Telegraph article-bond funds..

C_Mababejive

http://www.telegraph.co.uk/finance/personalfinance/investing/10324379/10-bond-funds-that-will-weather-the-storm.html

Now im not one of the mega wealthy and this may be because im failing to understand what others preach as received wisdom but the bottom line to this article seems to be

QE tap off or tapering= bad for bond funds

Why?

Surely corporate bond funds will still continue to generate the same returns as they are effectively long term loans? Surely they are a lower risk safe haven sheltered from the volatility of the stock market?

We keep hearing about this "great rotation". Isnt it all just baloney , guru speak and patter when there is really nothing to fear.

If good quality bonds were so wobbly,why do pension funds de-risk into them?

alanq

If you hold a bond until maturity the amount that you get is known and fixed (if the company doesn't fail!).

If you want to sell before maturity you will get what someone is prepared to pay for it. If you want to sell a bond paying 5% when the going rate is 10% your bond is worth less than its face value. If you want to sell a bond paying 10% when the going rate is 5% your bond will be worth more than its face value.

C_Mababejive

So how is the "going rate" decided and what is the linkage to QE?

gadgetmind

The going rate depends on many factors but the main one is what the risk is of the company defaulting is (which is what credit rating agencies are supposed to do), and this then establishes how much extra someone would want to hold that bond versus a (supposedly) risk free gilt or treasury.

The yield on fixed interest assets such as bonds and gilts can be shown as a "yield curve" and the shape of this depends on future expectations regards inflation and interest rates.

For an idea of how complex it can all get, have a read of this!

http://en.wikipedia.org/wiki/Yield_curve

and here is the current yield curve for UK gilts.

http://markets.ft.com/research/Markets/Bonds

Because returns on gilts are so low, investors are taking more risk to get the return they'd like. This pushes up the prices of those riskier bonds (when yields go down, prices go up as coupons are fixed) and if you buy at a higher price, then your return is less.

For example, if you buy a bond with a par price of £100 and a coupon of 10%, then you'll get £10 pa until the bond matures at which point you get your £100 back. This lets you work out your return *but* you won't know your real return until the end as you can't exactly predict interest rates.

Now imagine that you bought that bond from someone else and because you liked the look of that coupon, you paid £150. Because the coupon is fixed, your yield is only 6.6%, but it gets worse! At maturity, you'll only get £100 back, so you need to work out your yield to maturity.

You'll notice that some UK index linked gilts have a negative yield to maturity! Yes, you are guaranteed to lose money!

C_Mababejive

But gilts are not the same as investment grade corporate bonds so how can QE affect investment grade corporate bonds save for making them slightly less attractive in the face of increasing interest rates,which i dont think is going to happen any time soon..?

gadgetmind

Because bond buyers also look at the spread between any given bond and the rate that could be obtained from gilts and treasuries.

http://www.fixedincomeinvestor.co.uk/x/learnaboutbonds.html?id=98

This is the key paragraph but you really need to work through the rest for background.

"And how about corporate bonds? The relationship between price and yield for a corporate bond is exactly the same as a government bond, and the same yield calculators can be used for both. However, compared to a super-safe government bond, investors will demand an additional return for lending money to corporations due to the risk of default. This premium over the equivalent government bond yield is known as the spread."

BTW, that web site is a daily read for me, which shows how sad some people are!

slinga

Is the use of QE there to prop up the banks or help the UK economy.

gadgetmind

The banks were propped up by the government injecting cash in exchange for taking over majority ownership via various kinds of equity holdings.

QE is a way of injecting money into the economy by the government buying back their own debt. The idea is that those who previously held the debt now go off and buy something different and/or lend the money to someone. This buying also manipulated the yield curve for government debt, which has (as above) a knock-on effect on other debt making it easier for businesses to raise finance.

http://en.wikipedia.org/wiki/Quantitative_easing

They can play fancy games with the yield curve if they want to by buying debt with certain maturities while selling others.

http://en.wikipedia.org/wiki/Operation_Twist

jimjames

If QE drove up prices by buying more gilts and therefore yields went down when the buyers drop out with less QE, less buyers, less demand means lower prices and higher yields.

At least that's my simple view of how I think it is meant to work

gadgetmind

Yes, it's already working like that even with just the threat of tapering.

For example, 15 year gilt yields got down close to 2% but are now at 3.2% having got close to 3.4% (from memory).

Glen_Clark

gadgetmind wrote: »

This buying also manipulated the yield curve for government debt, which has (as above) a knock-on effect on other debt making it easier for businesses to raise finance.

and yet lending to business has fallen.....
Bank and Building Society managers tend to prefer lending on property because its less complicated for them to understand than industry. Help to Bubble has exacerbated this problem by making lending on property more attractive.