|
<p class="style8" align="justify">Bond Funds Reduce Your Portfolio's Volatility </p><p class="style7" align="justify"><strong><em><br/></em></strong><strong></strong>With the recent US sub-prime mortgage woes leading to substantial volatility in the global equity markets, some investors may hesitate to invest altogether. However, we believe that there are viable investment options for them to consider during times of volatility: Investing into specific classes of bond funds would help them ride over the volatility as well as receive a steady stream of income. </p><p class="style7" align="justify">Investments in high investment grade bonds such as US treasuries, and corporate bonds with high credit quality (rated AAA, for instance) would help your portfolio during times when markets undergo strong market volatility, like what we are seeing now. Due to the 'flight to safety' effect where investors are selling high-yielding assets to buy safer assets such as high grade bonds, the prices of the high quality bonds have risen. </p><p class="style7" align="justify">Therefore, we believe that investing in global bond funds is a good way to take advantage of the opportunities in the bond investment world. But let us first explain the characteristics of bond funds, and why investors should consider investing in them.<br/><br/><strong><br/><span class="style9">What You Need To Know About Bonds </span></strong></p><p class="style7" align="justify">Bond funds invest in a portfolio of fixed income debt securities which may include US treasuries, US agency bonds, corporate bonds, and sovereign or government bonds. A bond investor lends money to the bond issuers, and in return, the latter would give the investor an 'interest' or 'coupon' during the loan period .The underlying debt would normally pay out or accrue coupons at regular intervals throughout the holding period, and at maturity, the principal would be returned to the investor. </p><p class="style7" align="justify">To calculate how much income one would receive from a bond, investors need to look at the 'current yield', which is equal to the coupon divided by the price of the bond. That is, for a given coupon rate, the lower the price of a bond, the higher the yield, and hence, the higher the return for bond investors. The level of yield depends on the credit quality of the bond issuer, liquidity of the bond, current interest rates as well as the expected interest rates, among other factors. </p><p class="style7" align="justify">Credit rating agencies such as Moody's, Standard and Poor's and Fitch Ratings may give ratings to debt securities which are based on their analysis on the likelihood of default on the debt securities. The higher the ratings given, the lower the likelihood a bond would default. </p><p class="style7" align="justify">Bonds would also be subject to interest rate movements, where bond prices typically increase when interest rates decrease, and vice versa. Unlike equities, bonds have maturities which vary from days to 30 years. Fund managers may invest in bonds of different maturities, depending on the outlook for the bonds' yield or movements in the expected yield curve. Often, investors would look at the bond's duration, which provides some clues on the sensitivity of a given bond to interest rate movements. </p><p class="style7" align="justify">In order not to take on too much risk, we advise investors to build a portfolio consisting of different asset classes. We recommend investors to invest in a bond fund to build a bond portfolio; besides diversification, there are also other benefits, as we shall explore.<br/><br/><em><br/></em><span class="style9"><strong>Why Bond Funds? </strong></span></p><p class="style7" align="justify">Bond funds can form a crucial part of investors' portfolios, especially when the equity markets are volatile. As bonds belong to an asset class which has a low correlation with equities, the two asset classes tend not to move in tandem with each other. The correlation between equities (as represented by MSCI World Index) and bonds (as represented by the European Federation of Financial Analysts Societies or EFFAS Global Government Bond Index) was found to be -0.304 based on the past 5 years' weekly data (as at 7 August 2007). </p><p class="style7" align="justify">During the sustained equity downturn between end-2000 and end-2002, the MSCI World Index retreated by 34.2%, and investors would have found their equity portion decline. But if they had exposure to bonds, their portfolio would have been more resilient: bonds were up 16.9% during the same period. This helped to limit the decline in the value for the overall portfolio. </p><p class="style7" align="justify">The performance of the EFFAS Bond Index and MSCI World Index in the past 7 years is shown in Chart 1. Table 1 shows the resiliency of the bond index vis-à-vis the global equity index in 2000, 2001 and 2002 (in USD terms). </p><p class="style7" align="justify"><br/><strong>Chart 1: Performance of MSCI World Index and EFFAS Bond Index in the past 7 years<br/><img src="http://www.fundsupermart.com/main/articleFiles/webarticles/2305/SG/Bond-Funds_EN_1.gif" alt=""/><br/></strong><br/>Source: Bloomberg </p><p class="style7" align="justify"><strong>Table 1: Yearly Performance of MSCI World Index and EFFAS Bond Index (USD terms) </strong></p><div align="justify"><table bordercolor="#000000" cellspacing="0" cellpadding="0" border="1"><tbody><tr bgcolor="#006600"><td class="style7" width="162"><p align="center"><span class="style16"></span></p></td><td class="style7" width="162"><p class="style16" align="center"><strong>Returns from MSCI World Index </strong></p></td><td class="style7" width="168"><p class="style16" align="center"><strong>Returns from EFFAS Bond Index </strong></p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>Year-to-date <br/>(as at 31 July 2007) </strong></p></td><td class="style7" width="162"><p align="center">6.4% </p></td><td class="style7" width="168"><p align="center">3.3% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2006 </strong></p></td><td class="style7" width="162"><p align="center">18.8% </p></td><td class="style7" width="168"><p align="center">5.1% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2005 </strong></p></td><td class="style7" width="162"><p align="center">8.8% </p></td><td class="style7" width="168"><p align="center">-6.7% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2004 </strong></p></td><td class="style7" width="162"><p align="center">13.3% </p></td><td class="style7" width="168"><p align="center">10.1% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2003 </strong></p></td><td class="style7" width="162"><p align="center">31.6% </p></td><td class="style7" width="168"><p align="center">13.7% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2002 </strong></p></td><td class="style7" width="162"><p align="center">-20.5% </p></td><td class="style7" width="168"><p align="center">19.0% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2001 </strong></p></td><td class="style7" width="162"><p align="center">-17.3% </p></td><td class="style7" width="168"><p align="center">-1.8% </p></td></tr><tr bgcolor="#99ffff"><td class="style7" width="162"><p align="center"><strong>2000 </strong></p></td><td class="style7" width="162"><p align="center">-15.1% </p></td><td class="style7" width="168"><p align="center">-0.1% </p></td></tr></tbody></table></div><p class="style7" align="justify">Source: Bloomberg<br/><strong><br/><br/><span class="style9">What To Buy? </span></strong></p><p class="style7" align="justify">Global bond funds are typically diversified in terms of their holdings. They invest in instruments such as US treasuries, US agency bonds, and sovereign and corporate bonds globally — including those in Singapore. Varying with the country allocation of individual global bond funds, the exposure to the local bonds could be as high as 50%. The country allocation of global bond funds allows them to gain exposure to the potential appreciation in bond prices as well as currencies. </p><p class="style7" align="justify">Fundsupermart.com's house view is that the USD is likely to remain weak in the near-to-medium terms. As such, investors may be interested to look into global bond funds which usually do not have too substantial exposure in bonds issued in the US. Typically, global bond funds would have over 80% of their holdings invested in investment-grade bonds to minimise default risks. Table 2 shows the yield of the sovereign bonds of the major economies. </p><p class="style7" align="justify"><strong><br/>Table 2 : Yields of Sovereign Bonds </strong></p><div align="justify"><table bordercolor="#000000" cellspacing="0" cellpadding="0" border="1"><tbody><tr bgcolor="#9900ff"><td valign="bottom" width="157"><p class="style15" align="center">Sovereign Bonds </p></td><td valign="bottom" width="192"><p class="style15" align="center">Yield (as of 13 Sept 2007) </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style13">US Treasuries 2yr </p></td><td width="192"><p class="style7" align="center">3.974% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>US Treasuries 10yr </strong></p></td><td width="192"><p class="style7" align="center">4.418% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>US Treasuries 30yr </strong></p></td><td width="192"><p class="style7" align="center">4.691% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>Canada 10yr </strong></p></td><td width="192"><p class="style7" align="center">4.327% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>UK 10yr </strong></p></td><td width="192"><p class="style7" align="center">4.896% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>German 10yr </strong></p></td><td width="192"><p class="style7" align="center">4.144% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>Japan 10yr </strong></p></td><td width="192"><p class="style7" align="center">1.514% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>Australia 10yr </strong></p></td><td width="192"><p class="style7" align="center">5.834% </p></td></tr><tr bgcolor="#9999ff"><td width="157"><p class="style7"><strong>Hong Kong 10yr </strong></p></td><td width="192"><p class="style7" align="center">4.543% </p></td></tr></tbody></table></div><p class="style7" align="justify"><br/>Source: Bloomberg </p><p class="style7" align="justify"><br/>Although the outlook of the USD vis-à-vis other major currencies is not at all bullish, investment in US treasuries could also have other benefits. During volatile times, the flight from equities to safe havens such as US treasuries, which have a high credit rating because of their perceived low risk, means that their prices are expected to rise. And with the recent market volatility linked to the US sub-prime mortgage woes, even the bond yields of the investment grade bonds have become more attractive. Indeed, the recent selling has also hit the investment-grade bonds, hence the decline in their prices. However, we do not think the selling of investment grade bonds is justified – as such, we would expect demand to resume, and their prices to rise. Furthermore, based on historical relationship between the 10-year bond yield and the Federal Funds Target rates, the 10-year bond yield often peaks when the US Federal Reserve tightening ends, as shown in Chart 2. </p><p class="style7" align="justify"><br/><strong>Chart 2: Federal Funds Target Rate and 10-year Bond Yield<br/><img src="http://www.fundsupermart.com/main/articleFiles/webarticles/2305/SG/Bond-Funds_EN_2.gif" alt=""/><br/></strong><br/>Source: Bloomberg </p><p class="style7" align="justify">Investors can benefit from the diversification factor when they invest in bond funds. This is especially clear during times when the equity markets correct. In the event that the US housing market slump worsens to the point that the US Federal Reserve cuts interest rates, bond holders would further benefit from the appreciation in the bond prices associated with the interest rate cuts. The cut in the discount rate by 50 basis points on Friday 17 August 2007 also suggests that the US Federal Reserve is prepared to be proactive about stabilising the current situation. </p><p class="style7" align="justify">Investing in a global bond fund as part of the core portfolio may help investor ride over the volatility in the equity markets. A bond fund by itself is also suitable for investors who have a more conservative approach to investing. Such investors may consider building their portfolios with global bond funds. We suggest local investors to invest in global bond funds which do not hold a substantial portion of their assets in US securities. Currency views were also taken into account when researching on our recommended funds. Investors may be interested to consider our Recommended Global Bond Funds which, namely <a href="http://www.fundsupermart.com/main/fundinfo/viewFund.svdo?sedolnumber=370006">DBS Shenton Income Fund</a>, <a href="http://www.fundsupermart.com/main/fundinfo/viewFund.svdo?sedolnumber=370016">Lion Capital Global Bond Fund</a> and <a href="http://www.fundsupermart.com/main/fundinfo/viewFund.svdo?sedolnumber=FTGLBD">Franklin Templeton Funds – Global Bond Fund</a>.<br/></p> |
|