It Looks Like a Duck, Quacks Like a Duck… But Is
Read the weekly bond market commentary from Doug Drabik.
February 11, 2019
Reports reflect that bond funds and fixed income ETFs are experiencing net inflows. The stock market has recently demonstrated much more volatility while global economies are displaying uncertainty, both contributing to a flight to quality. As such, it is important to point out that just because other products use bonds, there are many differences to how individual bonds work within an investment portfolio. Understanding the purpose of holding individual bonds goes a long way into understanding why they can be such an important investment tool for balancing your portfolio.
One of the greatest hurdles for investors seems to be the different evaluation process between products necessary to gauge value. For example, the well-known idiom for equities, “buy low, sell high” exploits how that product often times relies on price appreciation to increase its value. When you purchase a house, there is typically an expectation that when you sell the house years later, your equity will grow by an appreciated market value. We are programmed as investors to monitor, seek and use these assets as a means to grow our wealth. Therefore when monitoring individual bonds, it is not surprising that investors may desire the same.
The truth is, comparing individual bonds to equities, real estate, bond funds or bond ETFs is like comparing apples to oranges (related article: True Fixed Income – A Favored Asset Class for a Rising Interest Rate Environment). Many investors have the need to protect their wealth and/or hedge the portfolio’s growth assets. I would argue that individual bonds are tailor-made to accomplish this and price is among the least important characteristics to achieve this purpose. Among the most important features is an individual bond’s stated maturity. When an individual bond is held to maturity, the interim interest rate volatility will not alter an individual bond’s yield, cash flow or date when its face value is returned, in essence negating any price movement experienced over the holding period. As long as a bond is held to maturity, price movement is irrelevant to a bond’s performance and the ultimate price (par at maturity) is known. No product without a stated maturity can be or should be compared in the same way. The option to hold an individual bond to maturity therefore protects principal as a bond’s face value (barring default) is returned in full on its redemption date.
In addition, individual bonds allow investors to customize strategies for desired cash flow stream, maturity schedule and credit profile. There are products that use bonds or even have some of the features, but no matter how they look or quack, these products are not individual bonds.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.