Some time ago, in 2011, I wrote a piece bringing to the attention of investors the fact that the low interest rate environment globally is here to stay. At that time the maturity of the GOJ bond on May 15th, 2011 was imminent, and I remember cautioning investors, in that article, that they will have to become accustomed to accepting lower interest rates on newer purchases of bonds to replace the maturing GOJ 11.75 per cent bond.

Well, that was four years ago, and the situation remains the same. Incidentally, the GOJ 9.0 per cent bond matures on June 2, 2015 (just a few short months from today). It’s déjà vu all over again.

Added to this is the fact that the Bank of Jamaica has just announced a reduction in benchmark interest rates. Again investors will be hard-pressed to find bonds with similar returns as the maturing GOJ 9.0 per cent 2015. This is what is known as reinvestment risk. Of note too, is the fact that last year, 2014, the Jamaican government went to market with a 7.625% per cent 2025 bond. Although the coupon rate was below those of the previously issued bonds, the bond unexpectedly performed creditably, rising to 113 from the initial offer price of 100.

We await the announcement of the coupon rate and the offer price of any new issue from the government, which to its credit, appears to have set the pace by reducing interest rates just before any further offering.

The Jamaican investor should not feel out of place, as globally investors have had to be accepting much lower yields on their investments, especially those investments of similar credit quality as the GOJ bonds.

First of all, AAA securities are all but extinct, let alone low-yielding. Secondly, most investment grade bonds, ie bonds rated BBB- and higher, are yielding in the region of 2.0 per cent to 4.0 per cent. To make matters worse, many of the previously rated investment grade bonds have seen their rating reduced to double-B status.

Investors, however, should not despair. When bond ratings decline, there is usually a corresponding decline in price (and an increase in yield to compensate for the higher risk). This is one way for investors to earn more, by buying bonds when the price falls. Of course, it goes without saying that one needs to ensure that such bonds are strong fundamentally, and that they are not buying only because the price is down.

In addition, when interest rates decline, the tendency is for a greater demand for instruments such as bonds, and this has the effect of pushing up prices. Investors therefore need to take advantage of any low prices in the bond market in order to get the uptick when the prices start to rise.

In some situations, bonds are the preferred way to go, when trying to decide between bonds and repos. Only companies and individuals who have a short-term time horizon, such as one to two years, should be looking at repos. Investors who buy bonds will lock in their returns at a particular price while having the prospects of capital gains when the price moves higher.

There are many investments in the market which will allow investors to improve their returns. In the past we have emphasised the focus on credit quality, but promoted the investigation of instruments with slightly different structures to enhance returns. Call options, floating interest rates and step-up bonds are a few examples of these structures.

Dreary repos

In order to earn more investors need to look at investing a little differently. This includes moving away from the dreary repos. Look again at the following comparison of the interest one would earn on a repo as against the interest realisable on a bond. For ease of comparison, the interest calculated is for a 180-day period for all the investments (based on a 365-day). No withholding tax was deducted.

180-day Repo

paying 4.00% pa Bond

paying 6.00% pa Bond

paying 7.00% pa

US$50,000

986.30

1,479.45

1,726.03

US$100,000

1,972.60

2,958.90

3,452.06

Getting higher rates involves taking on more risks. Unlike what most investors sometimes think, risk is not necessarily a bad thing. Many investors have realised considerable profits by taking risks.

All risks are not the same, although with all investment instruments there is some level of credit risk, ie the likelihood that the issuer will default. It is important for investors to preserve the credit quality of their investments, critical to which are the financial health of the entity and its strategic position. Liquidity risk is also important to the investor as it is clearly essential that investors are able to econvert their investments into cash.

The above makes it clear that investors can earn more in a low interest rate environment, but they need to be vigilant and also seek out strong, fundamentally sound investments.

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, e-mail us at: info@sterlingasset.net.jm or visit our website at www.sterling.com.jm

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The Bank of Jamaica in downtown Kingston

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