Investing in Bonds challenges and opportunities in 2015

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1 For Financial Brokers and Advisors Only Investing in Bonds challenges and opportunities in 2015 March 2015 Andy Ivory-Corr, QFA, Grad Dip, CFP Head of Investments New Ireland Assurance

2 What exactly is a Bond? Government bond Corporate bond A bond is a loan, whereby a government or company borrows money from an investor for a defined period of time at a specified fixed interest rate. (indexed bonds slightly different) 2

3 Government and corporate Bonds are typically categorised by maturity as follows: Shorts: up to 5 years in term. Mediums: 5 to 10 years in term. Longs: 10 years plus The term of a bond is also referred to as Duration 3

4 Two key lessons: 1.Bond price and Interest rate relationship 2.Bond yield and bond price relationship 4

5 Bonds: Price/Yield relationship NB: Yield and Bond Price move in opposite directions Price Yield As a bond s price rises, its yield falls As its price falls, its yield rises Price Yield For illustrative purposes only 5 5

6 Interest rate/ bond price Relationship Interest rate Bond Price Interest rate Bond Price NB: As with yield, interest rates and Bond Prices also move in opposite directions. 6

7 The key components of Bonds we need to remember Coupon = annual fixed rate of interest set at the start of the bond. Typically paid by the bond issuer in yearly or half yearly instalments. (hence the Fact: term Called fixed coupon interest because security) pre computer days, most bonds had coupons that Par Value = The amount investors the borrower would clip repays off and to present the lender in order at the end of the life of the bond. Bonds to claim will typically their interest issue payment! at par value and mature at par value. (this is where the security applicapable to bonds gets confusing for most!) 100 Par Value Interest Interest Interest Interest Interest Par Value 7

8 What factors influence the market value of a bond? Interest Rates: How the investment you own through holding the bond compares to what s currently on offer in the market. For more information on this look up time Inflation: The potential value to erode of money the future on real value of the payments due to you. Investopedia Creditworthiness: Anything that may affect the issuer s ability to repay you, the bond holder. Availability: Basic supply and demand. 8

9 Bonds what s been happening in last few years? QE has driven down Yields. Interest rates at emergency levels. Inflation prospects unknown. High levels of Sovereign debt What does AAA mean any more? Weight of Safe haven money But the only real uncorrelated asset class to equities?! 9

10 Recent Bond headlines not very encouraging. Warnings of a potential bloodbath in bonds.financial Times Dec 14 Do bonds still make sense?.jp Morgan Jan could see the biggest sell off in bonds since 1994.Irish Times Jan 14 Gilts are resting on a bed of nitro glycerine.bill Gross Sept 14 Bond yields hit record lows across Europe.JP Morgan Jan 15 The four most dangerous words in investing are, this time it s different.sir John Templeton 10

11 11 Quantitative easing explained as a linear process!

12 Quantitative Easing QE = (Printing Money) Market Impact on Bonds has been clear! Quantitative Easing X3 in the US = Massive market support

13 QE = EPO for equities, but beware of policy driven markets! 13

14 14 QE officially begins in Europe March 2015

15 Multi Asset: Diversification of assets a better long-term solution, but you must know your exposures in this environment! Real Estate Infrastructure Cash Equity What type of Bonds? Do I know the duration of my exposure? Long only? Benchmarked? Gov or Corporate? Alternatives Bonds Government/Corporate 15

16 16 But haven t bonds been a great investment in the last year?

17 17 In fact bonds have outperformed equities over 9 years!

18 Safe haven portfolio asset clearly evident in 2008! 18

19 19. Still a safe haven in 2015?

20 20 Duration risk bared it s teeth for the first time in mid 2013!

21 Today Bond yields are at historic lows! Jan 2013 Aug 2013 Mar 2014 Oct 2014 Jun 1991 Jan 1992 Aug 1992 Mar 1993 Oct 1993 May 1994 Dec 1994 Jul 1995 Feb 1996 Sep 1996 Apr 1997 Nov 1997 Jun 1998 Jan 1999 Aug 1999 Mar 2000 Oct 2000 May 2001 Dec 2001 Jul 2002 Feb 2003 Sep 2003 Apr 2004 Nov 2004 Jun 2005 Jan 2006 Aug 2006 Mar 2007 Oct 2007 May 2008 Dec 2008 Jul 2009 Feb 2010 Sep 2010 Apr 2011 Nov 2011 Jun 2012 Irish 10 year UK 10 year Geman 10 year US 10 year Ireland: 10yr 1.20% Germany: 10yr 0.36% Source BOI Global Markets 10 th Feb 2015 US: 10yr 1.97% UK: 10yr 1.64% 21

22 Changes in 1 year explain source of 2014 returns! Yields have been compressed lower 3.5% 3.0% 2.5% 2.0% 6th Jan th Jan % 1.0% 0.5% 0.0% Ireland German UK US Warning: Past performance is not a reliable guide to future performance. Source: Davy Asset Management, Bloomberg 22

23 23 Understanding what s happening in an example might be best..

24 What s Happening with Bonds? James buys a Bond Investment date: 17 th February, 2014 Investment amount: 100,000 Term of bond: 9 years Yield at outset: 2.99% p.a. Estimated value at maturity: 130,500 24

25 What s it Worth in February 2015? James s Bond Investment date: 17 th February, 2014 Original investment amount: 100,000 Term left: 8 years Value today (17 th Feb 2015): 121,900 Return in the last 12 months: +22% Estimated value at maturity: 130,500 Yield to maturity: 0.85% p.a. 25

26 And what if bond yields were to start to rise? Source: Davy Asset Management, Bloomberg Warning: Some figures relate to simulated past performance and are estimates only. Past performance is not a reliable guide to future performance. Transaction costs, interest and taxation have not been taken into account. 26

27 Risk of death by a thousand cuts?! Volatility takes no account of the starting price of any asset! 27

28 Standard Deviation does not equal the sum of all fears! 28

29 Yield Spread = Premium investors expect for taking on additional risk. Investors will expect a higher yield from a corporate bond over a government bond due to the increased risk associated. This extra yield is known as risk premium or credit spread. An issuers ability to make both coupon (interest) payments and repayment of Par value at maturity of the bond is determined by a credit rating. Each government and corporate issuer will have a credit rating with one of the recognised rating agency s. 29

30 Lets look at an example of real life Yield Spread in action.. Yield Spread 200bps+ 30

31 Corporate versus Government yields Yield spread represents the additional return for taking corporate bond risk % Spread Gilt index Sterling corporate bond index Source: Bloomberg, Merrill Lynch, March

32 Corporate bonds the reason for additional yield! Example: an individual corporate bond Corporate bond yield Currency Issue Company Industry = Corporate bond risk Liquidity Government bond yield = Government bond risk For illustrative purposes only 32 32

33 33 Credit Rating of Bonds.

34 Investing in Bonds for 2015? Diversification, Bonds still an important asset class in portfolios. Less volatility but a different level of risk! Returns likely to be greatly reduced on previous years. Liquidity, maybe not what it used to be! Policy (QE) distorts the true value of many assets. Know what you own, know why you own it! 34

35 Thank you for your attention. Delighted to take questions

36 Warning: The value of your investment may go down as well as up. Warning: These funds may be affected by changes in currency exchange rates. Warning: Past performance is not a reliable guide to future performance. Terms and conditions apply. Where relevant life assurance tax applies. This presentation is of a general nature and should not be relied upon without taking appropriate professional advice. The content is for information purposes only and does not constitute an offer or recommendation to invest in the Funds. All opinions and estimates constitute best judgement and are subject to change. Davy is a member of the Irish Stock Exchange and the London Stock Exchange. Davy Asset Management is regulated by the Central Bank of Ireland. Kleinwort Benson Investors Dublin Ltd is regulated by the Central Bank of Ireland. BNY Mellon Global Real Return Fund is a Sub-Fund of BNY Mellon Global Funds, plc. BNY Mellon Global Funds, plc is an open-ended umbrella type investment company with variable capital (ICVC) and segregated liability between sub-funds, incorporated with limited liability under the laws of Ireland. It qualifies and is authorised in Ireland by the Central Bank of Ireland as an undertaking for collective investment in transferable securities pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations, 2003 (S.I. No 211 of 2003), as amended. The Manager of BNY Mellon Global Funds, plc is BNY Mellon Global Management Limited. BNY Mellon Global Management Limited, 33 Sir John Rogerson's Quay, Dublin 2, Ireland. The Manager is approved as a management company and regulated by the Central Bank of Ireland under the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations, 2003 (SI No 211 of 2003), as amended. The Global (ex. US) Distributor of BNY Mellon Global Funds, plc is BNY Mellon Asset Management International Limited. BNY Mellon Asset Management International Limited, BNY Mellon Global Management Limited (BNY MGM), Newton and any other BNY Mellon entity mentioned are all ultimately owned by The Bank of New York Mellon Corporation. State Street Global Advisors Ireland Limited is regulated by the Central Bank of Ireland. Incorporated and registered in Ireland at 2 Park Place, Upper Hatch Street, Dublin 2. Registered number Member of the Irish Association of Investment Managers. New Ireland Assurance Company plc is regulated by the Central Bank of Ireland and a member of Bank of Ireland Group. CPD:1.5 hrs

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