5 Reasons You Need To Diversify Your Bond Investments
Diversification is one of the simplest things investors can do to reduce our risk without affecting our potential returns. The concept is fairly straightforward, instead of being exposed to one company, we can choose to gain exposure to multiple companies.
If we only invested in one company, and that company falls into financial difficulties, our entire portfolio will be at risk. If we invest in 20 companies, and that same company falls into financial difficulties, only 5% of our portfolio will be at risk. That’s the simple premise anyway.
We tend to see this more clearly when investing in company stocks, but less so when investing into bonds. Here are five reasons why it’s equally important to diversify our bond portfolio.
# 1 Gain Exposure Into Bonds
First of all, before we even start diversifying our bond portfolio, we need to have a bond portfolio. Many investors, especially younger or more aggressive investors, tend to ignore bond investments altogether.
While stocks are typically more popular or sexier investments, it’s important to spread our investment portfolio into different asset classes. This forms our asset allocation strategy and can help protect our portfolio in times of economic downturns and boost our returns in times of economic progress.
While our individual asset allocation strategy may differ, we still need to have one.
# 2 We Should Diversify Our Bond Portfolio The Same Way We Diversify Our Stock Portfolio
Perhaps because of the popularity of stocks, many articles and even advice from experts on diversification tend to be about stocks. All this advice holds true to bonds, commodities and other alternative investments as well.
It’s common knowledge that diversifying our stock portfolio protects us from the risks of any one of the companies we invested in from going bankrupt, being mired in fraud, affected by government policy updates, impacted by a sector downturn, hampered by a natural disaster or anything else.
These are risks that can be diversified by simply investing in other similar companies or companies in other sectors or geographical region.
There’s really no reason why we shouldn’t think about our bond portfolio the same way. We can avoid the agony of facing large financial losses if any one of the companies that issued the bonds get into trouble.
Some bonds that come to mind include the Lehman Brothers Minibonds in the 2008 Global Financial Crisis, Swiber bond default during the oil & gas downcycle and even the recently embattled Hyflux bonds.
While other bonds in the market were still paying out interest and continuing to deliver varying degrees of returns, these companies defaulted on their bonds. It’s simple to see why diversifying your bond portfolio is equally important to your stock portfolio.
# 3 Minimum Investment Of $250,000
This isn’t really the fault of investors. Many bonds sold through Over-The-Counter (OTC) markets tend to have a minimum investment of $250,000.
While many of us can’t even invest into these bonds, those that are able to often concentrate their bond portfolio into one or two bonds at most. Rather than offer benefits from holding diverse asset classes, we may be doing our portfolio more harm than good by investing this way.
# 4 Investing In The Bonds Of The Stocks You’ve Already Invested In
It’s probably quite intuitive when put this way, but many investors may inadvertently buy the bonds of the stocks they’ve already invested in. Mainly, this could be down to understanding the company very well in the first place and being kept notified of such bond issues over the bond issues of other companies.
While this does help spread your portfolio into different asset classes, you will still face the unique risk of that one company. This may not be the best way to diversify your risks.
# 5 Diverse Bonds In Singapore
Singapore has an increasingly diverse bond markets for investors to make our first investments into the asset class or further diversify our bond portfolio. With these options available, there’s really no reason to concentrate our bond portfolios into just one bond or even one type of bond.
Here are some types of bonds we get gain exposure to in Singapore.
i) Government Bonds
They are all backed by the government of Singapore, and offer a relatively safe way to gain exposure to bonds. They typically deliver lower returns as these bonds tend to be the safest bonds to invest into.
ii) Bond ETF
The ABF Singapore Bond Index Fund is the only bond ETF listed in Singapore. Investing in this exchange traded fund (ETF) enables us to gain exposure to a diverse basket of high-quality bonds issued by the Singapore government and quasi-Singapore government entities, for as little as $100.
Investing via a fund, we will typically have to fork out a small fund management fee for the convenience of having a professional fund manager tracking the bond index. We also don’t have to reinvest bonds that mature as the fund managers will do that on our behalf.
The ABF Singapore Bond Fund has a yield to maturity of close to 2.7%.
iii) Astrea IV PE Bonds
Listed on the Singapore Exchange (SGX) on 18 June 2018, the Astrea IV bonds is a new type of bond offered to retail investors in Singapore.
Issued by Temasek-unit, Azalea Group, the Astrea IV PE Bonds offer retail investors access to private equity. Interest payments are backed by cashflows from a diversified portfolio of private equity funds managed by world-leading private equity managers including Apollo, Blackstone, KKR, PAG, Silver Lake, The Carlyle Group, TPG and Warburg Pincus.
The Astrea IV PE Bonds are paying a coupon of 4.35%.
iv) Corporate Bonds
Corporate bonds are issued by companies. These bonds can vary greatly in terms of risk, and investors should carefully consider investing into these bonds.
There are several listed bonds in Singapore that you can invest on the SGX. The main difference between retail bonds and corporate bonds is that we can typically invest in retail bonds from $1,000 while most unlisted corporate bonds tend to require a minimum investment of $250,000.
Many of these retail bonds are also issued by companies that are already listed on SGX, and you can easily be holding both the stocks and bonds of a company. As you can see from the link above, companies such as CapitaLand Mall Trust and Frasers Property have listed bonds, as do companies such as Hyflux.
We Have To Diversify Our Bond Holdings As Well
Rather than just diversifying our investments into bonds, it’s equally important that we diversify our bond investments. Not doing so can leave our portfolio in a poorer state.
Even though there may be some stumbling blocks such as the high investment cost of certain bond investments, there are ample options for ordinary investors like us to get started.
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