24 October 2016
Investors have to select bonds very carefully, since high-yield bonds usually have low credit ratings.. Photo: HKEJ
Investors have to select bonds very carefully, since high-yield bonds usually have low credit ratings.. Photo: HKEJ

Bonds are a necessary asset class in your portfolio

The US Federal Reserve decided to hold interest rates unchanged this week.

It has also trimmed expectations for future rate hikes from four times to twice this year given various external uncertainties.

In the meantime, the European Central Bank has moved to expand its monetary easing stimulus on a scale that beats market expectations.

In this light, bonds should play a key role in investment portfolios, since the stock market will remain volatile amid the low-interest-rate environment worldwide.

Bonds can provide a cushion against volatility in stocks and offer steady income for investors.

The US treasury yield is likely to hover near the bottom for some time as the Fed dials back the pace of its rate hikes.

On March 8, the 10-year US treasury yield was 1.9 percent, far below the average level of 3.2 percent in the past decade.

Investors are looking for investment returns under low-rate conditions.

They would prefer corporate bonds or Asian credits, which offer more attractive yields.

Investment-grade corporate bonds have an average yield of 2.7 percent at present, and Asian US-dollar bonds have an average yield of 3.9 percent.

Bonds could also reduce the risk of a portfolio. They usually have a low correlation with equities, and bonds would help stabilize the performance of the whole portfolio.

Since the beginning of the year, global equities had dropped by 3.4 percent by March 8, because of volatile commodity prices and the slow recovery of the global economy.

By contrast, investment-grade bonds posted a rise of 2.2 percent during the same period. High-yield debt generated a return of only 1.7 percent.

However, investors should be aware that different bonds may have divergent performances during different stages of the rate hike or economic cycle.

They should watch market developments closely.

For example, short-duration bonds are usually less sensitive to interest rates, while high-yield bonds benefit more from the later stage of an economic recovery.

Besides, different countries differ in their interest rate cycles.

For example, the United States has started a rate hike cycle, while the ECB and other major central banks are still facing pressure to cut rates.

That would affect the performance of bonds in different currencies.

Bond yields are likely to pick up in the long term as the US raises interest rates.

Investors could buy some short-duration bonds or deposit certificates first, to lock up returns.

They could shift to bonds that pay higher yields when the short-term bonds mature.

Investors could also invest in bond funds.

The entry threshold of these bond funds is very low, compared with those for single bonds, and they are diversified among different issues, credit ratings, currencies, industries and durations.

Global high-yield bonds have an average yield of 8 percent amid plunging oil prices and faltering economic growth.

However, investors have to select bonds very carefully, since high-yield bonds usually have low credit ratings.

This article appeared in the Hong Kong Economic Journal on March 18.

Translation by Julie Zhu

[Chinese version 中文版]

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Head of wealth development for Hong Kong, HSBC

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