Happy Friday, everyone! The four-day week has passed by swiftly and we are now looking forward to a superb sport-filled weekend. Well, I am anyway. So, without further ado, let’s jump straight into this week’s News, Views and Truths.
And let me start with diversification. Never put all your eggs into one basket, certainly in investment terms. Investment 101; basic, yet eminently sensible stuff. Diversification acts as both a shock absorber to your portfolio and ultimately determines the returns you receive. Yes, the decisions of individual investment managers held within your portfolio can certainly influence the returns experienced, but the diversification within the portfolio sets the foundations.
This week’s piece is going to stray from both the regular (stock markets) and the esoteric topics that I usually furnish this publication with and venture down the path of…
The incredibly dull.
Bonds. I love bonds. I love super dull boring bonds. The mirror to the economy, high quality sovereign bonds are the element within your portfolio that can provide the low volatility return that many investors crave. And if you are meaningfully diversifying your portfolio, there should be an allocation to bonds, in one form or another. Fabulously dull.
But this week, they aren’t. Oh no, this week, bonds are in the headlines (let’s be perfectly honest, my headlines, not yours – you are normal people, after all). “Why are bonds in the headlines, Andrew?”. Well, settle back and let me tell you…
So, quick recap… Bonds are offered by institutions, both governments and companies, to raise finance. As an investor, you get back a fixed percentage of the initial purchase value of the bond (fixed interest) each year, normally payable every six months. On maturity, you get back the initial price paid. These can be traded on markets, just like stocks and the value can go up or down, depending on both the stability of the bond issuer (will they go bust before maturity?) and whether the interest they are currently paying is of value. Supply and demand, just like stocks, determine the daily return.
The beauty of high-quality sovereign bonds issued by the likes of the US, UK and Germany, is that they act in reverse of stock markets; when stocks are going up, money leaves bond markets and flows into equities, reducing the demand on bonds and therefore lowering their prices. However, when the reverse happens and investors are unsure about the economy, investors sell their equity allocation and move into bonds, increasing demand and obviously their price.
However, as the annual income that the bond pays (the coupon) is fixed at outset, when the price of a bond rises, the percentage yield of the bond falls – that’s an inverse relationship. So, remember, falling yield equals rising price.
This week, the yields on German 10-year bonds hit a record low of -0.202%. Yep. Minus. Investors are paying interest to the German government to allow them to hold their bond. That’s like Barclays offering to pay you to take one of their personal loans. That’s extreme.
Yet a similar fall occurred in both the US and UK, albeit at different start points. The 10-year US Treasury yield fell to 2.1766%, with the UK 10-year gilt yield falling to 0.869%. All of this has coincided with a fall in equity markets…
And that’s the kicker. It’s absolutely natural to focus upon stock markets. However, this is only ever one part of a truly and meaningfully diversified story. A well formulated portfolio can benefit from both rising and falling equity markets if it’s well formulated. The chart below, showing the last 3 months performance of the FTSE All Share Index demonstrates this perfectly.
This diversification is crucial to the ongoing robustness of our investment proposition and forms the cornerstone of our investment committee discussions. To this end, clients of Three Counties should expect correspondence in the coming days, relating to our recent findings and the recommended changes to our investment portfolios. Think of this as a public service announcement. As ever, myself and my fellow investment colleagues are always available to answer any questions and we look forward to talking to you.
And to conclude, our usual playlist. Have a great weekend and I shall see you all next week!
