Aparna_A4 Temp 16/05/2011 16:23 Page 9
Bond Market Bargains The Canadian comedian (of Indian descent) Russell Peters once joked in his stand-up routine that the Chinese and the Indians cannot do business together. “Indians cannot live without a bargain and Chinese can’t give you a bargain.” He then proceeds to relate a story of a Chinese market stall holder who when requested to reduce the price of a bag down from 35 Dollars, leaves the Indian customer displeased with this reply – “You seem like nice guy. I give you good price. 34.50”. f, like above, your discount-seeking cultural sensibilities drive you to bargain hunt in the government bond sector, you may be sorely disappointed, for it seems neither US nor UK’s debt is looking cheap currently. Contrarily, you may even feel, as Bill Gross of PIMCO suggested, that your pockets are being picked. The yield on a UK Government bond (also called a Gilt) that pays a coupon of 5% and matures in March 2012 is a paltry 0.61%. But you might also have noticed inflation in the UK was recently reported to be a target busting 4%. Like Russell Peter’s Indian consumer, you might already be starting to get annoyed – “What?? I get a measly 0.6% for lending to the UK government but then they wipe my money out with 4% inflation? Yeah, that’s fair!” It is pointless lending to the government unless you agree to lend money for a longer period. Buying a Gilt maturing in 10 years yields 3.4% while inflation is expected to average around 3.1% a year. You could make a small gain on your investment. It helps to remember a bond’s price always moves in the opposite direction of its yield, so that if yields rise, bond prices will fall, and vice versa. Investors have enjoyed a twenty year bull market as the yields on UK, European and US government bonds have declined along with policy rates in these regions. After this decline to record lows, many city analysts now expect there to be a natural turnaround in bond yields as policy rates rise. After all, how long
Aparna Ram, Investment Analyst, Seven Investment Management
can the Bank of England’s interest rates stay at 0.5%, they ask. The expectation is that the Bank will increase rates to combat high levels of inflation, with the first rate hike coming even as early as August. This will drive Gilt yields up and prices down. In the US, government bonds or Treasuries are being purchased chiefly by the Federal Reserve through the Quantitative Easing II program. This is expected to end in June. The question on everyone’s mind is who will take up the buying instead. Will there be a drop in demand and hence a fall in the prices of these bonds? These are all valid concerns. The high cost of government bonds plus the bleak prospects ahead makes investors rightly justified about shunning these ‘riskless’ securities. But there are two sides to every trade just as the Indian customer’s annoyance above is matched by the insistent Chinese seller. There are some dissenting voices in the bond world who expect the prices to rise further still and yields to fall lower. What could drive this? A possible slowdown in the UK or global economy, (not completely out of the question, as evidenced in recent falls in commodity prices, house prices and high unemployment levels) could drive investors who are uncertain about the future to sell risky assets like equities and buy into the safety provided by government bonds. Furthermore, traditionally big bond buyers like banks and pension funds are likely to keep demand high for longer dated issues. High demand leads to higher prices. In addition, understandably, there is a difference in opinion about UK inflation. Just as some expect inflation to keep rising (thereby eroding bond returns), others expect it to be a temporary blip and to fall next year. These people place the chances of a rate rise, not in August as mentioned above but further in the future. Therefore, in the short term, they do not expect yields to rise, or prices to fall. Are bonds expensive? Quite probably. Do they still provide a good opportunity for investment? It depends on which side of the argument here you agree with.
Asian Voice & Gujarat Samachar - 2011
Finance Banking Insurance (FBI)