What’s the first thing you’ll ask about when considering investing in a bond fund? Chances are, the word ‘yield’ just popped in your head. And that’s understandable. After all, most people think bonds are lower risk anyway so if you’re going to invest, you’ll want to know the return.
However, what many people don’t realise is that before you even start looking at yields, you need to ask: ‘Will the bond issuer pay the coupon and will I receive my principal back?’
Until you’ve established that, you shouldn’t even be thinking about the yield.
Protecting your nest egg
Now you might be asking why. Much like how markets can change, any company’s fortune can also take a turn for the worse. If a corporate or government issuer suffers a default, then the eventual return you get might be substantially below the yield that is being shown. In a worst case scenario, you could even lose your entire investment if you go all in on a single bond.
Which is why a key advantage of buying an actively managed fund is diversification by geography, sector and credit quality. This helps to manage risk and volatility.
Another key principle in all of this is credit research. Yes, the term might sound boring but if you familiarise yourself with it you’ll get to ask the right questions the next time you consider to invest in a bond fund.
Some background to begin with. There are two main roles in a credit team: the portfolio managers and the credit analysts. Although they work closely together, their jobs can be quite different.
Analysts do the necessary research to identify and vet investment opportunities. They deep dive into a company’s balance sheet to figure out if there are any considerations which may affect the bond issuer’s ability to repay its coupon or principal. If that’s the case, those bonds are excused from consideration, regardless of the yield.
The most important role for any analyst is to ensure that the bonds under consideration have good credit fundamentals, with a very high chance of repaying the coupon and the principal.
Think of it this way, the analysts will set out the buffet for the portfolio manager to pick what to eat. Only when the analysts have screened all the good and healthy “food” options available and laid them out as a buffet, then will the portfolio managers and analysts work together to decide which bonds have the best relative value.
However, presenting a good buffet is not easy as credit research is a labourious task which requires resources and time. Indeed, assessing a company's balance sheet, particularly complex companies that are diversified and stretch across markets, requires resources, time and a disciplined process. There are no shortcuts to deep dive into their financial books and assess their balance sheet.
Remember, there could be a big performance advantage in buying a bond fund that gives you fewer yield basis points but repays all its capital compared to buying a bond fund which suffers big capital losses due to defaults.
At the end of the day, no investor wants to suffer capital losses. And unfortunately, if a portfolio manager has been too ‘gung-ho’ and bought only higher yielding bonds without sufficient credit research, then that fund could let you down in the long run.
When it comes to bond investments, don’t assume higher yield is always a better deal.
This document is for information only and is not an advertisement, investment recommendation, research, or advice. Any views and opinions expressed are subject to change without notice. It does not have regard to the specific investment objectives, financial situation, or needs of any specific person. You should seek advice from a financial adviser. Investment involves risk. Past performance of the managers and the funds, and any forecasts on the economy, stock or bond market, or economic trends that are targeted by the funds, are not indicative of future performance. The value of the units of the funds and income accruing to them, if any, may fall or rise and investor may not get back the original sum invested. Changes in rates of currency exchange may affect significantly the value of the investment. HSBC Global Asset Management (Singapore) Limited ("AMSG") has based this document on information obtained from sources it reasonably believes to be reliable. However, AMSG does not warrant, guarantee or represent, expressly or by implication, the accuracy, validity or completeness of such information.