The Business Of Bonding
About ten years ago, my editors dubbed me the Bond girl... for all the wrong reasons.
It was my coverage of debt capital markets that earned the nickname. Since then, I've had an affection for fixed income markets. Yes, bonds are rather dull and poorly understood but they are frankly one of the most important things you need to know about, in order to make sound financial decisions.
Asia is still a very short-term, equities-driven investing culture. But you would do well to grasp the magic of bonds. They ought to form not only a crucial part of your financial portfolio, but also factor into many financial decisions -- from when to dip your toe into the property market, to when to jump out of the equity market. Bonds help smarten up your portfolio -- and make you a smarter investor.
Bonds Can Help Steady Your Financial Ship
Before we go further, let's make the distinction between a government bond and a corporate bond.
A government bond is issued by a national government denominated in the country's own currency. Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity. An example of a government bond is the U.S. 10-year Treasury note.
Corporate bonds are issued by a corporation -– Ford Motor is a good example. These bonds are often listed on major stock exchanges and interest payments are usually taxable. Compared to government bonds, corporate bonds have a higher risk of default.
Bonds though are traditionally less volatile than stocks, which mean they offer more stable returns in relatively unstable times. That also means you pay a price for that stability -- bonds traditionally underperform stocks in the long term. That's one reason why individual investors generally forget or ignore bond investing. It's tough to settle for small payouts when you're seeing eye-popping returns in the stock market. But bonds are critical to helping smooth out the volatility that comes with equity investing.
Bond mutual funds offer the best way to get into the market. All the big mutual fund companies -- Fidelity, Vanguard, Oppenheimer -- offer a large variety of bond funds you can invest in for a few thousand U.S. dollars. There are also exchange-traded bond funds that trade like stocks, which I'll tell you about a little later.
The general rule of the thumb is that when you're young, say in your 20s and 30s, you can be a bit daring with risk and thus, your financial portfolio should generally hold about 15% to 20% in bonds. If you are pushing 60, you would want to up the bond ante by making it 60% to 70% of your portfolio. You may not earn astronomical returns, but you get the peace of mind that your financial portfolio is more protected against the peaks and valleys of the stock market.
Bonds Can Help You Peer Into The Economic Crystal Ball
Ever wonder what the Federal Reserve may do with interest rates or whether investors expect a recession coming up? The bond markets offer distinct and often accurate clues.
Now this works mostly in large, developed bond markets rather than in Asia, where fixed-income markets are still quite small. But you will still do well to know where, say, the U.S. economy is headed because so much of what happens there affects your pocketbook here. One very effective indicator of what investors think the Fed will do at a certain point -- say December 2007 -- is to check out where the three-month eurodollar futures are trading for that month.
If you see a spike in that eurodollar rate, pay attention, it may be a bad time to start piling on risky stock investments or to plunge your savings into a high-priced condo. Traditionally when rates go up, stocks fall, mortgage rates rise and property prices decline.
Another indicator is to check out bond yield curves to see if investors expect the economy to grow or slip into recession. Last year, we heard much about how the Treasury yield curve "inverted." Treasury yield curves typically slope upwards, in line with expectations for a stable, growing economy.
In simplest terms, an inversion means investors may expect a recession in the U.S. economy, or at least a significant slowdown. Since the inversion occurred, a U.S. recession has not yet emerged, which means nobody should double down on a recession bet. But it certainly signals caution on the investment front.
Bonds Can Help You Make Better Stock Investment Decisions
When you evaluate a company's fundamentals, don't forget to check out its bond ratings. The higher a company's bond rating, the stronger it is financially. Basically a rating evaluates how likely a company is going to pay back the investor. An investment grade rating usually signals a company is financially sound, which means it's also likely a good investment. Of course there are a litany of other factors to consider when buying into a stock, but don't forget to check out the bond rating. The two major agencies who rate these bonds are Standard & Poor's and Moody's Investors Service. Check them out. They offer you the ability to search for ratings on thousands of companies.
Lastly on the bond front, let me tell you about something unique in Hong Kong. The city is home to two bond ETFs that trade on the Hong Kong stock exchange. One gives exposure to the Hong Kong dollar bond market and the other gives exposure to eight Asian countries. Bond ETFs are basically mutual funds that trade like stocks so you can buy and sell them the way you do for shares. They offer an easy, painless way to get into the bond market. These bond ETFs were launched as part the Asian Bond Fund 2 Initiative and you can read all about them on their site.
That may get you started on some happy bond investing!
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