As we discovered, when it comes to investing, most of the time people talk about stocks and stock ETFs. Bonds are rarely mentioned , even though they are included in most portfolios - especially those of digital and traditional asset managers.
What is a bond?
A bond is a type of security that companies or governments use to raise money from investors. It is debt capital similar to a loan .
With a fixed-interest bond, the bondholder receives a fixed agreed interest rate (coupon). Interest payments are usually made annually, half-yearly or quarterly. At the end of the term, the bondholder receives the nominal value of the bond back.
The volatility of bonds is generally much lower than that of stocks. Bonds are often viewed as a more stable and safer asset class that offers regular interest payments.
Example: Sonnenschutz AG issues a bond at 100% or CHF 1,000 with an interest rate of 3% and a term of 6 years. The bondholder receives 6 x CHF 30 = 180 and at the end CHF 1,000 (nominal value). In this case, the bondholder receives a return of 3% .
Bond types:
Government bonds are bonds issued by a government or government institution to finance public spending.
Corporate bonds are bonds issued by a company to finance investments, expansions or debt.
Criteria for selecting a bond:
Credit rating: Credit rating is a measure of an issuer's ability and willingness to service its debts. Government bonds are generally considered safer than corporate bonds because they are backed by a country's fiscal strength and political stability. Corporate bonds depend on a company's financial situation and business activities. Credit rating is assessed by rating agencies such as Moody's, Standard & Poor's or Fitch and ranges from AAA (highest quality) to D (default) .
Yield to Maturity : Yield is the income an investor receives from a bond, based on the current market price. The yield is made up of the interest coupon and the price gain or loss . Because government bonds are considered less risky, they typically offer a lower yield than corporate bonds. The yield on a bond also depends on the maturity , currency , inflation and market expectations.
Interest rates : General interest rates in the economy affect the value of bonds. When interest rates rise, existing bonds with lower interest rates become less attractive, causing their prices to fall. Conversely, when interest rates fall , bond prices rise .
Maturity : The maturity of the bond determines how long the investor has their money tied up. Bonds with longer maturities usually offer higher interest rates but carry a higher interest rate risk.
Duration : Duration (one of the most important ratios) depends on the maturity, coupons and market interest rates. A longer duration means a higher sensitivity of the price to interest rate changes . For example, if you buy a bond with a duration of 5 years, this means that if the interest rate falls by 1%, the price of the bond will rise by 5%.
Example of a bond: Nestle, with a coupon of 1.625% and a maturity of more than 3 years.
The yield to maturity of 1.373% is slightly lower than the coupon of 1.625%. This is because the price of the bond (100.85%) is slightly higher than 100%. At the end of the term, you will be paid back 100%. Accordingly, the yield is "only" 1.373%.
The modified duration is approximately 3.4. A 1% change in interest rates would therefore change the price of the bond by 3.4%.
Conclusion:
Bonds are particularly interesting for the cash portion of a portfolio. You currently receive almost no interest on cash . With a bond from a Swiss company with a good credit rating, you can still achieve around 1.5%. Your bonds also stabilize your portfolio. The stock market is not a one-way street and a well-diversified stock portfolio can fall by 50%. Bonds react to economic changes differently than stocks and you can further diversify your portfolio accordingly.
If you would like to gain in-depth knowledge about Swiss bonds, international bonds in USD and EUR, bond ETFs, iBonds and also learn what you need to pay attention to when investing in bonds, then please join the waiting list for our course:
Bonds – a forgotten asset class:
We look forward to teaching you everything about bonds.
sincerely
Jeff and Reto
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