Bonds – An Investment Opportunity?

06.11.12

Please note that this article is over six months old. While Blevins Franks takes care to make sure that information is accurate on the date of publication, some content may change over time. You should not rely on the accuracy of legislation and tax information in this article; take professional advice for your circumstances.

Arguably, the most important aspect of portfolio planning is your asset allocation ? how much of your investment capital is allocated to equities, to bonds, to property, to cash etc.

Arguably, the most important aspect of portfolio planning is your asset allocation ? how much of your investment capital is allocated to equities, to bonds, to property, to cash etc. Before you buy or sell investments you need to have established the most appropriate asset allocation for your personal circumstances and objectives.

Bonds play an integral part in many investment portfolios, and could prove very beneficial for you. As a diversification measure they can help reduce overall risk, and, importantly for many people, they also provide a regular income. Bonds also have the potential to generate capital growth over the longer-term.

Bonds are an asset class known as fixed interest securities. With the way bonds work, the rate of interest they pay holds up even when capital values fall. Your income stream is therefore unlikely to be impacted by events like the Eurozone crisis.

Bonds, by their nature, generate a natural income, so you can receive regular income without having to touch your capital. The capital therefore remains invested to continue producing income in the future, with the ability to also generate capital growth.

If you do not need income, with a bond fund you can reinvest the income in the fund as additional shares to enjoy accelerated growth rates. These are known as accumulation units

In order to establish how much of your capital to allocate to bonds you should seek professional advice from an experienced wealth manager to expatriates such as Blevins Franks. Asset allocation can account for around 80 to 90% of portfolio performance according to academics, so getting it right is key to your investment success.

Different types of bonds

Bonds issued by governments are known as gilts in the UK and Treasuries in the US, both of which are issued in the local currency. Government bonds issued in a foreign currency are known as sovereign bonds. Since they are generally considered a more reliable investment than corporate bonds, government bonds usually pay a lower rate of interest.

Corporate bonds, which are issued by companies and sold to investors, are a major source of capital and financing for many companies. The issuers are grouped by their credit rating, with higher quality bonds classified as ?investment grade?. Non-investment grade bonds are those which have a lower credit rating; they are known as ?high yield bonds? since they typically pay a higher rate of interest and can be a very attractive investment opportunity for many investors.

High yield bonds can be categorised into two categories ? ?fallen angels? and ?rising stars?.

Rising stars are relatively new companies which do not yet have the history, or track record, of borrowing or paying back debt to be classified as investment grade.

Fallen angels are bonds which were once investment grade but have been downgraded because their financial strength is not as strong as what it previously was, therefore affecting their credit worthiness. Nokia is a recent example of a company whose credit rating has fallen below investment grade and is therefore now classified as a fallen angel.

An article in the Financial Times on 28th September highlighted how the difficult corporate environment in the Euro crisis and subsequent rating downgrades is resulting in an unprecedented number of companies becoming fallen angels.

This could prove very beneficial for the European high yield market, since it would inject new money and liquidity and create fresh market opportunities for fund managers.

This therefore actually provides an opportunity for investors.

The article explained: ?If all the major corporates in Italy, Spain and Portugal, now teetering on the edge of investment grade, lost that status, it would help to more than double the market?s size to ?500 billion over the coming years and over time it would help the high yield market on its way to being as large, deep and efficient as in the US.?

The European high yield bond market has been one of the star performers of 2012, with the major index posting strong double digit returns year to date to the beginning of October, in both Euro and Sterling terms.

Buying bonds

Bonds are best bought through a professionally managed fund, which invests in a wide range of bonds depending on its mandate, providing you with a high level of diversification and the expertise of a recognised fund manager.

Although bond interest is fixed, their capital values can rise and fall over their term. Fund mangers actively buy and sell bonds and can make significant gains on some bonds if they buy them when values have fallen and hold them to maturity.

These views are put forward for consideration purposes only as the suitability of any investment is dependent on your objectives, time horizon and attitude to risk. The value of investments and the income arising from them can fall as well as rise. Past performance should not be seen as an indication of future performance. Seek advice from an authorised wealth manager such as Blevins Franks Financial Management Ltd.

Blevins Franks Financial Management Ltd is authorised and regulated by the UK Financial Services Authority for the conduct of investment and pension business.

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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