There's no such thing as a common bond
Smarten up your portfolio and take a less volatile route to overall stability
About 10 years ago, my editors dubbed me the 'Bond girl'. For all the wrong reasons. It was my coverage of debt capital markets that earned me the nickname. Since then, I've had an affection for fixed income. Yes, bonds are rather dull and poorly understood, but they are, frankly, one of the most important things you need to know about to make sound financial planning decisions.
Asia is still a very short-term, equities-driven investing culture. But you would do well to grasp the magic of bonds. They not only ought to form a crucial part of your portfolio, but also should factor into many other financial decisions - from when to dip your toe into the property market to when to jump out of Hong Kong stocks. Bonds help smarten up your portfolio, making you a smarter investor in the process.
Here's what I mean:
1. Bonds can help steady your ship.
Bonds are traditionally less volatile than stocks, offering stabler returns in relatively choppy times. For that stability you pay a price: bonds traditionally underperform stocks in the long term. That's one reason retail investors often ignore bonds. After all, it's tough to settle for small payouts when you're seeing eye-popping returns in the stock market.
But bonds are critical to helping smooth out the volatility that comes with equity investing.
The general rule of the thumb is that when you're young - say, in your 20s and 30s - you can be a bit daring with risk and, thus, your financial portfolio should generally hold about 15 per cent to 20 per cent in bonds. If you're pushing 60, then you'd want to up the bond ante to up to 70 per cent of your portfolio in order to ensure stable returns.
2. Bonds can help you peer into the economic crystal ball.
Ever wonder what the Federal Reserve may do with interest rates or whether investors expect a recession? The bond markets offer distinct and often accurate clues.
This works mostly in large, developed bond markets rather than in Asia, where fixed-income offerings are still quite small. But you will still do well to know where, say, the US economy is headed because so much of what happens there affects your pocketbook here. Besides, with the Hong Kong dollar pegged to the greenback, what the Fed does to rates in the US effects your property investments in Mid-Levels.
One very effective indicator of what the market thinks the Fed will do at a certain point - say, December 2007 - is to check out where the three-month euro futures are trading for that month. If you see a spike in that euro-dollar rate, pay attention, since it may be a bad time to pile into risky stocks or a high-priced condo. Traditionally, when rates go up, stocks fall, mortgage rates rise and property prices decline.
Another indicator is to check out bond yield curves to see if investors expect the economy to grow or to slip into recession. Last year, we heard much about how the Treasury yield curve 'inverted', meaning short-term notes were offering a higher yield than long-term bonds. Treasury yield curves typically slope upwards, since generally investors expect to receive more the longer they need to lock in their money.
But if investors expect a downturn, they might not be that demanding for a higher rate over the long term, worried that in a year or two, the bonds they acquire might offer even less. Hence, the inversion.
3. Bonds can help you make better stock investment decisions.
When you evaluate the underlying companies' fundamentals, don't forget to check out their bond ratings. The higher a company's bond rating, the stronger it is financially. Basically, a rating evaluates how likely a company is going to be able to pay back its loans. An investment grade rating usually signals a company is financially sound, which also makes it a more attractive investment.
The two major agencies that rate bonds are Standard & Poor's (www.standardandpoors.com) and Moody's Investors Service (www.moodys.com). They offer you the ability to search for ratings on thousands of companies.
Bond mutual funds offer the best way to into the market. All the big mutual-fund companies - Fidelity, Vanguard, Oppenheimer - offer a large variety of bond funds you can invest in for a just few thousand US dollars. There are also exchange-traded funds that trade like stocks, including two interesting in Hong Kong.
One Hong Kong traded ETF gives exposure to the Hong Kong dollar bond market and the other to eight Asian countries. Offering an easy, painless way to get into the bond market, they were launched as part of the Asian Bond Fund 2 Initiative (www.abf-paif.com), a programme by the region's banks and regulators to deepen the fixed-income market. Betty Liu is an on-air correspondent for CNBC Asia based in Hong Kong and author of Age Smart: Discovering the Fountain of Youth at Midlife and Beyond. You can reach her at firstname.lastname@example.org.