Why have bonds in our portfolio and which ones?

I had a lengthy conversation with a friend on bonds. He bought into Aspial's 5 year bond that carries a coupon of 5.25% a few months ago at the recommendation of his father. 

When I asked him why did his father recommend the bond to him, he said his father felt good about it.

It boggles my mind, really, to be able to plonk down $XXX,XXX based on feeling good.




Actually, many people in this (still) rather low interest rate environment are taking more risks to get higher returns on their money. 

There is nothing wrong with this but they seem to be taking risks they don't understand or they might understand but have underestimated.

Well, it could be a case of ignorance is bliss if nothing goes wrong and they get their regular interest payments in the next few years and also their capital at maturity.

Why AK so kaypoh?

Bad AK! Bad AK!

Recently, I got this message:

Hi Ak, disturb u again
Saw on your recent post, you have purchase the perrenial bond.

I am first time in bond, what is the risk of bond?

Does the bond rate fixed?

If the company does not go bankrupt, mean I can get promised rate end of years?

Alamak. I think that it is time for another blog post.

I hear people saying that they put some of their money in bonds for diversification. 

They don't want all their money in equities. This is actually quite prudent.




However, for many, the prudence ends there because they think that as long as they have a good percentage of their portfolio in bonds, they have done a good job of diversification.

For example, my friend who plonked down $XXX,XXX in Aspial's recent bond offering told me he has maxed out his allocation to bonds in his portfolio with that one bond! 

Has my friend done a good job of diversification for his portfolio?




When we talk about diversification, it is to reduce the volatility of a portfolio. 

In the long run, all assets in our portfolio should ideally produce positive returns but do not move up and down together.

The idea about having bonds in our portfolio is that prices of bonds and equities move in opposite directions. 

However, this is only true if we are talking about certain types of bonds.

A sovereign bond that is issued by AAA rated country like Singapore or a high quality investment grade corporate bond add stability to an investment portfolio. 

They are less volatile in price.




When we park our money in bonds which are of questionable quality, we are not reducing risk nor volatility in our portfolio.

Do you wonder why is this so?

Lately, we have been talking about interest rate risk. 

We have been talking about how rising interest rates would put a downward pressure on bond prices. This is especially the case for long term bonds and perpetual bonds.

So, if we value peace of mind, avoid long term bonds and perpetual bonds. 

Also, avoid bond funds as they have no maturity dates and are like perpetual bonds.

Now, it stands to reason that when the economy does badly and the stock market plunges, investors seek safe harbours for their money. 

High quality, investment grade bonds are one of the things they would go for.

In a bear market, stocks of weaker companies or businesses of the more speculative kind get sold down more aggressively and, together with them, the bonds which they issued. 

Mr. Market is not worried about interest rate risk in such an instance. 

Mr. Market is worried about the risk of default.




Where is the supposed stability that comes from diversifying into bonds then? 

Bought the wrong bonds. So, no stability lah.

So, if you have bought some bonds and because of that, you think you have added stability to your portfolio, think again.

What are the bonds you have in your portfolio?


Related post:
1. Singapore Savings Bond.
2. Lost money in a bond fund.
3. Perennial's 3 year bond.
4. CPF as a AAA rated sovereign bond.
5. Perpetual bonds.