Bonds – Again : )

I can’t recall if I had referred to Bill Gross before. I fruitlessly searched for biographies on him through the National Library Board (NLB) online catalogue. But I did get something on Forbes.

In any case, here is another writeup on bonds. Be prepared – it is a mash up.

Bonds are not always safe. Particularly unsafe are those junk bonds and those government treasuries with a history of defaults (i.e. not paying up.) Just last week, I spoke to someone in the industry and she mentioned some corporates (companies) similarly fail to pay their coupons; I inferred this was not necessarily because they were insolvent. Some investors in another instance took a haircut of nearly 50% (I think on the original capital) when their investment turned bad. Finally there was the “Lehman Brothers Minibond saga” in Singapore, 2008 (see NLB’s Singapore Infopedia for more details).

Added to this was the recent reading of Simon A Lack’s Bonds are not forever : the crisis facing fixed income investors. (2013). Hoboken, New Jersey.  John Wiley & Sons, Inc. You can see some author information here at The Wall Street Journal review of his earlier book on hedge funds. He is described on the CFA Institute site as below (The extract is broadly convergent with the description at the back flap of his book on bonds):

the founder of SL Advisors. Previously, he held several positions at J.P. Morgan, working in North American fixed-income derivatives and forward foreign exchange trading, a business he ran through several bank mergers. Mr. Lack also sat on J.P. Morgan’s investment committee and founded the J.P. Morgan Incubator Fund. He serves on the board of trustees of the Wardlaw-Hartridge School, where he chairs the investment committee. Mr. Lack also chairs the Memorial Endowment Trust Investment Committee of St. Paul’s Episcopal Church in Westfield, New Jersey.

Back to the topic at hand, his main persuasion is to induce the exit from bonds. On p. 122, he cited the traditional reasons for government bonds were public works or war. He argues that the reasons in the US today are different. In one example, the 2004 Medicare Prescription Drug Benefit law effectively makes the younger generation pay for current bills. We can cross reference this to p. 116 where already each US citizen is saddled, according to his calculation, with US$75,000 of debt.

From a political economy perspective (the chapter was entitled ‘Politics’), there is vested interest (no pun intended) to keep the central bank interest rates low. It is cheaper to borrow money since the government bond coupons are cheaper to repay. (p. 191 records that China holds US$ 1.2 trillion of US government debt.) This evidently is negative news for bond owners who hope to profit from interest payments, especially when inflation exceeds the investment return. (The situation is the same for corporate bonds with floating rates.) Further, heightened interest rates in the prevailing political climate appears suicidal for the ruling political party/Presidency. Taking the lead from the central bank rate, they can exact greater payment from their borrowers. Thus, no one desires to be observed as ‘…helping banks or wealthy savers…’ (p. 132)

The conclusion? I am mostly likely to stay off bonds not only due to the above, but that after visiting the below references, bonds hardly seem the most straightforward investment instrument.

References:

For a greater overview, you may want to visit the US Securities and Exchange Commission, Office of Investor Education and Advocacy or MoneySENSE by the Monetary Authority of Singapore.

[In this discourse, higher interest rates would be a bad omen for investors who want to sell their bonds.] Mike Patton. (30 Aug 2013). Why Rising Interest Rates Are Bad For Bonds And What You Can Do About It.  http://www.forbes.com/sites/mikepatton/2013/08/30/why-rising-interest-rates-are-bad-for-bonds-and-what-you-can-do-about-it/#6597435c2c7a. Forbes Advisor Network.

Investopedia. How do central banks impact interest rates in the economy? http://www.investopedia.com/ask/answers/031115/how-do-central-banks-impact-interest-rates-economy.asp.

Bank of England. How does monetary policy work? http://www.bankofengland.co.uk/monetarypolicy/pages/how.aspx.

[‘The rate at which the issuer pays you – the bond’s stated interest rate or coupon rate – is generally fixed at issuance.’] Wells Fargo Asset Management. (2016). Relationship between bonds & Interest Rates. https://www.wellsfargofunds.com/wfweb/wf/education/choosing/bonds/rates.jsp.

[‘When rates rise, lenders try to raise the amount they charge for loans faster than what they pay on deposits.’] Dakin Campbell. (16 Nov 2013). Banks Want Higher Interest Rates. http://www.bloomberg.com/news/articles/2013-11-14/2014-outlook-banks-want-higher-interest-rates. Bloomberg Business.

[Two other ways contribute to higher indirect bank earnings when interest rates rise. One when the banks invests in short term notes while paying the same . The other is ‘…economic growth is strong and bond yields are rising. In these conditions, consumer and business demands for loans spike, which also augments earnings for banks.’] Investopedia. How do interest rate changes affect the profitability of the banking sector? http://www.investopedia.com/ask/answers/041015/how-do-interest-rate-changes-affect-profitability-banking-sector.asp.

[‘…floating-rate bonds that have fluctuating interest rates tied to money markets, the London Interbank Offered Rate (LIBOR) or U.S. Treasury bonds. These tend to have lower yields than fixed-rate securities of comparable maturities but also less fluctuation in principal value. ‘] PIMCO Asia Pte Ltd. (Mar 2012). What Are Corporate Bonds and What Benefits Do They Offer? http://www.pimco.com.sg/EN/Education/Pages/CorporateBonds.aspx.

Linette Lim. (30 Oct 2015). Sing-dollar corporate bond market faces rare default. http://www.channelnewsasia.com/news/business/singapore/sing-dollar-corporate/2228564.html. Channel Newsasia.

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