Bond prices falling

[TheMotorcycleBoy]

Hi all,
I've been looking at some random bonds and have noticed that quite a few seem to be falling in price, with an odd one or two being below par. What's your view on this - would it be a bad time to be buying now, or would it be good to buy them lower as the yields will be higher and we'd get more bonds for our money?

Also, I came across this this morning:

http://citywire.co.uk/money/is-this-the ... s/a1087310

I found this last bit interesting........would you agree that this is fair advice to go by for newbies? - would this be for retail bonds or is it likely to mean just Government bonds/gilts? -

The flipside of falling prices is that yields will rise; once the 10-year US treasury yield reaches 3% it will represent an important milestone, Iggo says. This is because it represents a yield level that is likely to attract investors back into the asset class. Notably, this would include institutional investors, such as pension funds.

‘If we get to 3% in US treasuries and close to 1% in [German] bunds, it's probably time to buy,' he said.


Mel

[tjh290633]

You might like to read https://realinvestmentadvice.com/the-mi ... k-freeier/ on the subject of whether US Treasuries are risk free.

TJH

[TheMotorcycleBoy]

What we are also wondering is, if some bond prices are currently falling, would it actually be wise to wait till after May before purchase, since any interest rate announcement (e.g. a 0.25% or 0.5% hike) is most likely to push their price further down?

In other words, if we are considering investment in GB corporate bonds, we will probably 1) be able to purchase more units 2) get a higher yield if we wait till after the May announcement. Sound about right?

Of course, we are after opinions here.....not financial advice

thanks Matt

[GoSeigen]

You might like to read https://realinvestmentadvice.com/the-mi ... k-freeier/ on the subject of whether US Treasuries are risk free.

TJH

Really TJH? Now you're scraping the barrel! How about this for pseudo-scientific nonsense:

Back to the solar system. If we told you that, over the last few years, Mercury was tracking progressively closer to the sun, you would likely assume the orbit of Mercury is changing. Although inconceivable based on current scientific knowledge, what if it was determined that Mercury’s orbit was unchanged and the altered distance was due to the re-positioning of the sun?

Actually no, I'd "assume" [r. conclude or infer] that you don't know what an orbit is and question the strength of the logic and understanding in your entire article!


TJH, perhaps you could explain in your own words the reasoning behind your rejection of fixed interest securities for at least the ten years or so we have discussed them.


Matt,

What we are also wondering is, if some bond prices are currently falling, would it actually be wise to wait till after May before purchase, since any interest rate announcement (e.g. a 0.25% or 0.5% hike) is most likely to push their price further down?

The usual response to this sort of comment is: if you are so confident of what will happen in May and the market's response, then you might as well just make a huge one-way bet on it and get wealthy!

Here are two problems with trying to predict little things like what the Fed will do in May:
1. long-dated or perpetual securities are a claim on a long stream of cashflows. Small events which occur from month to month are unlikely to have as much effect on the many future cashflows as all the other events which are also likely to happen.
2. short-dated bonds are of course a claim on only a few cashflows, but the value of those cashflows is relatively certain and events in May will have minor effects on the yield of those short-dated securities.

IOW it's hard to win here on either short- or long-dated securities. Rather than focus on the myriad short term events, it is better use of time to think about asset allocation, risk management and value.


Unless, as I said, you have a particularly accurate crystal ball, in which case go ahead and bet the bank!


GS

[Bink333]

The problem with waiting until May is that the prices might continue to fall in anticipation of the next interest rate hike.

The problem with the rate of return increasing (because prices are falling) is that it isn't in real terms, those real terms being in line with inflation or indeed central bank base rates.

The medium to long term outlook for this gilted asset class seems to be that there's increasing risk to capital for diminishing real returns. Alternative low risk asset classes should be considered.

AS ever DYOR

[colin]

n other words, if we are considering investment in GB corporate bonds, we will probably 1) be able to purchase more units 2) get a higher yield if we wait till after the May announcement. Sound about right?

Melanie/Matt
It depends on who are the big purchasers are of the bonds you are thinking of buying but one can assume that big players like pension funds investment banks and investment funds will try to 'price in' BofE interest changes before they actually happen, the big money does not wait until announcements are made ,those who control this money look at general indicators from economic data and also forward guidance and comments from the Bank of England as well as data that shows the economic activity in the rest of the world. If they believe that the economic cycle is trending upward then they will sell bonds that may be due to mature many years into the future because they believe such bonds will not protect their money from future inflation and that better returns over the foreseeable future will come from equities.
Whether or not individual 'retail' bonds marketed at small investors are priced in the same way I have no idea. I would hope so !
Generally speaking investing in low risk bonds is something one does to offset some of the risks of equity investing and how the two assets work together is a whole other discussion, if you want to make a few more percent than you would get from a competitive savings account then you need take some risk with your bonds, which either means buying long duration but higher rated bonds to get a higher interest rate but at the risk that capital value will fall as the economic cycle improves, or buying higher yield short duration but lower rated bonds to get a higher yield but at the risk that economic conditions will deteriorate.
Generally the advice with bonds is match the duration to your holding period. If you only intend to hold for a few years then the safer bonds are just not worth buying you may as well put your money in the bank, if you want to take more risk to make higher returns on short duration bonds you absolutely should buy a diversified fund either managed or a high yield index tracker, high yield bonds are nearly always short duration . But then there is the changing yield spread over Gilts effect as the economic cycle rolls on or changes direction, ( Google it)
Don't build an investment strategy based on predicting future changes in interest rates because the wider market will have already done so well ahead of you and priced in whatever conclusion the economic data indicates, rather come to understand the nature of the risk you are buying and ask yourself what are the potential rewards for taking on that risk, is it worth it to you, within the context of your entire portfolio and financial requirements.
It's essential to look at the big picture and your place within it.
Certainly don't just buy stuff just because other people on boards like this think it's a good idea.

[colin]

tjh290633

you might like to read https://www.express.co.uk/life-style/science-technology/437733/The-end-of-the-world-IS-nigh-Huge-asteroid-will-hit-earth-in-2032-claim-astronomers on the subject if anything is risk free!

[Alaric]

Whether or not individual 'retail' bonds marketed at small investors are priced in the same way I have no idea. I would hope so !

I would expect that institutional investors have major holdings in such bonds. The "retail" label is only the concession that they are available in smaller units. Unlike shares where at a dealing cost you can buy just one, bonds may be issued as a minimum size of £ 10,000 or much larger.

[TheMotorcycleBoy]

The usual response to this sort of comment is: if you are so confident of what will happen in May and the market's response, then you might as well just make a huge one-way bet on it and get wealthy!

Here are two problems with trying to predict little things like what the Fed will do in May:
1. long-dated or perpetual securities are a claim on a long stream of cashflows. Small events which occur from month to month are unlikely to have as much effect on the many future cashflows as all the other events which are also likely to happen.
2. short-dated bonds are of course a claim on only a few cashflows, but the value of those cashflows is relatively certain and events in May will have minor effects on the yield of those short-dated securities.

IOW it's hard to win here on either short- or long-dated securities. Rather than focus on the myriad short term events, it is better use of time to think about asset allocation, risk management and value.

Thanks GS, just the answer we were looking for.

Unless, as I said, you have a particularly accurate crystal ball
GS

Don't be silly! Were that the case, we'd not be here....we'd be enjoying the morning at our Lake District estate, bought on the proceeds of a massive lottery win a couple of decades back.

Matt

[TheMotorcycleBoy]

It depends on who are the big purchasers are of the bonds you are thinking of buying but one can assume that big players like pension funds investment banks and investment funds will try to 'price in' BofE interest changes before they actually happen, the big money does not wait until announcements are made ,those who control this money look at general indicators from economic data and also forward guidance and comments from the Bank of England as well as data that shows the economic activity in the rest of the world. If they believe that the economic cycle is trending upward then they will sell bonds that may be due to mature many years into the future because they believe such bonds will not protect their money from future inflation and that better returns over the foreseeable future will come from equities.

Thanks Colin! Like what GS said earlier, this is sound thinking. A very good point and one which I will bank!.

Generally the advice with bonds is match the duration to your holding period. If you only intend to hold for a few years then the safer bonds are just not worth buying you may as well put your money in the bank, if you want to take more risk to make higher returns on short duration bonds you absolutely should buy a diversified fund either managed or a high yield index tracker, high yield bonds are nearly always short duration . But then there is the changing yield spread over Gilts effect as the economic cycle rolls on or changes direction, ( Google it)

Yes. I recently read about "duration" in my Mark Glowrey book. I'd better refresh myself on that. Me and Mel are trying to learn so much so fast, we both forget recently learned terminology.....if it's not applied quickly in anger!

Don't build an investment strategy based on predicting future changes in interest rates because the wider market will have already done so well ahead of you and priced in whatever conclusion the economic data indicates, rather come to understand the nature of the risk you are buying and ask yourself what are the potential rewards for taking on that risk, is it worth it to you, within the context of your entire portfolio and financial requirements.
It's essential to look at the big picture and your place within it.
Certainly don't just buy stuff just because other people on boards like this think it's a good idea.

More good points, thanks again.

Matt

[hiriskpaul]

Last time the BoE put rates up many corporate bond prices went up!

Bond investors know all about expected changes in base rates and factor these into current bond prices.

Right now I am far more concerned about the low credit spreads on investment grade corporates than I am about base rate rises. We are not quite back to the lows of 2007, but not far off and at some point the market will revert to more prudent pricing of risk. As to when it will happen I have no idea, but I suspect it will be around the same time as the next stock market crash.

[TheMotorcycleBoy]

Thanks Paul

the low credit spreads on investment grade corporates

Forgive me, but me and the wife at newbies at this. What do you mean by low credit spreads, here please?

will revert to more prudent pricing of risk

And by that? Lower bonds prices?

Matt

[hiriskpaul]

A number of factors feed into bond pricing such as maturity date, the risk free yield curve, liquidity, bond specific features, such as seniority, put/call options, and finally perceived credit worthiness. Credit spread is a measure of the extra premium above the risk free rate that is associated with the credit worthiness of the issuer. Typically on a 10 year bond you might expect a yield of around 2% above the equivalent gilt yield. So if 10 year gilts are yielding 4%, a reasonably liquid 10 year investment grade corporate, with no special price distorting features, might yield 6%. However, credit spreads can vary a lot over time. In 2007 they were below 1%, during the financial crisis they went over 5%. Now they are around 1.2%.

The world is awash with cash at present, partially due to measures by central banks, but there are a finite number of liquid investments (mainly government bonds, corporate bonds and listed shares) available, so demand has pushed up prices. Many large investors are not particularly enthusiastic either, more a case of "I have to do something with this money and this looks like the least worst option". Large investors such as pension funds cannot simply leave money in banks because that makes them unsecured creditors to banks and banks don't want the money anyway, so only offer next to nothing in return. In 2007 this all ended with huge demand for government bonds and significant mark downs in prices of corporate bonds and shares. Hard to see how the present situation can end the same way as there is already large demand for government bonds, but at some point it will end. Corporate bond spreads will widen and prices will fall, along with share prices.

You can mitigate the risks of widening spreads and/or rising gilt yields to some extent, by shortening duration. The downside with that approach is a reduction in expected return. Nor will short dated bonds give spectacular returns even if we get something as dramatic as the financial crisis again.

[Alaric]

What do you mean by low credit spreads, here please?

Anglian Water, to use your earlier example, have to pay more to borrow money than the UK government. Credit spread is the name given to the difference. When the credit spread is low, the difference is smaller than on average.

The supply of all bonds is finite, so prices and thus yields can be affected by the amount of cash looking for investment in Bonds.

[tjh290633]

Really TJH? Now you're scraping the barrel! How about this for pseudo-scientific nonsense:

Back to the solar system. If we told you that, over the last few years, Mercury was tracking progressively closer to the sun, you would likely assume the orbit of Mercury is changing. Although inconceivable based on current scientific knowledge, what if it was determined that Mercury’s orbit was unchanged and the altered distance was due to the re-positioning of the sun?

Actually no, I'd "assume" [r. conclude or infer] that you don't know what an orbit is and question the strength of the logic and understanding in your entire article!

Orbits do not come into it. Of course it is pseudo-scientific, because it is part of debunking pseudo-scientific theories on the behaviour of fixed interest securiteies.

TJH, perhaps you could explain in your own words the reasoning behind your rejection of fixed interest securities for at least the ten years or so we have discussed them.

The reason why I reject fixed-interest securities is simply because the income from them is fixed.

I prefer a growing income. Yes, the income from equities can and does fluctuate, but there are a good few ITs which have increased their dividend for a long time now.

TJH

[tjh290633]

tjh290633

you might like to read https://www.express.co.uk/life-style/science-technology/437733/The-end-of-the-world-IS-nigh-Huge-asteroid-will-hit-earth-in-2032-claim-astronomers on the subject if anything is risk free!

I see that the probability of it missing the earth is:

Nasa tonight appealed for calm.

The space agency said the threat of the asteroid hitting earth was only one in 63,000 and the likelihood of it missing earth is 99.9984 per cent.

Don Yeomans, manager of Nasa’s Near-Earth Object Programme Office at the Jet Propulsion Laboratory in California, said: "To put it another way, that puts the current probability of no impact in 2032 at about 99.998 per cent.

"This is a relatively new discovery. With more observations, I fully expect we will be able to significantly reduce, or rule out entirely, any impact probability for the foreseeable future."

I shall be 99 if I live that long, so I'm not unduly worried. Remember Peak Oil, and the prophesy that we would run out sometime in the 1990s?

TJH

[colin]

Melanie/Matt
the way I manage the sort of market timing risk that seems to concern you Is that I hold and have held in the past multiple asset classes , equities, govt bonds high yield bonds cash etc, when a risky volatile asset rises in price above a certain level I sell some of it and feed the money into what i hope will be a lower volatility lower return asset, when the price of the risky asset falls I feed some money back into that asset from my pool of 'safer' investments. So far this has worked more often than not and the risks of market timing are much reduced.
If you are intending to buy a bond fund only you would achieve the same effect by making new purchases every time the capital value of your fund fell and selling some of your fund when the capital value rises. Do this over your lifetime and short term market movements become relevant.
This is why I personally would not buy retail bonds because I have no way to adequately manage the market risk or the specific risk that comes with buying bonds of individual companies. I do hold some preference shares though and the recent shenanigans are a case in point, when a diversified fund of high yield bonds falls 20% I know that is due to widespread 'market' risk and that i need to feed cash into that asset class,in time the asset class will recover and all will come good, when an individual investment falls 20% the success or failure of one's response is largely a matter of luck.

[GoSeigen]

TJH, perhaps you could explain in your own words the reasoning behind your rejection of fixed interest securities for at least the ten years or so we have discussed them.

The reason why I reject fixed-interest securities is simply because the income from them is fixed.

I prefer a growing income. Yes, the income from equities can and does fluctuate, but there are a good few ITs which have increased their dividend for a long time now.

TJH

Thanks TJH, that is very clear and simple.


GS

[TheMotorcycleBoy]

Thanks Paul

A number of factors feed into bond pricing such as maturity date, the risk free yield curve,...

When you say "yield curve" you mean the plot of yield against bond maturity, correct? And so when say "risk free yield curve", you mean the same excepting that the sample set of bonds are government ones (treasury bonds, gilts etc.)?

Credit spread is a measure of the extra premium above the risk free rate that is associated with the credit worthiness of the issuer. Typically on a 10 year bond you might expect a yield of around 2% above the equivalent gilt yield. So if 10 year gilts are yielding 4%, a reasonably liquid 10 year investment grade corporate, with no special price distorting features, might yield 6%. However, credit spreads can vary a lot over time. In 2007 they were below 1%, during the financial crisis they went over 5%. Now they are around 1.2%.

Yup, understood now.

The world is awash with cash at present, partially due to measures by central banks, but there are a finite number of liquid investments (mainly government bonds, corporate bonds and listed shares) available, so demand has pushed up prices. Many large investors are not particularly enthusiastic either, more a case of "I have to do something with this money and this looks like the least worst option". Large investors such as pension funds cannot simply leave money in banks because that makes them unsecured creditors to banks and banks don't want the money anyway, so only offer next to nothing in return. In 2007 this all ended with huge demand for government bonds and significant mark downs in prices of corporate bonds and shares.

What I remember of the 2007/2008 crisis (subprime crisis) was a reversal of the above scenarios. Banks were out of cash. Indeed people started running on them (Northern Rock etc.) Banks were nervous about lending to each other. So post-QE we have so much cash, that's why Banks give me zero incentive (i.e. savers rates) to save with them?

Hard to see how the present situation can end the same way as there is already large demand for government bonds, but at some point it will end. Corporate bond spreads will widen and prices will fall, along with share prices.

You can mitigate the risks of widening spreads and/or rising gilt yields to some extent, by shortening duration.

Forgive my naivety but surely if gilt yields rise, then the spread to gilts narrows? I.e. corporate bond yields are not as advantageous as they were previously upon gilt yields.[/quote]

Matt

[TheMotorcycleBoy]

In this thread, one or two posters have mentioned the term duration. I am vaguely familiar with what it means.....I think it indicates "how long it will take to make your original investment back" (correct me if I'm wrong). However, on reading some bumpf about the term on the internet, I'm somewhat confused by one of the definitions I found.

On this site: https://www.thestreet.com/topic/46361/duration.html it says:

Duration measures the time it takes to recover half the present value of all future cash flows from the bond. The discount rate for calculating the present value of the cash flows is the bond's yield. So as a bond's price and yield change, so does its duration.

For example, a bond with 10 years till maturity and a 7% coupon trading at par to yield 7% has a duration of 7.355 years. At a yield of 6% (price 107 14/32), its duration is 7.461 years. At a yield of 8% (price 93 7/32), its duration is 7.246 years.

I tried to apply some maths, and couldn't quite apply the results to the above. I firstly assumed a fixed yield of 7% and sited the stated duration of 7.355 years. I then multiplied those two figures to see that in that time:

7 * 7.355 = 51.49

(i.e. ~51 units due to cash flows)

But surely if the above bond has 10 years left at 7%, then the sum of the future cash flows is 10 * 7 = 70. However the italicised definition states that the duration will recover half the future cash flows, but half of 70 is 35, and the above 51.49 is most certainly not equal to this.

Where as 51.49 is approximately half of 100, which would have been the value of my original investment, so it would appear that I was along the right lines with my original understanding, but the internet definition I found screws up my thoughts by it's reference to the phrase all future cash flows from the bonds.

Can anyone tell me where I have gone wrong? Or what I've misunderstood?

many thanks
Matt