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AN IDEAL MIX WITH HIGH CREDIT QUALITY BONDS by Dian Blackwood, Assistant Vice President Personal Financial Planning

safe bonds of high credit quality and the benefits of including them in our investment basket.

What is credit quality and why does it matter?

Dian Blackwood


eek after week we’ve educated our readers on market activities, terminologies used and opportunities that exist in the investment arena. As investors we are now more informed about the investment options available and the selection of different assets for our portfolio has become a bit easier. Our focus this week is on

It’s easy to think of a credit rating like a grade in school. The higher the grade, the better the performance of the student. Similarly with other forms of investments, the higher the credit rating of the issuer of a bond, the better the performance and the safer the issuer. Credit quality, can most easily be described as a measure of the risk of default i.e. the probability that the issuer of the bond won’t repay the bondholder. High credit quality implies a low risk of default and low credit quality implies a high risk of default. Credit quality is usually assessed by well-known credit rating agencies such as Standard & Poor’s, Moody’s and Fitch. These credit rating agencies perform detailed and thorough analyses of the

economic, competitive and financial characteristics of an issuer. They then assign a rating based on the results of their analysis. These credit ratings have come to be used as a guide for assessing the safety of an Kevin Richards investment. Each agency uses a similar scale but names the category differently but invariably the ratings are the same. Credit ratings of BBB+ or higher (the maximum being AAA) are termed “investment grade”, and are assigned to companies or governments with very sound and safe financial and competitive positions. Credit ratings between BBB and C are called “junk” bonds or “below investment grade bonds” and are less safe than investment grade bonds. Investors who value safety, should consider investing primarily in investment grade bonds. These bonds have relatively low levels of



• An ideal mix with high Credit quality bonds

• Making money on bonds • Changing Landscape of the Local Financial Services Industry

• Credits We Like • Sterling Personality • Sterling Social THE


• Charles


• Pamela


• Dian


• Kevin


• Lisa Minto






Judith Bloomfield


•• Eugene Dave Stanley

Trading Trading

• Eugene

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Capture Sterling’s experience in bond portfolio

management through Sterling Investments Ltd.



bonds have relatively low levels of credit risk (i.e. the risk of default by the issuer and the ultimate loss of your investment). These bonds have also become very attractive with the decline in the global interest rates. The lower interest rates mean that we can earn similar returns on safer bonds with high credit ratings than we earn on more risky bonds with lower credit ratings.

A Closer Look – investment grade bonds are for everyone Bonds of a high credit quality are always a worthy option for a well-established investment portfolio. These bonds are for clients who want to earn returns at a steady pace and don’t want to worry about the safety of their investment. For active traders, the opportunity for capital appreciation heightens the attractiveness of investment grade bonds. There are a number of high credit quality bonds available in the market have outperformed many stocks. This illustration displays the great rewards that can be gained by actively buying and selling high credit quality bonds.

Over the years rating agencies have gained acceptance as a widely used and convenient tool for assessing the credit quality of the various bond issuers. While the ratings indeed provide guidance as to which instrument to invest in, other variables should be used in conjunction with those findings before making an investment decision. Weight should also be given to knowing the company that you are investing in and its longevity and past performance.

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Bonds allow for capital appreciation, significantly increasing your returns Total return on AIG 4.25% 2013 =159.3%


Market volatility provided attractive opportunities during the financial crisis

43 Purchase price in 2009

Sale price in 2011

Total return on AIG 4.25% 2013 =159.3%


Investment grade bonds provide income, capital gains and stability


Purchase price in 2009

Market price in 2011




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MAKING MONEY ON BONDS – by Pamela Lewis – Vice President, Investment and Client Services

to your needs. However, today we go a step further to discuss investment strategy – in other words, how we can use these products to make money.

Investment strategies

Pamela Lewis


ur articles have generally been aimed at informing the wider public about different investment products that exist in the market place. The wide array of investment structures and characteristics means that you can find something tailored specifically

The traditional and conservative way to make money on bonds (and just about every other financial instrument) is to buy and hold. This means, you could purchase bonds with very attractive interest rates or yields and hold them until they mature. This way you enjoy a fixed stream of income at specific intervals. Another way of investing in bonds is by employing an investment strategy called “laddering”. This is where a series of bonds is bought with different interest rates and maturity dates. A rung on the “ladder” represents an individual

bond in the series and the distance of one rung from the next is represented by the duration or tenure of each bond. The objective is to structure the bond maturity dates (or “rungs”) to coincide with your need for cash or other investments. This strategy is popular among large institutions as well as high net worth individuals who need to maximize the use of their medium term funds. Investors can also make money from bonds through active portfolio management. Here the investor’s primary objective is that of capital appreciation, i.e. buy at a discount and sell at a premium. He also enjoys income during the period within which he holds the bonds. Timing is literally everything as the investor does not want to sell his bonds too quickly when further upside is likely to occur; neither does he want to hold the bonds for so long as to wipe out any appreciation he may have been able to realize previously. An analytical eye must be kept on the interest rate and macro economic

environment at all times. Regardless of the strategy, a sound understanding of the credit quality, liquidity and financial soundness of the issuer of the bonds must be garnered by the investor. Recently, a number of issues have come onto the market which have presented good opportunities to take advantage of capital accumulation. The bonds we refer to are convertible bonds, popularly known as “cocos” because of their convertible feature. Minimum investment in these bonds are usually very high, some as high as US$200,000.00. Recent examples of successful purchases in these types of bonds include the following:

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A big part of


financial freedom is having your heart and mind free from


worry about the what-ifs of life.


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Suze Orman






Barclays Bank




Credit Agricole





Judith Bloomfield

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Judith holds the position of Vice President of Operations and has been with Sterling for twelve years. Judith brings to Sterling a wealth of experience gained through working for more than 25 years in the financial industry. Judith's skills are diverse and

PRICE at 28/2/2014

range from implementing client account software and operating procedures, to assisting in strategic planning and managing the day-to-day client operations of companies such as Sigma Investment Management Systems Ltd./Manufacturers Sigma Merchant Bank and Eagle Unit Trust. Judith is a graduate of the University of the West Indies (U.W.I.), Mona, Jamaica, where she holds a B.Sc in Management Studies. She is an avid field hockey player and has represented Jamaica in a number of caps and has mastered not only the bond markets but knows a thing or two on the dancefloor.




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The Changing Landscape of the Local Financial Services Industry Kevin Richards

fall of Ponzi schemes. There is really never a dull moment in the financial sector. The latest local market investment trend is the move towards Collective Investment Schemes or CIS’s.

Kevin Richards


he local financial sector has had more than its fair share of upheavals over the last twenty (20) years; crises range from high interest rates and the collapse of major financial institutions, to multiple debt exchanges, outright debt defaults and the rise and

Investment managers have been promoting these products as a way of shifting the risk of holding local assets from their balance sheet to the client’s portfolio. It is important to understand that when an investor buys a share in a unit trust or a mutual fund, he/she ultimately owns a proportional share of the underlying assets within the portfolio. Thus, it is very imporatnt for investors to understand what types of assets are held by the mutual fund or unit trust in which they are

investing. This move is expected to 2.50 reduce the capital 2.00 adequacy shortfalls that are currently facing many 1.50 financial institutions. This 1.00 shortfall has resulted from 0.50 the sizable reduction in the 0.00 prices of local6/1/2005 assets 5/16/2007 that 5/26/2003 collateralize the large repo portfolios issued by these institutions. Let’s explain how this happens in English: Step 1: Institution A purchases a government bond yielding 12% per annum. Step 2: Institution A approaches prospective client and offers said client 4% per annum, for example, to keep their

money for a term ranging from 30 days to 365 days or even longer. The government bond will act as “collateral” for the client’s funds. This common structure is known as a “repo”. Short for “repurchase agreement”. Effectively, Institution A is “Selling” the client the 4/22/2009 3/23/2011 2/20/2013 government bond for a pre-determined tenor and agreeing to buy it back (i.e. “repurchase it”) at a price that yields the investor 4%; hence the term “repo”. Institution A is essentially giving the client the asset (i.e. the government bond) in exchange for his/her cash and taking a spread on the rate differential between what the client is paid and what the asset earns. Institution A therefore earns the difference between the income from the asset

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Changing Landscape of the Local Financial Services Industry

(12%) and the price paid to the client (4%). In the event, the government bond falls in value or if the interest rate is reduced, the spread for the financial institution will narrow and the amount of the asset needed to collateralize the repo will increase. It is useful to compare this structure to a bank loan; if the market value of the loan collateral falls belows a specific amount, the borrower may have to put up more collateral to satisfy the conditions of the loan. Similarly, the effect of the fall in value of the repo “collateral” and the reduction in the interest rate is borne solely by Institution A . The client still earns theirCREDITS 4% when Institution A is... only earning, say 6%. WE LIKE Alternativley, if a client invests in a CIS, he/she owns an economic interest in that “government bond” described above. Technically, the client owns a state in a vehicle (i.e. a unit trust / mtuual fund) that in turn owns the asset. This means that the client will share in both the upward or downward shift in value of the bond. Ostensibly, the spread of eight (8) percentage points is what Institution A requires to maintain its operations on a day to day basis. The move is certainly one that should bring more stability and diversity to financial institutions, reducing their exposure to price volatility of funded assets. However, this could create a prolonged

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period of adjustment for clients who have only been schooled in the art of the Repo and know nothing of price risk. In such an instance, a client would no longer be able to precisely predict their returns and there will no longer be any fixed repurchase dates and total return rates as there are with repos. This shift has already begun as some institutions have dropped the axe on repo rates, leaving clients scampering. We have observed rates below 2% on significant sums of Jamaican dollars. In the context of inflation and 14.4% devaluation in 2013, an investor would have been better off purchasing USD and stuffing the cash at the back of his/her closet. What is particularly unfortunate is the fact that despite rising local Treasury Bill and interbroker interest rates, client repo rates have been moving in the opposite direction. This has resulted in increasingly negative real rates of return for investors; their life savings are being whittled away in real terms. The most recent Bank of Jamaica Treasury Bill tender saw six months rates averaging approximately 9.11% p.a. compared with 6.22% p.a. one year ago. The Central Bank is also offering a new security with yields of 9.03% for the first six months, again affirming higher prevailing local interest rates that are not being passed on to the investor. What is certain, is that the era of “guaranteed” rates




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of returns on fixed income investments with “minimal risk” is part of the past, particularly so for larger financial institutions that maintain large repo portfolios. Institutions will now have to focus on being more efficient and nimble in order to meet this new paradigm shift. How will your investment manager sustain attractive returns? Currently, we see the market engaging more actively in the sale of CIS to reduce their own balance sheet risk. However, what are the implications for the investor and how aligned are the incentives of the investment manager? We expect that more efficiently run organisations with strong track records of managing a variety of protfolios, may still be able to offer some sort of fixed period, short term fixed income investment. Investors will now have to review the track record of some investment houses to determine which CIS is worthy of their investment. In an era of negative real returns on investments, return of capital and return on capital will rank equally in the scheme of things.

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January - March 2014 VOLUME 1, ISSUE 4



Sterling Asset Management is a licensed securities dealer and provides investment management and advisory services to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, please e-mail us at: or visit our website at Like our page on Facebook and follow us on Twitter. For more details on how you can benefit from Sterling’s expertise call one of our advisors at: 7 Barbados Avenue Kingston 5 Jamaica, W.I. Phone: 876 754-2225-7 Fax: 876 754-8103 E-mail:

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Sterling Reporter Vol 1, Issue 4