With the amount of bonds this year expected to reach record levels, do YOU understand what this could mean for your investments (potential investments or existing)?
If not, don’t you think you SHOULD know?
Answer: (Note: It’s “an” answer, not “the” answer. )
First, we have to understand that bond values are priced daily and that, like stocks, these prices can go up or down.
So what drives prices? Supply and demand plus EXPECTATIONS of future interest rates. Simply put, if rates in the future are expected to rise, prices of bonds offering today’s lower rates will drop.
Companies like SM are borrowing heavily today because they EXPECT that interest rates will go up in the near future. Thats why they want to borrow your money today at these low rates. When you are borrowing in the billions of pesos, a 25-bip increase in rates equals millions of pesos in additional payments every year.
Now, rising interest rates are bad news for bond funds. This is because what they currently have are low-yielding bonds and once interest rates rise, the value of those bonds WILL drop. And unless they can quickly replace those bonds with the higher yielding ones, the value of their funds will suffer. So, will there be enough supply for them? And if you believe interest rates will rise, why would you buy these low-yielding bonds?
Rising interest have conventionally been thought to be bad news for equities and there is good reason for this. Higher rates mean that it will be harder for companies to grow. Plus, people traditionally shift to fixed income when interest rate rise. So equities and equity funds will be under pressure as well.
Keep in mind, interest rates are expected to rise over a period of time. It will NOT be a one-shot thing so these pressures will persist for the next couple of YEARS.
So what should YOU do?
I have absolutely NO idea. Lol.
Seriously though, there is no one strategy or answer to this situation. As we teach in Pesos and Sense, the answer would depend on your Time, Money and Knowledge.
Put another way: I know what I will be doing. I honestly don’t know if it will work but I do have a plan. How about you?
Aral muna bago invest.
Jeff Diaz says
Hi Mr. Aya Laraya,
Does this mean that bonds and equities have inverse effect to each other, ei. bond rates rise = equities suffer, and bond rates fall = equities improve. This means that bonds and equities cannot be good investments at the same time. Is this correct? Does this also mean that it is better to get equities mutual fund if the bond rates are low, then transfer to a bond mutual fund if bond rates increase, instead of getting a balanced mutual fund.
Also, how can banks and mutual fund companies sell low rate bonds? Who would want to buy them if there are bonds with higher interest rates?
Aya Laraya says
Those are the textbook relationships between equities and fixed income. However, the massive easing programs done over the past several years have led to a situation wherein rising interest rates will be bad for both equity and fixed income funds.
As you said, who would buy the currently low-yield bonds if higher -yield bonds are expected in the future.
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