Bond prices are rising, what does this mean?

REPORT

BONDS, like many other asset classes, have recovered from their novel coronavirus pandemic-induced sell-off in March 2020 and prices should continue to rise since the US central bank plans to keep its policy rate near zero until at least 2023 even as the economy improves.

Higher bond prices, however, mean lower yields on new bond investments. As bond prices rise, yields, which move in the opposite direction, fall. This, however, does not translate into lower returns for bond investors. In fact, quite the opposite.

An investor, for instance, that bought a 10-year bond with a coupon of 8 per cent at a price of $100 and sells it at a price of $112 one year later would have made a return of 20 per cent (coupon of 8 per cent plus capital gains of 12 per cent) on his bond investment.

The capital gain was made possible by falling interest rates which boosted the price of the bond by the time the investor decided to sell. If interest rates were higher in the market at the time of sale, the investor would have suffered a capital loss instead and his or her overall return would have been less than the 8 per cent coupon being offered by the bond. Investors who buy bonds for the prospect of capital gains prefer this kind of environment where market yields are falling and bond prices are rising, but for investors who primarily rely on bonds for income (periodic coupon payments) maybe not so much. Income investors worry about lower coupons on new bond issues and the likelihood of early redemption of relatively “high” coupon older bonds as issuers seek to refinance them at lower costs.

Investors are also constantly being challenged by the decision of what to buy and falling yields make that task harder for bond investors.

An investor may have to extend duration and or buy lower credit quality bonds to improve yield and or obtain a certain level of income.

However, since all bonds are not created equal, a bond investor could outsource the bond selection hassle to a professional fund manager and simply buy into a mutual fund. Apparently, one of the best kept secrets in the market is a bond mutual fund that has produced, on average, double-digit returns since its inception. So, speak with your investment adviser and see if you can gain access to this investment.

If you own bonds and plan to sell them before maturity, now may be a good time to do so while bond prices remain elevated, bearing also in mind that prices will eventually move to par (price of $100.00) as the bond approaches it maturity date.

In parting, here are some useful investment tips for the new year that I recently came across:

(1) Revisit your financial goals for 2021 and beyond, including a review of your budget. Priorities could include replenishing your emergency fund, taking advantage of retirement accounts, paying down debt and/ or increasing savings toward a financial goal.

(2) Review your diversification to help ensure your portfolio is well-positioned to navigate and take advantage of sector rotation as economies recover.

(3) Set appropriate expectations for your portfolio.

(4) Keep your investment performance expectations realistic and your portfolio decisions aligned to your long-term goals to help stay on track as you progress through 2021 and beyond.

Eugene Stanley is the VP, Fixed Income & Foreign Exchange at Sterling Asset Management. Sterling provides