Making money on bonds
Our weekly articles have generally been aimed at informing the wider public about different investment products that exist in the market place. The wide array of investment structures and characteristics means that you can find something tailored specifically to your needs. However, today we go a step further to discuss investment strategy -- in other words, how we can use these products to make money.
The traditional and conservative way to make money on bonds (and just about every other financial instrument) is to buy and hold. This means, you could purchase bonds with very attractive interest rates or yields and hold them until they mature. This way you enjoy a fixed stream of income at specific intervals.
Another way of investing in bonds is by employing an investment strategy called "laddering". This is where a series of bonds is bought with different interest rates and maturity dates. A rung on the "ladder" represents an individual bond in the series and the distance of one rung from the next is represented by the duration or tenure of each bond. The objective is to structure the bond maturity dates (or "rungs") to coincide with your need for cash or other investments. This strategy is popular among large institutions as well as high net worth individuals who need to maximise the use of their medium term funds.
Investors can also make money from bonds through active portfolio management. Here the investor's primary objective is that of capital appreciation, i.e. buy at a discount and sell at a premium. He also enjoys income during the period within which he holds the bonds. Timing is literally everything as the investor does not want to sell his bonds too quickly when further upside is likely to occur; neither does he want to hold the bonds for so long as to wipe out any appreciation he may have been able to realise previously. An analytical eye must be kept on the interest rate and macro economic environment at all times.
Regardless of the strategy, a sound understanding of the credit quality, liquidity and financial soundness of the issuer of the bonds must be garnered by the investor.
Practical examples of successful investment strategies
Recently, a number of issues have come onto the market which have presented good opportunities to take advantage of capital accumulation. The bonds we refer to are convertible bonds, popularly known as "cocos" because of their convertible feature. Minimum investment in these bonds are usually very high, some as high as US$200,000.
Recent examples of successful purchases in these types of bonds include the Barclays Bank Sepember bond issue, which price appreciated by 14.9 per cent in little over five months, and the Creidt Agricole October bond issue, which price moved by 11.25 per cent up to the end of Febraury.
Underlying all these purchases was a sound understanding of the entities' financial soundness and systemic importance.
It must be noted that the current state of the global economic climate presents great opportunities for capital appreciation on investments, particularly bonds, as the global economies show signs of improvement. This appears to be the reason that bonds generally are on the upswing and it is up to investors to take advantage of these opportunities.
Pamela Lewis is Vice President, Investments and Client Services at Sterling Asset Management Ltd. Sterling provides financial and advisory services to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, please e-mail us at: email@example.com or visit our website at www.sterling.com.jm