In difficult years for stocks, bonds often stabilize investors’ portfolios. This was not the case in 2022. On the other hand, the yields on bonds are now significantly more attractive again. Where experts see entry opportunities.
In the past year, investors suffered losses not only with stocks but also with bonds.
The year 2022 was a very bad year not only for stocks but also for bonds. Anyone who had securities considered safe investments in their custody account in the past year generally suffered significant losses with them.
This is shown by a look at common indices and investment products from the bond sector. In the “horror year” 2022, as the analysts at Bank LBBW put it, the index for government bonds in the euro zone, the iBoxx Euro Sovereign Index, lost 18.4 percent in value. Anyone who had an exchange-traded fund (ETF) in their portfolio that reflects this index must expect losses of this magnitude. As Bank LBBW explains, this index already lost value in 2021, at that time a manageable 3.5 percent.
However, these losses also have a – positive – downside. Finally, when bond prices fall, bond yields rise. Conversely, this means that bonds are again offering significantly more attractive returns than in previous years. The main reason for this development is the significant rate hikes by the central banks over the past year, with which they responded to persistently high inflation.
Higher yields also for Swiss franc bonds
The higher interest rates are also reflected in the yields on bonds on the Swiss capital market. Traditionally, many new bonds come onto the market at the beginning of the year. This week, for example, according to agency reports, the Walliser Kantonalbank issued a bond with a term of five and a half years and an interest coupon of 2.05 percent. Meanwhile, the Luzerner Kantonalbank launched a bond with a term of nine years and a coupon of 2.125 percent.
Other new issues included a five-year bond from French bank BNP Paribas with a coupon of 2.4125 percent and an equally long-dated bond from the Royal Bank of Canada with a coupon of 2.445 percent. Other new bonds came from Britain’s Nationwide Building Society building society, Münchener Hypothekenbank and Svensk Exportkredit, a Swedish state-owned company that supports domestic exporters.
Small investors are interested again
For Swiss private investors who want to invest money in bonds, Marco Köpfli from the Zurich-based credit risk consulting firm Independent Credit View (I-CV) sees Swiss franc bonds with credit quality in the “investment class” (investment grade) area as the most suitable option. Such bonds therefore have ratings of “BBB–” and better.
With the sharp rise in interest rates since the beginning of 2022, the papers would again be of great interest to small investors, says Köpfli. In the low-interest environment of the past few years with interest coupons of 0 percent or a little more, bonds would hardly have played a role for them. This has now suddenly changed.
The expert advises private investors to focus on bonds with a short to medium-term term, i.e. two to five years. The duration risks are higher for longer maturities, which can lead to high price volatility in the event of a strong interest rate movement – in his view, this is “more for professional investors” who deal with the financial markets on a daily basis and trade actively.
Don’t be fooled by high coupons
If investors buy a bond and hold it to maturity, they get the corresponding yield – provided there is no default. So you have the option to «log in» the currently paid returns. However, when investing in bonds, careful selection and continuous monitoring remain the top priority, says Köpfli. Finally, the creditworthiness of an issuer can change over the term, which increases the risk of default. From his point of view, bonds from large, broadly diversified companies with a robust balance sheet structure and activities in defensive, less cyclical sectors are to be preferred. Such papers also had sufficient liquidity on the capital market.
This is not the case for many issuers in the high yield bond market. These have received a rating below the so-called “investment class” from the rating agencies. In return, they offer risk-taking investors higher returns. However, should a recession break out, some of these issuers could face difficulties. The rating agency Standard & Poor’s (S&P) assumes that the number of loan defaults in Europe could increase significantly in 2023. By September, S&P expects the default rate for companies with speculative ratings to be 3.25 percent. A year earlier, this rate was 1.4 percent.
Eliminate currency risks
When buying bonds, it is also important to pay attention to the currency. According to Köpfli, Swiss private investors should treat the purchase of securities denominated in euros or dollars with appropriate caution. Investors should not be dazzled by the often higher yields and should bear in mind that when they buy such securities, they are taking on a currency risk that is not insignificant. Over the past few decades, the Swiss franc has become significantly stronger against the dollar or the euro. Movements on the foreign exchange markets could quickly eat away a large part of the return, says Köpfli.
Another problem with bonds in euros or dollars is the high minimum denomination. Some bonds can only be bought from an amount of 100,000 euros or 200,000 dollars. In the case of Swiss franc bonds, on the other hand, the minimum denomination is often 5,000 francs.
Bond funds or ETFs are alternatives for private investors. ETF stands for Exchange Traded Funds. Such financial products reflect the development of bond indices. Their big advantage is that their fees are generally significantly lower than those of actively managed bond funds. With all these financial products, Swiss franc investors should ensure that the currency risk is hedged.
When investing in bonds, it is also important to remember that these are returns before inflation is deducted. If you include these, you as an investor quickly end up back in the red. On Friday it became known that inflation in the euro zone amounted to 9.2 percent in December last year – in November it was still 10.1 percent. In 2022, Switzerland also recorded average annual inflation that was high for the country 2.8 percent.
Monetary policy affects returns
For investors, before buying a bond or a corresponding financial product, the question arises as to how the monetary policy of the central banks will continue. This also has a significant impact on bond yields.
The investment experts at Raiffeisen Switzerland assume that inflation has peaked. They expect annual inflation of 5.5 percent for Europe and around 4 percent for the USA, as they announced on Wednesday when presenting their investment outlook.
Even if inflation should drop this year, the central banks are likely to stick to their restrictive monetary policy for the time being, the Raiffeisen representatives expect. The strong figures on the US labor market published on Friday also suggest that the US Federal Reserve is likely to make further interest rate hikes. In December last year, 223,000 new jobs were created outside of the agricultural sector. In addition, the unemployment rate fell from 3.6 to 3.5 percent.