorities are utilizing these kinds of fundraising in order to support their foundation plans. Buyers can expect their payments at common gaps.
You might wonder how government securities function. Once an investor engages in a government type of bond, they have come to an agreement with the government that the funding will be lent only for an accepted interval of period. The administration will also submit itself to settling the financier’s return with an interest accepted upon, and the settlement is finished at the usual duration; this is commonly familiar as vouchers. That explains how these bonds could be a possibility fixed yield benefit.
What if the securities have achieved their expiration date? Then, in this case, the investor will receive his/her original investment. The specific date on which the original investment is paid back is dubbed as the maturity date. There are different maturity dates for different bonds. Sometimes, bonds mature for less than a year, sometimes it would need 30 years to expire. It relies on the agreement.
3.) Mortgage-backed securities
If you are looking for bonds that are secured by mortgages, then mortgage-backed securities are what you need. Technically, it is an asset-backed security, meaning, investors invest in the security with anticipation that he/she will gain returns through other’s efforts. The investor will have gains from the credit enterprise less the need to trade or purchase a factual household credit. Most often than not, purchasers of such securities are individual investors, corporations, or institutions.
So buying this kind of investment is simply you procuring the privilege to be released of the price of a package of pledges, as well as expenditures to monthly pledges and reimbursement of the capital. You never have to procure the whole of the pledge; considering it’s a guarantee, you can procure simply portions of it, then, you will acquire the compensation comparable to the part you bought.
4.) Corporate Bonds
Corporates (or better known as corporate securities) refer to commitments pertaining to liabilities that are being released by public or private corporations. There are different reasons why companies do the sale of bonds. The raised funds can be utilized in the procurement of facilities or the construction of business branches.
Procurement of bonds is simply loaning funds to the releaser (company). The issuer will then guarantee you the taking back of your principal on a date specified. The appointment when your principal is returned is so-called the maturity period. Until the bond has not yet reached maturity, the issued will settle the interest twice a year. However, the settlement of interest is not free from taxation. Finally, dissimilar to stocks, buying bonds doesn’t mean you own a portion of a company.
These are securities that have been supported up by monetary resources. This type of pledge will include a number of advantage dues (apart from pledge lending). One distinguishing feature of this bond is its ‘creditworthiness’, making it a very wise investment.
What happens under this bond is that several financial institutions that originally transact loans, will convert loans into securities for the bond market. This process is called ‘securitization’. The issuers of the loan are also considered as the ‘sponsors’.
6) International Bonds
If you want to buy bonds that are issued by overseas business enterprises, then buy international bonds. The issues of the debts could be companies abroad or foreign government. The currency used in these bonds are usually the denominations for the issuer’s country, and therefore could be highly affected by inflation. There are a number of government bonds abroad which has better offering (higher interest rates) compared to those of the United States government bonds. However, these high-interest rates can also affect the economic activities of the borrowing country or company, worst, might cause economic depression once the country’s currency had significantly weakened. Most investors would wish to invest in bonds with countries having remarkable economic growth.
What to Consider in Buying Bonds
Bonds can be bought in various ways. It can be directly from the government, with a broker’s assistance, or through a bond fund. But prior to buying the bond, be sure to fully grasp the type of bonds, the rewards you will gain from each type, and the risks as well. It is advisable that you diversify your portfolio since not all bonds could give you immediate returns or long-term gains. The best advice for you if you really desire to procure bonds is to consult with a monetary consultant.
Again, there exist several means to procure bonds. Choose your issuer wisely. Your investment in the bond marketplace may come from the State Treasury Department, through US Brokerages such as TD Ameritrade, Fidelity, and many other more sellers in the market.
Once you had finalized the issuer of the bond, study the rates, yields, and prices since these three are interrelated and will impact each other.
But if ever you want to buy yourself new bonds and keep it until it matures, then you must know that price changes, market interest rates, and yields will not have a significant effect on you. However, it’s a common notion that some investors do not plan to hold their bonds until they mature; they would rather buy bonds and put them on sale in the secondary marketplace. The pricing of securities holdings can go up or drop due to the issuer’s monetary status and the economy.
Measuring the Price of Bonds
You might wonder how prices are being appraised. Undeniably, price is an extremely significant component when investing in the bond market. The price of the bond is equivalent to the amount investors are willing to cash in in order to secure specific bonds.
The interest rates will have a great impact on the price of the bonds. If the present interest rate is higher than the time the bond was issued to the investor, then the bond price is therefore dropping. The grounds why the price reduced is because newly-issued bonds possess better coupon rates as the interest rates rise. This only means that the previously-issued bonds will be less enticing already and will most likely be bought at even a lower price. This concludes that when the interest rates are very high, then the prices of existing bonds may be lower.
But what if interest rates drop rapidly? In that case, the prices of existing bonds will most likely rise, meaning, an investor can sell the bond at a price greater than when it was purchased because a lot of investors will be very open to paying a premium for higher-interest paying bonds (or coupon).
What Impacts the Prices of Bonds?
There are multiple factors why bonds are valued in a certain amount.
1. Inflation
Our general knowledge of economics will remind us that the prices of bonds will fall if inflation gets high. Inversely, when inflation is dropping, the price of bonds is increasing. You might ask why. It is since any potential rise of inflation can negatively impact the purchasing power of what you’re expected to be earning from your bond investment. In simple terms, once the bond investment had reached maturity, then an investor will acquire the returns from the investment, however, its value would become lesser in today’s currency.
2. Credit Ratings
The credit ratings are being assigned to specific bonds and to bond issuers by several reputable agencies. These so-called ratings can be very informative to investors since they will gain sufficient idea as to the efficiency of the issuers especially in terms of paying interests and repaying the principal on a bond. Wise investors will search for issuers with high credit ratings since surely, these are the issues that will punctually pay its monetary obligations to the investors. Whenever there is an increase in an issuer’s rating, the bonds will also increase. Inversely, if the rating decline, so are the prices of bonds.
3. Rate of Interest
As a rule, the moment the interest rates climb, the prices of bonds decline. Inversely, when the interest rates decline, the bond prices increase.
To illustrate – You purchased a bond that guarantees 4% interest. But the moment the interest rates are lower – for instance, just 2% — your interest rate is, therefore, better and more than the going rate. This is very appealing to investors. But if ever the interest rates catapult to, like 7%, then the bond you bought is less enticing.
How are Bond Markets Performing during the COVID-19 pandemic?
The COVID–19 pandemic had been affecting the worldwide economy. During this corona crisis, the bond market remains remarkably volatile. Its volatility is visible in the thriving markets and high-yielding ETFs. Accordingly, in connection to the expected volatility from equity markets, the higher-risk end of the bond market drop by 20-25% from February of this year until March. It can be noted that the US S&P 500 had relatively dropped by 33%, meaning bonds are preferable this year.
According to Dominique Maire, investors should not purchase a knife that is falling but purchase it when the policy reaction is crystal clear to the buyer.
Maire is the head of Fixed Income Investment Management at Julius Baer. She further explained that right now, fear is taking over the bad market. These bad markets are the over-the-counter markets that solely depend on the trader’s willingness to engage in trades. Because of fear, the commitment of investors to trading has highly declined because everyone is taking a stronger hold of their risk budget. Not everyone has an amazing risk appetite.
Therefore, in these trying times, only the investors who traded when the markets had frozen eventually crystallized their financial losses. Unfortunately, there were those who were forced to sell in order to gain enough funds to pay for their loans. On the contrary, the investors who were able to hold their investments had definite returns in US dollars during the first six months of the year 2020, since the US bond market was able to deliberately deliver 6% to 5% returns. Meanwhile, the high-yield market in the United States needed time for recovery, in fact, the said market remained even until August.
The COVID-10 pandemic is teaching the investments the hard lessons in life. It can be fathomed that in crises like this, bond investors should always be ready for lower trading liquidity and higher price volatility. Investments should be mentally and emotionally prepared for whatever changes that will come their way.
But there are also positive results from this pandemic. As mentioned, there are thriving investments that unexpectedly yielded even greater gains. But this is impossible if not because of amazing policy actions. Policymakers, issuers, and investors must all be prepared for liquidity shock which might eventually drown a corporate, government, or individual into debt, and later on, become an economic crisis and financial meltdown. Due to policy actions, there are greatest chances for quick revival and restoration of trust in the credit markets.
The Hard Lessons COVID–19 Taught Investors
The pandemic had tested the level of preparation the investors have. Maire mentioned that tracing back history, there are several market shocks that instead of pulling everyone down and were able to open doors of opportunities for investors to purchase credits. Therefore, in times like this, investors must learn how to manage their portfolios.
As suggested by Maire, investors must adjust to the current trends must be adaptive to it, and more importantly, must adopt a long-term investment strategy must devise specific strategies for investment allocation and must maintain a positive behavior coupled with discipline. Finally, investors should learn how to employ a portfolio construction process, while doing a risk diversification.
What is the future of bonds after COVID-19?
There is what we call an ‘economic cycle’, and this cycle is composed of ups and downs; the downs this year include the COVID-19 pandemic which shocked the global market and nation’s economies. In fact, a lot of economies had to lean on debts just to survive financially. According to the calculations made by IMP, the total debt (a combination of loans and bonds) had reached 226% of global GDP in 2018 or USD 188trio.
Considering the bond market, as of now, its value had reached more than USD 63 trillion, as assessed by Bloomberg Barclays Global Aggregate Bond Index. This means that the value of the market had doubled within ten years after the Great Financial Crisis. The growth is estimated to be USD 6 trillion a year until this date.
What does history tell investors? The past will prove that the bond market is growing, and the number of corporations offering bonds is increasing. With all these, new opportunities for active investments have been opened to investors.
The seemingly endless potentials of the bond market to progress had encouraged investors to keep on diversifying their portfolios to include different types of bonds. The growing bond market would also compel the policymakers to never seize monitoring and to be open to any innovative and sustainable policy ideas.
Additionally, Maire is a firm believer the pandemic was a key for the quick, abrupt, and necessary changes to finally be moving. Maire perceives the financial market behavior to be growing and shall eventually yield great assets. Meanwhile, Maire sees excess savings and quite lower growth for the global economy because of politics and policies. But topping it all, Maire sees the bond market with a positive light and incomparable optimism.
How to Invest in Bonds during the Pandemic?
Since the market is never devoid of volatility, then one great way to counter that fact is to create a diversified investment plan. Not only does it reduce volatility, but it also decreases the risks the bonds possess. Planning, therefore, can positively help you achieve your financial goals regardless of drastic changes and market swings. But is it safe to invest in bonds during a pandemic?
Normally, investors would be in search of less risky investments especially during a pandemic (considering the financial crisis and global lockdowns that come with the COVID-19 pandemic). For lesser risks, investors can put their attention to bonds (or they may simply just keep their cash with them). In a volatile market, bonds will still keep on paying its investors, and will never give investors the degree of losses they may encounter in the stock market.
How did the bond market thrive during a pandemic? Well, there are a number of reasons why bonds remain afloat and are smoothly still operating and yielding gains. Central banks worldwide had been releasing money in bulk and unimaginable amounts due to the health crisis causing a financial shock. In desperation, central banks are exhausting all possible means to help the corporate world survive, in fact, banks had the ‘whatever it takes’ approach to keep alive. One of the ways banks considered for sustenance is through bonds which are being issued with rates higher than ever.
Is Diversifying Portfolio the Best Thing to Do?
Bonds had been experiencing stability since April of this year. A lot of nations had observed the increase in price and the decrease in yields. This phenomenon is not true to all universally, but still, no one can perfectly predict what is there to come for the bond market in the future. Considering this fact, governments and corporations must make sustainable policies, and take necessary measures so that the economy can bounce back to its former glory, and will never be barred again by any lockdown measures in the coming years.
As an investor, do not look at just one opportunity. Learn to open as many doors and windows as you can. Spread out your investments in order to also control the risks each investment possesses. By doing you, you are not only managing your potential losses but is also boosting your finances and securing it for long-term goals.
Continuing worries
There are still great risks remaining because a COVID-19 revivification, specifically, would have a disadvantageous impact on bonds — triggering yields to grow and costs to consequently collapse. Moreover, there’s no accord yet on the commission rehabilitation funding or the circumstances of the Brexit. A crucial component will be the action carried out by the ECB and diverse main banking institutions to sustain the marketplace. Buyers emerge to be putting their trust on these considerations: Resources influx to company bonds with increased classification nearly achieved the earlier-year degree in early June. And there are great grounds for this. Progress throughout the preceding period has displayed that despite business rates experienced greater ups and downs than government securities, buyers were remunerated for this increased risk under greater rates of return.
Selecting the proper bonds and having the precise timing each require intensive information and experience. These are all good causes for permitting knowledgeable fund supervisors to actively deal with the evaluation and particular funding decisions, one who makes a specialty of this asset class. Even when the prospects are good, do not forget that company bonds are topic to dangers starting from worth decline to complete loss if the borrower can not repay the debt – and this is applicable to bonds.
