Corporate Bonds?

turbobob

Particularly at the moment, I think value would depend on what you believe the future default rate on corporate bonds within the fund will be. Currently the funds which are heavily invested in lower grade debt (high yield bond funds etc) are "cheap", because they've priced in a high default rate. Consequently the yields on them are very high. Even funds focussed in what was considered less risky debt are quite cheap. But the funds which focus exclusively on government bonds and AA and AAA rated corporate bonds are comparatively expensive.

As an aside, I think a lot of the current UK life insurance company share prices have been affected by this at the moment, as some of them have had to take huge write downs on the value of their bond portfolios. They all have billions tied up in bonds. E.g. L&G (LGEN) had to revise their assumptions on bond default rates recently, and you can see the effect this had on their share prices (well its one of the factors anyway).

tradetime

Ok, as a start point, on the example I gave above, would it be fair to say that valuation is a function of whether the bond is trading at a premium or discount, and by how much, coupled with the rating (whether or not you can trust that) / your own perception or judgement of life expectancy of the company (multiple companies in the case of the example) and how that relates to the coupon rate (risk payment?)

tradetime

An explanation of ratings here.

turbobob

Disclaimer: I'm far from knowledgeable in any of this! I did look at bond and gilt pricing for an exam I did a few years ago but I've forgotton a lot of it!! But lets look at the portfolio of the ETF that you've linked to - http://uk.ishares.com/fund/fund_all_holdings.do?fundId=157495&asOfDate=1236240000000&track=false

The top one is "BANCA INTESA SPA 5.5% Dec 19 2016". That is name of issuer (Banca Intesta SPA), the coupon (5.5%) and the redemption date (19/12/2016).

The nominal face value of this bond is £100 (this being deduced from the coupon rate being 5.5% and the coupon being £5.50). So at the redemption date it will pay £100, and each year until then, it will pay £5.50 interest. However it is currently priced at £96.13 which is below the face value. But I would guess that price is factoring in that theres a reasonable chance they'll still be around in 2016 and able to pay you the £100.

Now then, lets look at "GAZPROM 6.58% Oct 31 2013". The nominal face value is again £100. This one has a higher coupon rate of 6.58% and a shorter time to redemption. This one is priced at just £78.56, significantly under the face value, despite the higher coupon rate. This suggests the market thinks Gazprom has a greater chance of not paying up than the first one. However if they don't default then you'd stand to make a good profit.

Now take a look at "ARGON CAP PLC 8.162% Oct 5 2012" down at the very bottom for comparison. Thats priced at only £12.50. I think that is factoring in a huge chance of it not being paid at redemption.

Short and long dated bonds differ (I think) in that short dated bonds will tend to be priced closer to the face value (unless the risk of default is high). Longer dated bonds appear to be more volatile in price, and (guessing here) more sensitive to interest rate changes.

If I'm wrong in any of this please correct as like I said this is just as I understand it..

cloud_dog

Soooooooooo, in a very simplistic way............. Could someone (me, for example) possibly use the following as a guidance or planner:

Assume my risk profile is someone who would accept a 20% loss, would it be reasonable for me to plan a Corp Bond holding where the current price is up to 20% below the face value, or where the overall average of my Corp Bonds holding is around 20% of face value.

Is that a method of assessing bond acceptability, or have I made it just way too simplistic?

Edit: The huge assumption I've made is that the current bond pricing reflects the likely repayment risk.

turbobob

Hi Cloud_dog are you thinking of buying individual corporate bonds or managed funds that invest in them?

TBH I wouldn't be too concerned about the pricing of individual bonds if you are going into funds. If you are buying bonds individually then yes you would have to take a decision on each of them

It might not even be practical as its not easy to find as much info on the full holdings of most OEIC funds as it is for the iShares ETF. And it will change. I really think the way to mitigate risk is to diversify and make sure you have a good spread of different types of bond fund, as Dunstonh has posted. Within the corporate bond sector there is a fairly wide range of approaches taken by fund managers. E.g. compare these two:
Invesco http://www.h-l.co.uk/funds/fund_analysis/view/in_detail/sedol/3302877
M&G http://www.h-l.co.uk/funds/fund_analysis/view/in_detail/sedol/3128590

You also have other bond sectors to consider like gilts and index linked gilts, strategic bond, high yield bond, and global bonds.

FYI the sector definitions are :

UK Gilts Funds which invest at least 95% of their assets in Sterling denominated (or hedged back to Sterling) triple AAA rated, government backed securities, with at least 80% invested in UK government securities (Gilts).
UK Index Linked Gilts
Funds which invest at least 95% of their assets in Sterling denominated (or hedged back to Sterling) triple AAA rated government backed index linked securities, with at least 80% invested in UK Index Linked Gilts.
£ Corporate Bond
Funds which invest at least 80% of their assets in Sterling denominated (or hedged back to Sterling), Triple BBB minus or above corporate bond securities (as measured by Standard & Poors or an equivalent external rating agency). This excludes convertibles, preference shares and permanent interest bearing shares (PIBs).
£ Strategic Bond
Funds which invest at least 80% of their assets in Sterling denominated (or hedged back to Sterling) fixed interest securities. This includes convertibles, preference shares and permanent interest bearing shares (PIBs). At any point in time the asset allocation of these funds could theoretically place the fund in one of the other Fixed Interest sectors. The funds will remain in this sector on these occasions since it is the Manager's stated intention to retain the right to invest across the Sterling fixed interest credit risk spectrum.
£ High Yield
Funds which invest at least 80% of their assets in Sterling denominated (or hedged back to Sterling) fixed interest securities and at least 50% of their assets in below BBB minus fixed interest securities (as measured by Standard and Poors or an equivalent external rating agency), including convertibles, preference shares and permanent interest bearing shares (PIBs).
Global Bonds
Funds which invest at least 80% of their assets in fixed interest securities. All funds which contain more than 80% fixed interest investments are to be classified under this heading regardless of the fact that they may have more than 80% in a particular geographic sector, unless that geographic area is the UK, when the fund should be classified under the relevant UK (Sterling) heading.

Hope this helps a bit.

Lokolo

Hey could you explain:

This includes convertibles, preference shares and permanent interest bearing shares (PIBs).

I don't know what they are and your explanation of the above was pretty good so I'd rather you explain the google lol. I think thats the only difference between Corp Bond and Strategic Bond funds yes?

turbobob

Hi, convertibles refers to convertible bonds - bonds that can be converted into ordinary company shares. Preference shares are shares which have a higher priority for the payment of dividends than ordinary shares, and a higher priority for debt in the event of the company going into liquidation. But they don't have voting rights. AFAIK the government has preference shares in the banks it has bailed out!

I've had to look up PIB's - They are issued by Building Societies - here is a good explaination http://www.bsa.org.uk/faq/whatarepibs.htm

tradetime

Thanx for taking the time to post all this info turbobob, very helpful indeed. :beer:

cloud_dog

turbobob, as you may have been able to tell my knowledge of bonds is somewhat lacking so, I have taken the fund route and have identified four bond funds with varying focus or diversification.

I have researched the funds / fund managers and the top 10 holdings for each fund (which is pretty much all the info a private investor can find out).

I know one should never invest in something you do not fully understand but I recognise the need for me to diversify and I do understand investing but have never really got in to bonds.

Thanks for all your info.

cloud_dog