DBS

29 are more likely to remain constant for weeks or months at a time 51 . This is one of the reasons why high-yield bonds appeal to investors who seek equity-like returns at much lower volatility levels than equities 52 . When buying shares, an investor is betting the stock will go up in value based on market research. There are high risk stocks and low risk stocks, but there is always risk involved because performance of the market is never definite 53 . Buying a bond, debenture or loan note, on the other hand, is much less susceptible to fluctuating market sentiment, as it is based on a promise (often asset backed) that the issuer will pay regular interest at regular intervals and repay the capital. It’s not based on complicated valuations and third party perceptions. There is always the chance a bond issuer will go bankrupt and default, but many debt based securities offer strong mitigations for this risk. In addition, the greater stability in crowdfunded DBS returns make it easier to plan for a client’s financial future; knowing that an asset will pay a certain amount each year allows advisers to set targets and better estimate returns on investment 54 . FIXED TERM / DEFINED EXIT A debt based security promises a regular payment – from monthly, to six monthly or annually (the interest or coupon), which some products allow to be rolled up, and the return of capital (along with any rolled-up interest) at the end of the term, as agreed in the investment documentation. Market conditions have been difficult to predict over the last few years, so for some degree of certainty in investment returns, bonds and debentures can provide that measure of dependability; only with DBS with fixed maturity dates and fixed coupons can the returns that will be earned over a given time frame be calculated and the date of capital repayment be confidently determined 55 . There is a lot to be said for a defined investment exit date. As well as, again, giving advisers great information with which to structure a client’s advice and recommendations with some certainty, it also simplifies determining the exit risks associated with the investment. There are risks to be aware of, but debt based securities that generate a predictable level of income and return the capital can create a useful portfolio that will appeal in particular to those who want certainty about their investment income. Those in retirement, for example, may prefer such a portfolio to the purchase of an annuity, handing over all their savings to an insurer in the process. Whilst this won’t give them the guaranteed income for life that an annuity offers, it is likely to pay a better rate of income. UNCORRELATED TO MAINSTREAM EQUITY Portfolio theory dictates that it’s important to include uncorrelated assets with price movements that are largely independent of one another rather than moving up and down in tandem. Since over long periods, bonds and equities do not tend to move in tandem, the use of bonds and equities in the same portfolio is a common method of diversification. As a result of this negative correlation, (one variable increases as the other decreases, and vice versa) a ‘traditional’ portfolio may comprise simply equities and bonds 56 . Nevertheless, correlations can vary significantly over time. In an economic downturn, equities are less popular and demand for safe haven government bonds picks up, leading to a negative equity-bond correlation. This pattern has continued throughout this millennium thus far, driving a predominantly negative equity-bond correlation – on average it has been negative since 2000 57 . This represents a shift from the positive correlation seen for most of the previous 30 years. More recent experience has been particularly extreme due to the risk-on risk-off nature of markets since the financial crisis. BlackRock’s expectation is that the current relationship will persist, even if at times it may become positive 58 . And, if we look at high yield bonds (of lesser credit quality and with greater returns than investment grade bonds such as government bonds/gilts, but still listed) as a proxy for debt based securities, they don’t correlate exactly with either investment-grade bonds or stocks. Because of their higher yields, they’re less vulnerable to interest rate shifts, especially at lower levels of credit quality 59 . For example, a debenture with a fixed interest rate of 6% will be much more attractive than a government bond with a yield of 1.5% when inflation is running at 2%. This can make debt based securities even more useful within a portfolio. “A significant decline in yields has increased the appetite for riskier, high-yielding bonds, suggesting that bond markets should remain accommodating of non-financial corporations and further bank disintermediation.” - Michel Carayon, Moody’s A perfect negative correlation is represented by the value -1.00, while a 0.00 indicates no correlation and a +1.00 indicates a perfect positive correlation.