What is risk? – Bonds

By Peter Brooke
This article is published on: 23rd April 2013

In this series of articles we are considering the different TYPES of RISK we take when investing in different assets. This should help to build a portfolio in which we fully understand what risks each part of the portfolio expose us to.

The term bond is broadly used in the financial industry; here we concentrate on the “investment asset” often known as fixed interest, fixed income or debt securities. Government Bonds have their own specific names too; e.g. UK GILTS, US T-Bills & German BUNDS.

If a company or government needs to raise money and doesn’t want to (or can’t) issue new shares or borrow from a bank they may issue a bond. It promises to repay the bond holder its face value on a set date in the future and until then will pay interest for the loan (the coupon). Bonds are issued on the ‘issue date’ but can be freely traded on the bond market so their price can fluctuate with normal market conditions. The fluctuation in price means that the ‘yield’ changes too – this is the fixed coupon but if bought at a different price gives a different actual yield.

When a company is wound up (e.g. on bankruptcy) the bond holders, as creditors, are repaid from the assets of the company before shareholders; this means that bonds are considered safer to hold than shares. The coupon must also be paid before any dividends. So what risks should we consider before buying bonds:

Default Risk – can the bond issuer repay me my coupon every year AND can they pay me back at the end of the term?

Interest rate risk – as rates go up, bond values fall (and vice versa). In a low interest rate environment are we exposing the value of our capital to risk if interest rates are increased?

Market risk – these are investments, and though considered safe a flow of money out of the bond markets because of lack of confidence can affect prices.

Issuer specific risk – a lack of confidence in the future of the company can, like shares, create a selling of the bonds too.

Liquidity risk – if buying smaller company or peripheral government bonds, it can be tricky to sell them should you need to quickly.

SAFETY vs RISK – at the moment developed government and many ‘blue chip’ company bonds are trading at record low yields, and though they are considered SAFE (as they are unlikely to default) this doesn’t mean they are without RISK. If a bond has a yield of 1.5% and interest rates go up by 1% it is possible to lose 10% of the capital value… this is now not LOW RISK.

Buying bonds through a fund can often help reduce many risks; the manager can choose which sectors to invest in or not and can manage the specific risks appropriately. We favour global strategic bond funds as they have a very broad remit and a very large bond universe to invest into.

This article is for information only and should not be considered as advice.

What is risk? – Bank accounts and Cash

By Peter Brooke
This article is published on: 12th March 2013

RISK:  The dictionary definition: exposure to the chance of injury or loss; a hazard or dangerous chance.

We all think the concept of LOSS as being the principle financial risk, but there are different types of risk which can affect the value of our capital and the return we get from it;

The safest form of investment asset is considered to be CASH, but what are the risks (OF LOSS) if I hold €100 000 in my French bank account?

1. 1.    Counterparty & Jurisdictional Risk – If my bank (my counterparty) goes bust the French (my jurisdiction) government will currently underwrite the first €80 000 of all individual deposits –  a potential 20% counterparty risk in having this much money on my account. If I bank with a big name in a well protected jurisdiction I should be ok, but should I move the excess to another bank to reduce risk?
2. 2.    Inflation Risk – with time the COSTs of goods and services tend to increase; this eats away at the real value of money or ‘it’s buying power’. Today global inflation is approximately 2.5%p.a.

But that’s not the whole story as inflation is based on an average ’basket of goods and services’. At different stages of our lives the inflation of different elements within the ‘basket’ can vary: The cost of living might drop for a family with a mortgage when interest rates fall, but an elderly couple with food and fuel bills, and no mortgage feels the pinch as oil, coal and food prices rise.

1. 3.    Interest rate risk – the bank pays me interest on my money and lends it out at a higher rate and pockets the difference as profit. If interest rates are high I am taking risk that my return may  fall; can I get a similar return for similar risk elsewhere?

If interest rates are low, like today, then I am swapping interest rate risk for  inflation risk by having my money on account. It is therefore the amount of my return OVER INFLATION which should be my only concern when looking at the amount of risk I am willing to take.

Today if I am lucky enough to earn 0.5% interest it means I am losing 2% per year…. guaranteed.

1. 4.    Default risk – the bank should continue to pay me the interest as it receives it from its lenders. There is a small risk here if I choose a weaker bank.

But by banking my money I am NOT taking the following risks:

1. Liquidity risk – I can get to my money anytime.
2. Investment risk (volatility of returns) – my money is just in a bank account, the interest may change a tiny amount but the capital value remains stable (except for inflation).
3. Opportunity risk – as my money is not tied up I can use it to buy any sudden opportunities that come along (once I understand the risk/return swap).

This article is for information only and should not be considered as advice.

It’s not timing the market – It’s time ‘in’ the market

By Craig Welsh
This article is published on: 5th June 2008

Global stock-markets are currently extremely volatile. Craig Welsh tells you what you can do if you have savings or investments?

The volatility seen in recent months in global stock-markets has prompted many headlines. The credit problems emanating from the US housing market slump, and recessionary fears, have had an impact on the value of shares on all market indices. So if you have savings or investments, it is only natural to have some concerns – so what do you do?

Well, every market cycle can experience periods of volatility, with both up and down days. Often, a few very good days account for a large part of the total return. Staying the course ensures that investments will be ‘in’ the market on the good days. It can be tempting to try to time market movements by selling stocks / funds when you think the market is about to decline and by buying stocks / funds when it appears the market is about to rise.

Resist being a market timer! Very, very few people, including many professionals, are successful. By trying to time the market, you will potentially (and most probably will) miss out on market rallies that could substantially improve your overall return and long-term wealth. What is most important is not timing the market, but rather time IN the market. Staying the course can prove very rewarding in the long run. Consistently predicting which days will move in which direction, though, is virtually impossible and can ultimately be very costly.

Missing only a few of the best days over the last few years would have had an adverse effect on total return. For example; a hypothetical USD 10,000 initial investment in the S&P 500 Index held over the entire period of 1 January 1997 through 31 December 2006 would have grown to USD 22,446. Missing just the five best days would have reduced the ending value to USD 17,357.

To put it another way, from 1992-2007 the UK FTSE All-share returned an average annual return of 9.84 percent. Had you missed only the best 10 days of market rallies, your annual return would have been 6.89 percent, or only 2.78 percent had you not been invested in the best 30 days over the period. (Source: Fidelity International)

So resist trying to time the markets. Set clear objectives, be mindful of how long you want to invest for and ensure you have a well-diversified portfolio. Understand exactly the risk involved, and, very importantly – have regular reviews.

Is now a good time to start investing?

Many people do see opportunities when markets are more volatile, and like in any line of business, buying low and selling higher is fundamental to success. However it really depends on your own circumstances.

• Establish what your financial planning needs are and set some objectives. Where are you now and where would you like to be in the future? Are there other areas which require attention first? Investment is about making your money work harder for you, so think about what sort of returns you are expecting.
• Be clear about your time horizon. For example when do you plan to use the money? If you have a medium – long-term view (5 – 10 years) then it really does make sense to consider investing.
• Be clear about your attitude to risk. The relationship between risk and reward means that greater long-term returns are often delivered     through investments that involve a higher degree of short-term risk. Hence the length of time you have is crucial.

For expats, or people in the international community, managing finances can be difficult and time-consuming. Add to that the various tax, pension and currency implications of moving countries and it can become a real headache.

Proper planning is vital and on-going assistance and advice from a properly licensed adviser, with particular focus on expatriates, can prove invaluable.

Please note that past performance is no guide to future performance and that you should take professional independent advice before investing.