Hedging Market Volatility with Fixed Income Investment September 27, 2024
How I got into Selling Corporate Bonds
When I first entered the stock broking industry, I had never given any serious thought to fixed income investments. My impression was that fixed income investments generally generated lower returns compared to equities and equity funds.
However, approximately 15 years ago, a client asked me about corporate bonds and that’s where my journey with fixed income investments began. Over the next five years, I conducted extensive research and read countless articles on fixed income, and gained a solid understanding. Overtime, with practice, I developed a strong expertise in the bond market.
One of the biggest turning points that made me appreciate bonds was the volatility I witnessed in corporate bonds during the COVID-19 pandemic. There was a major sell off in the global equity markets, and a client of mine became very anxious and contacted me frequently. Fortunately, his corporate bond portfolio was able to help hedge against the market volatility. The volatility of bonds was lower compared to equities, allowing him to sleep better at night.
The credit goes to the client. He was prudent with his investments and did his due diligence before investing in corporate bonds, which eventually paid off. None of the bonds he held defaulted. During this period, while many listed companies cut their dividend payment to investors, the coupon payment for bonds remained consistent.
Hedging market volatility with fixed income investments can be an effective strategy to preserve capital and generate stable returns. Here are some key points and strategies to consider:
Key Points
1. Fixed Income Basics:
- Definition: Fixed income investments typically involve loans made to corporations or governments, which pay interest over time and return the principal at maturity.
- Types: Government bonds, Statutory board bonds, Corporate bonds, and Perpetual securities.
2. Market Volatility:
- Impact: Equity markets can experience significant price fluctuations due to economic, political, or global events.
- Goal of Hedging: To reduce the overall risk of a portfolio by balancing more volatile assets (like stocks) with more stable ones (like fixed income).
Strategies for Hedging with Fixed Income
1. Diversification:
- Spread investments across various types of fixed income securities (e.g. government, corporate, and municipal bonds)
- Diversify by credit quality, maturity dates, and geographical locations
2. Laddering:
- Invest in bonds with staggered maturity dates
- This approach ensures that a portion of the portfolio matures regularly, providing liquidity and reducing interest rate risk
3. High-Quality Bonds:
- Invest in high credit quality bonds, such as U.S. Treasuries, Singapore Government Bonds, Temasek/GIC backed corporate bonds or AAA-rated corporate bonds, which are less likely to default
- These are generally safer during times of economic uncertainty
4. Interest Rate Considerations:
- Be mindful of the interest rate environment. When rates are expected to rise, shorter-duration bonds are less sensitive to rate increases
- Conversely, longer-duration bonds may perform better when rates are expected to fall
5. Tax Considerations:
- Interest Income is taxable for corporations in Singapore. For individuals, it’s not taxable (Please check with your tax consultant if ever in doubt)
6. Bond Funds:
- Bond funds offer diversification within fixed income and can be more liquid compared to individual bonds
- They provide access to professional management and a wide range of bond markets
- A small amount of money as little as S$1000 can be invested into Bond funds
Considerations
1. Credit Risk:
- The risk that a bond issuer may default. Mitigate by investing in high-quality bonds and diversifying
2. Interest Rate Risk:
- The risk that changes in interest rates will affect bond prices. Manage by laddering and using short-duration bonds
3. Liquidity Risk:
- The risk of not being able to sell a bond quickly without affecting its price. Fixed income funds can offer more liquidity
4. Reinvestment Risk:
- The risk of reinvesting proceeds at lower rates. Staggering maturities helps mitigate this risk
Conclusion
Hedging market volatility with fixed income involves careful selection and management of various types of bonds to create a balanced and diversified portfolio. By understanding and applying these strategies, investors can achieve more stable returns and protect their capital from market volatility.
Contributor:
Lionel Lim
Principal Investment Specialist
Phillip Securities Pte Ltd (A member of PhillipCapital)
https://bit.ly/TTPlionellim
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About the author
Lionel Lim
Principal Investment Specialist
Lionel Lim joined Phillip Securities as a Trading Representative in 2005, driven by a passion for investments. Over the years, Lionel has gained extensive experience in servicing clients across various investment products, including stocks, corporate bonds, unit trusts, CFDs, and ETFs. Lionel enjoys engaging with clients and exchanging investment ideas. In addition, Lionel provides clients with daily updates through research reports and market news. Prior to joining PhillipCapital, Lionel also gained experience in auditing and banking.
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