Investors Sell Bonds But Keep Shares
I heard a fascinating account of a client’s bond strategy last week that I think is worth sharing because it perfectly illustrates why investors should not over-rely on any one asset class.
Back in 2011, Simon first started investing in bonds because his term deposits were no longer generating the same income they had in the past. A friend had recommended he try bonds for higher income and slightly higher risk.
Using his superannuation fund, Simon bought bonds worth approximately $350,000 consisting of four floating rate bonds and one fixed rate bond. Four of the bonds were trading at a discount, that is, below their face value of $100 meaning that if he held them to maturity, he would get back a higher capital sum that what he outlaid for them.
Two of the five bonds, he then sold 18 months later, prior to maturity, as the price of the bonds had increased delivering him a higher than expected return.
One of those, large Swiss reinsurer Swiss Re, was bought in May 2011 at $88.25. He sold in December 2012 for $100.50, delivering a capital gain of $12.25 in just 18 months, plus interest payments that would have delivered about 10 per cent per annum over that period. The other bond was issued by Vero insurance, a subsidiary of Suncorp and Simon also achieved a $1.25 gain on sale.
At this point three new bonds were purchased – a fixed rate Telstra bond, a Dampier to Bunbury Natural Gas Pipeline bond and a long dated inflation linked Sydney Airport bond maturing in 2030. The Sydney Airport bond was bought for $99, probably the sweet spot for this bond since it was issued.
Simon just made one additional trade on his SMSF account earlier this year when he sold National Wealth for a $4 gain and bought a short dated Vero fixed rate bond, maturing in December 2015. In the same month Simon set up another account in his own name and bought the Sydney Airport 2020 and 2030 inflation linked bonds.
Roll forward to the start of this month and Simon is now selling all of the bonds held in his superannuation account. I’m not sure of the reason but he needs the money.
At first I was baffled by the decision. In every instance bar one, Simon had made higher than expected profits on his bonds. In fact the Swiss Re and the Sydney Airport bonds would have earned better returns than many shares over the same period - the price of the Sydney Airport 2030 bond is now around $120.
Income was paid consistently and none of the investment grade companies he invested in had been downgraded or had any negative press.
Then I discovered the reason he sold his bonds was that they were in profit while his share portfolio was showing losses. His case illustrates the reason investors should diversify and hold bonds to complement their shares. The consistency of the bond portfolio allows Simon to sell off his bonds and use the funds without incurring any losses. Meanwhile, he can afford to wait for his shares to recover.
Unexpected life and market events can coincide. In this instance had Simon just held shares, he would have been a forced seller and incurred losses.
Note: The client’s name has been changed to protect his privacy.
Elizabeth Moran is a director of education and fixed income at Sydney-based bond broker, FIIG Securities.
She is a specialist on the bond market and regularly presents at conferences across Australia. Elizabeth is the editor of FIIG's weekly newsletter The Wire and is the is the author of "The Australian Guide to Fixed Income".