Investing in bonds in a rates hike environment
Out of interest, is there any way to invest in bonds in an environment when US rates will be rising?
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What do you mean? Of course there is a way and it's the same as always, you buy bonds, you collect coupons...
Ok, I understand holding the bond until you collect par (in that case to maximise returns, you would just invest in whatever provides the highest yield?)
But what about if you don't want to hold the bond until the end of the its life? Wouldn't the impending rates hike kill its price? How would you get around that?
Sorry if the question is very basic!
There is no way to get around the basic nature of the instrument, other than by not buying the bond in the first place.
Haha fair enough. Thanks for the response.
One last question: Would you say there is any country whose government bonds are more shielded from the impending rates hike?
German bonds, Swiss bonds, etc... Hikes in the US are unlikely to move rates in Europe. Obviously, you will have to accept a much lower yield, but, like they say, there ain't no free lunch.
Well I guess you could.... not buy bonds?
Or just short it like most people do. Just be wary of capitulation
You could buy bonds... If you think rates will rise faster and higher than the forwards predict, you could buy floaters. Another option is to buy callable bonds whereby you are selling swaptions and picking up the premium unless rates fall (or don't rise), just as you are expecting. Both will still have duration, meaning they will drop in value as rates rise, but by less than a normal fixed rate bond.
On the other hand, there are bonds which will actually increase in value as rates rise which can be bought by retail investors. Let me ow if you want to find out more about structured notes!
I'd be interested if you don't mind sharing. I'm looking at getting into investing in bonds.
Sure, no problem. Anything in particular? Joseph Halpern writes a good blog on them called "Deconstructured Notes". As a quick rundown, structured notes are a combination of a bond investment and some kind of derivative. They can be linked to pretty much anything that has a derivative market - stocks, interest rates, commodities etc etc. They will be available (or not) depending on the type of brokerage account you have, how sophisticated you are as an investor, and how much money you have to invest.
Regarding this topic, one simple example of a bond which could rise in value as rates increase could be a levered floater. A regular 5 year floater might have a coupon like 3m$LIBOR + 0.5%. This will still have duration, but the duration will be much lower than 5 years because as interest rates (which I'll callously approximate as LIBOR) rise, not only will the discount factor rise (which is the thing that usually makes bonds fall in value), but the coupon will also rise partially offsetting this.
Instead of making the coupon 3mL+0.5%, someone at an investment bank, who for the record will usually be a structurer, could change this coupon to (4 x 3mL - X%) for the same credit, so that from his point of view the present value of the two coupon sets is the same based on the Libor forwards, but the return profile is now different. Now if rates rise beyond the forward predictions, the coupon on the latter rises much faster than the coupon on the traditional floater. The chances are in this case the bond value will actually increase as Libor increases.
Why do you want to invest in bonds when US rates rise? There must be greener pastures.
" Based on last week's secondary market trading, market participants expect that the new issues, particularly the tax-exempt offerings, will be popular, with particular interest in the short and long end of the curve, as investors take what is often referred to as a "barbell strategy." However, unlike traditional barbell buying that prioritizes zero to two year and 10- to 15-year durations, the focus has been pushed further along the maturity schedule, said a New York based trader. Instead, the 10-year range has been particularly popular along with the 30-year end of the curve, said the trader. "
I work with primary market debt issuance but maybe somebody who is more familiar with the investing side can explain the above a bit better. You get your duration by combining long and short bonds where your short end is less susceptible to interest rate movement.
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