Maximizing returns on your bond portfolio
In times of turbulent markets and uncertainty, bond investors will need to turn to their trade plans to remind them of their goals.
It pays to plan. In times of rising global and local interest rates, a plan will keep you on track towards achieving your goals. Now more than ever, a trade plan will help you maximize your returns or keep you from losing money.
If you are looking to buy bonds, you can start with three questions: Are the funds to be invested intended for hold-to-maturity? Are you after the cash flows from coupons? Or are you aiming to make gains from trading?
These questions will help you to choose which among the wide selection of securities is best suited for your goals—considering the tenor and yield. They will help you determine your investment horizon, or the amount of time you can leave your funds invested before you need the proceeds.
However, if your goal is to take profit on existing holdings, either to reinvest in better yielding bonds or to liquidate positions, then setting target exit and entry levels is a must. Trade plans should have very specific target levels, which give the investor the benefit of estimating their gains.
When to buy, when to sell
They say that timing is everything, and this is especially true for bonds now. Investors would want to buy when yields are high (bond prices are low) and sell when yields are low (bond prices are high).
Forming a trade plan should always be guided by an outlook on interest rates. As a concrete example, major central banks around the world, as well as the Bangko Sentral ng Pilipinas (BSP), are currently looking at hiking rates throughout the year to quash inflation.
With the prospect of higher interest rates on the horizon, any price rally should be taken as an opportunity to take profit, especially in the short- to medium-term bonds, where new and better yielding bonds are likely to be offered.
Keep an eye on bond issuances
For those who are looking to buy peso bonds, it would also be valuable to pay attention to the weekly issuances of government securities by the Bureau of the Treasury (BTr) and to opportunistically participate in these auctions with a target yield.
This should give bond investors a better idea of where virtually “risk-free” peso rates are, which should also be helpful in comparing with higher-yielding corporate bonds. Needless to say, being up-to-date with new corporate bond issuances is also ideal.
When assessing which bonds or tenors offer good value, some traders often evaluate “yield spreads”. In bonds, the yield spread, or simply the “spread”, is the difference between two yields. Take, for example, a five-year peso government bond that yields 6% and a similarly-tenored five-year peso corporate bond that yields 7%. The difference is 1%, expressed as 100 basis points (bps).
On the other hand, if another five-year corporate bond from another issuer yields 7.40%, then the spread between the two corporate bonds is 40 bps. This 7.40% peso corporate bond would also offer a 140-basis point spread over the 6% peso government bond.
Compare with other bonds
Trade plans take into account a bond’s “relative value” and look at the spread that a particular security offers over comparable bonds. Comparable bonds are usually those that have the same risk rating, the same (or closely similar) issuers, across either the same or different tenors. Oftentimes, it is also important to consider the spread over the key benchmark interest rate.
Traders also look into the historical trends in spreads, to see whether a particular bond or tenor is already looking attractive at current levels. If seven-year peso government bonds offered a 200-basis point spread over the key policy rate five years ago, and high inflation now offers 400 bps in spread over the same benchmark, then some may consider this pick-up in yield spreads substantial.
Considering other factors such as the outlook for rates, other tenors, sentiment, etc., some may find this current pick-up in yield spreads a good entry level for a seven-year peso government bond.
Feeling the market
Lastly, market sentiment for risk is another important consideration when crafting trade plans. For example, if the market is not optimistic about the near future, a sell-off in short-term bonds would ensue, and market participants would favor longer-term bonds.
Short-term yields would then go higher, which would not bode well for holders of these short-term bonds. Therefore, anticipating market sentiment when planning where to reinvest bond proceeds should be done in a timely manner. Trade plans may also be updated from time to time, in keeping with the goal of being opportunistic with trades.
Overall, being guided by target entry or exit levels, as well as an assessment of relative valuation, are the most crucial benefits of a trade plan. Having said that, coming up with one could be very tricky in times of rapid increases in rates.
But don’t fret—you can always consult with your investment specialist to ask for timely trade strategies and market outlook. Luckily, Wealth Insights is also here to keep you abreast of the latest developments in the financial markets, top portfolio picks, and the latest trade plans.
PATTY MEMBREBE is a Financial Markets Analyst at Metrobank – Institutional Investors Coverage Division, under the Market Strategy and Advisory Section. She communicates strategies on fixed income, rates, and portfolio solutions for our high-net-worth individual and institutional clients. She holds an AB Economics degree from Ateneo de Manila University and is currently pursuing graduate studies. On her free time, she enjoys watching indie films and watching gigs to support local indie music.