The Inverse Relationship in Bond Markets
Within the fixed-income world, the term “yields” typically refers to yield to maturity, which represents the expected annual rate of return on a bond if held until maturity, assuming no default by the issuer.
One fundamental concept to grasp in the bond market is the inverse relationship between bond prices and yields. When yields increase, bond prices decrease, and vice versa. This phenomenon occurs because as prevailing interest rates or bond yields rise, existing bonds with lower yields become less attractive, leading to a decline in their prices. Conversely, when interest rates decline, existing bonds with higher yields become more appealing, causing their prices to rise.
This inverse relationship has been evident in recent market trends. In 2022, global central banks raised interest rates to combat inflation, leading to significant pressure on the bond market. Conversely, since April 2024, as inflation moderated, central banks were able to reduce policy rates, resulting in a strong performance in the bond market.
Choosing the Right Bonds
When deciding which bonds to invest in, it is essential to consider the following factors:
Types of Bonds
- Developed market government bonds are generally perceived as low-risk investments.
- Government bonds issued in emerging markets may carry higher levels of risk but offer access to diverse income and growth profiles.
- Corporate bonds come in two categories: investment grade and speculative grade, with the latter posing higher default risks.
Considerations for Singapore Retail Investors
Singaporean retail investors have various bond options, including government bonds like Singapore Government Securities and Singapore Savings Bonds, domestic corporate bonds, and foreign currency-denominated bonds from international companies.
Factors to Evaluate
When selecting a bond for income generation, investors should assess factors such as the bond’s coupon rate, issuer’s credit quality, time to maturity, investment objectives, risk tolerance, liquidity, investment horizon, and the credit fundamentals of bond issuers.
Understanding Callable Bonds
Callable bonds are bonds that can be redeemed by the issuer before their maturity date. The primary risk associated with investing in callable bonds is reinvestment risk, where investors may struggle to reinvest the principal at the same rate if the bond is called early. To compensate for this risk, callable bonds often offer higher yields.
Investing in Bond Funds vs. Individual Bonds
When deciding between bond funds and individual bonds, investors should consider:
Individual Bonds
- Provide predictable income streams and full control over risk exposure and holding periods.
- No management fees, but brokerage firms may charge transaction fees.
Bond Funds
- Offer diversification, professional management, higher liquidity, and smaller minimum investment sizes.
- Management fees apply, but they are a suitable option for both individual and institutional investors due to the rigorous credit analysis required for bond investments.
Buying and Selling Bonds
In Singapore, bonds can be bought and sold through financial institutions, brokerage firms, or online platforms. The minimum investment sum varies depending on the bond type and platform, so it’s crucial to understand the associated fees.
Risks to Consider in Bond Investments
When investing in bonds, it’s essential to be aware of the following risks:
- Credit risk: The risk of issuer default.
- Interest rate risk: Bond prices decrease when interest rates rise.
- Liquidity risk: The ability to buy or sell bonds without affecting prices.
- Inflation risk: The potential for inflation to erode bond returns.
Understanding these risks and their impact on bond investments can help investors make informed decisions.