Ask Your Advisor: What to do about bonds bought during the pandemic?

When the COVID-19 pandemic struck in late 2019 and wreaked havoc on the economy, some investors did what they thought was the wise thing to do.

They purchased 5- to 20-year peso and dollar bonds that promised yields of 2%-3%, which were slightly higher compared to the Bangko Sentral ng Pilipinas (BSP) and Federal Reserve (Fed) policy rates. At that time, BSP policy rates were still at 2%, while Fed policy rates were at 0.25%.

New bonds issued during this period were priced at lower coupon rates while older bonds with higher coupon rates became much more expensive, resulting in much lower yields.

Little did they know that just a couple of years later, both central banks would aggressively hike their policy rates to combat high inflation, bringing both peso and dollar bond yields to the 4%-5% level.

Now some clients reached out to us and asked, “My funds are tied up in lower-coupon bonds and I couldn’t invest in higher-yielding bonds. What can I do?”

Here are two options we recommend:

1. Hold-To-Maturity (HTM)

Investors may continue to accrue coupons while waiting for their bonds to mature. As long as the bond issuer remains in good financial health, it will completely repay its investors on the bond’s maturity date. With excess funds finally available, investors can then simply reinvest the proceeds in a new bond.

However, this opens up investors to reinvestment risk or the risk that new investments could pay an even lower rate of return. Both the BSP and Fed have already started to cut policy rates and the opportunity to invest at higher yields is slowly slipping away.

Peso and dollar bonds that previously yielded more than 5% have dropped to the 4% level. While we do not expect policy rates and bond yields to return to pandemic lows over the next few years, we cannot say for certain what the monetary policy will be and how the financial markets will look like in the next 10-20 years.

This brings us to the next option.

2. Switch to a higher-yielding bond and recover any potential loss

A prudent investor must know when to cut losses in one investment to generate greater returns in another.

If the bonds these investors are holding are liquid enough, they might be able to sell in the secondary market, albeit at a lower price than originally purchased. But the good news is that a bond’s price is not the only factor that determines whether an investor realizes a gain or a loss.

It is also important to consider all the coupons accrued since the bond had been purchased because these add to the recovery of capital. For investors who should have already accumulated 2-3 years’ worth of coupons, the loss, if any, may not be so substantial.

These investors can now purchase new higher-yielding bonds that can also help them recover any potential loss from the sale of their old bonds. This option also partially hedges against reinvestment risk as investors can lock in a higher rate of return over the next several years when policy rates and bond yields are expected to decrease.

No single best solution

There is no single best solution between the two options. If a bond will mature when policy rates are expected to bottom out, then we encourage investors to consider switching to a higher-yielding bond.

However, some longer-term bonds may realize significant losses if sold now. We prefer to hold on to these bonds until maturity or when there is an opportunity to sell at better prices.

For those who are in a similar situation, we advise you to consult your investment advisor for help in reviewing your bond portfolios and determining the most appropriate course of action.

(Beginner investors who are just starting to get into bonds may consider our Unit Investment Trust Funds (UITFs) such as the Metro Unit Paying Fund, Metro Short Term Bond Fund peso and US dollar variants (PHP and USD variants), and Metro Max-5 Bond Fund peso and US dollar variants. These products pool investors’ money and invest them in a diversified portfolio of different bonds. The underlying bonds are actively managed by our professional fund managers. Not a client yet? Please sign up here so you can begin your wealth journey with us.)

EARL ANDREW “EA” AGUIRRE  is the Head of the Investment Counselor Department under the Financial Markets Sector of Metrobank. He has over 10 years of experience in foreign exchange, fixed income securities, and derivatives sales. He has a Master’s in Business Administration from the Ateneo Graduate School of Business. His interests include regularly traveling to Japan and learning its language and culture.