His name is John (not his real name). He’s 50 years old, married, with two college-age children. His family business is involved in commercial real estate and he and his siblings are already part of the second generation of owners.

Over the years, John has accumulated a considerable amount of US dollar-denominated bonds, which now account for 80% of his portfolio. This has allowed John to generate natural dollar cashflows that help pay for overseas travel with family.

However, a potential issue emerged. The average duration of John’s portfolio was only about 3.5 years, with 40% of the bonds set to mature between 2024 and 2026.

The financial experts were predicting that US interest rates would likely decrease in the next few years. This could create a problem for John. When his current bonds mature, he might have to reinvest his money at lower interest rates. This means he could earn less income from his investments in the future, which might affect his long-term financial goals.

Although there is market uncertainty on the US Federal Reserve’s first rate cut of the year, the general consensus is that the US interest rates will fall over the next 2 to 3 years as inflation moderates from their 2022 highs. Should he trade or invest? If John continues to hold onto some of these bonds until maturity, he faces reinvestment risk as the available bonds by then might yield much lower than 5%.

A plan was needed. We proposed a switch trade. What is a switch trade? This is a strategy of selling certain bonds in an investment portfolio and simultaneously buying other bonds to replace them.

Goals of the switch trade

We wanted to improve overall investment portfolio yield by conducting a switch trade.

1. Improve overall portfolio yield
2. Adjust the portfolio’s duration
3. Enhance diversification
4. Capitalize on market opportunities
5. Manage risk

Our proposal

1. Sell:

• US Treasury Note, 4.25% coupon, 2024 maturity
• US Treasury Note, 4.25% coupon, 2025 maturity
• Hyundai Capital America bond, 5.5% coupon, 2026 maturity

2. Buy:

• Korea Electric Power Corp bond, 5.5% coupon, 2028 maturity
• Citibank bond, 5.803% coupon, 2028 maturity
• Philippine retail dollar bond, 5.75% coupon, 2029 maturity
• New Hyundai Capital America bond, 5.4% coupon, 2031 maturity
• Starbucks Corp bond, 4.8% coupon, 2033 maturity
• Bangkok Bank bond, 5.5% coupon, 2033 maturity
• T-Mobile USA Inc bond, 5.5% coupon, 2033 maturity

What were the results?

This switch allowed John to:

• Increase his average yield from 4.25% to 5.34%
• Extend his portfolio’s average duration from 3.5 to 5 years
• Diversify across different sectors and geographies
• Potentially position his portfolio better for expected interest rate declines

This bond swap was a smart move to improve John’s investment performance while reducing the risk of lower returns in the future. His previous focus on shorter-dated US Treasury bonds was becoming less advantageous.

By switching to corporate bonds from different companies, John now has the potential for higher returns, but also takes on some additional risk. We carefully researched these companies to make sure they’re financially strong. We also advised John to spread his money across various companies, industries, and countries to reduce risk through diversification.

In one case, we recommended switching to a Hyundai bond with a slightly lower interest rate but a later maturity date. This strategy helps John maintain a yield of at least 5% for several years, which could be valuable if overall bond yields decrease as expected.