All investments carry risks but it may be possible to reduce them by adding investment-grade bonds to your portfolio.
While stocks offer the potential for higher returns over the long term, they do not offer the same level of protection as investment-grade bonds, which may be more resilient in falling markets.
This is because, unlike stock dividends, the interest payments on bonds are contractual and cannot be cut. The principal, which is the amount of money borrowed, has to be repaid in full when the bonds mature. In contrast, stock prices can be highly volatile and there is no guarantee how much a stock can be sold for in future.
At a time of increased global uncertainty due to the war in Ukraine, supply chain disruptions and decades-high inflation, you may want to consider adding investment-grade bonds to your portfolio.
Near zero default rates
Historically, the risk of default was very low in the case of investment-grade bonds.
Moody’s, a global rating agency, said AAA-rated bonds, the safest available, have had a zero per cent default rate since 1920. Adding on, Moody’s also found that for AA-rated and A-rated bonds, the historical average annual default rate is 0.1 per cent, while the default rate for BBB or Baa-rated bonds is 0.3 per cent1.
Bonds can, however, fall in value if interest rates rise. For example, a bond that pays an annual interest rate of 3 per cent may have to be resold at a discount if investors start demanding a higher return. Conversely, the bond may fetch a higher price if interest rates fall.
Greater uncertainty, lower growth
“Holding investment-grade bonds helps manage risks in this current environment where there are all sorts of uncertainties. Covid-19 remains a problem, with lockdowns in certain countries disrupting global supply chains and trade,” says Mr Bertram Sarmago, Nikko Asset Management’s investment director and portfolio manager for Asian Fixed Income.
In April, the World Bank cut its 2022 growth forecast for East Asia and the Pacific to 5.0 per cent from 5.4 per cent and warned that the region’s economy could lose further momentum if conditions worsen2.
“Bond ETFs (exchange-traded funds) can also be more liquid than their underlying bonds, giving investors greater flexibility to adjust their bond-equity allocations,” Mr Sarmago mentions.
“On the other hand, if inflation remains high, this could lead to faster policy rate hikes from central banks, leading to higher interest rates, negatively impacting performance of bonds.”
Two bond ETFs to consider
It may be rather difficult for retail investors to invest in bonds since many were sold in large denominations of around $250,000.
Investors can, however, invest in ETFs that offer investors exposure to a large basket of different bonds. Such bond ETFs typically charge lower management and trustee fees that together account for less than 0.3 per cent per annum.
One such ETF is the ABF Singapore Bond Index Fund, which tracks a basket of high-quality AAA-rated bonds issued primarily by the Singapore government and quasi-Singapore government entities such as the Land Transport Authority and Housing & Development Board3.
Managed by Nikko Asset Management Asia ("Nikko AM Asia"), the ABF Singapore Bond Index Fund is the Republic’s first Singapore dollar-denominated bond ETF and one of the city-state’s largest in terms of assets.
The ABF Singapore Bond Index Fund Total Return for Calendar Year (%)
The ABF Singapore Bond Index Fund’s net return4 was -5.38 per cent last year, as rising interest rates reduced the resale value of its bond holdings. This contrasts against the fund’s net return4 of +8.13 per cent in 2020 when the falling interest rates boosted bond prices as economic activity slowed amid the outbreak of Covid-19.
Over the past 10 years, the ABF Singapore Bond Index Fund returned an average of 1.32 per cent per annum4.
“For more than a decade, the ABF Singapore Bond Index Fund has demonstrated resilience and performed well even during volatile market conditions. A key reason is the high level of safety provided by AAA-rated Singapore government bonds, which offer higher yields compared with lower-rated bonds from some European countries,” says Nikko AM Asia's Mr Sarmago.
For investors who are prepared to take on a slightly higher risk, Nikko AM Asia offers another bond ETF called the Nikko AM SGD Investment Grade Corporate Bond ETF5, which invests in high quality Singapore dollar-denominated bonds issued by entities such as Temasek as well as local banks DBS Group, Oversea-Chinese Banking Corporation and United Overseas Bank.
The Nikko AM SGD Investment Grade Corporate Bond ETF’s net return6 was -0.55 per cent in 2021 but achieved net return6 of +5.7 per cent in 2020.
Both ETFs can be bought and sold on the Singapore Exchange using cash savings or money in the Central Provident Fund and Supplementary Retirement Scheme.
Nikko Asset Management Bond ETFs at a glance: Singapore dollar-denominated bonds pay relatively attractive interest within the high credit quality space
Stronger Singapore dollar in new era of higher risks
Investors in the ABF Singapore Bond Index Fund and Nikko AM SGD Investment Grade Corporate Bond ETF may potentially benefit from indirectly owning bonds denominated in the Singapore dollar, given the local dollar’s tendency to appreciate against other regional currencies over time.
Over the past 10 years, the Singapore dollar has strengthened by as much as 4 per cent per annum against regional currencies such as the Indonesian rupiah, Malaysian ringgit and Thai baht10.
Looking ahead, the Singapore dollar is likely to strengthen further following the Monetary Authority of Singapore’s recent decision to rein in inflation by increasing the local dollar’s rate of appreciation against a basket of other currencies11.
Bonds are an essential part of all investment portfolios since they provide greater certainty of income in the form of regular interest payments. Credit risks are also lower since bond issuers are legally required to repay the debt upon maturity.
As the world enters a new era of higher inflation and increased geopolitical uncertainties, investors may want to focus more on managing risk and shift towards more balanced portfolios that include investment-grade bonds.
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Footnotes
1 All information is sourced from Moody’s Investor Service issuer-weighted corporate default rate data by rating, average from 1920-2021.
2https://www.worldbank.org/en/publication/east-asia-and-pacific-economic-update
3, 5 Fund holdings are as at March 31, 2022. Source: Nikko AM Asia.
4, 6 Source: Nikko AM Asia, as at March 31, 2022. Returns are calculated on a NAV-NAV basis and assuming all dividends and distributions are reinvested, if any. Past performance is not necessarily indicative of future performance.
7 Cash is included in the calculation of the average credit rating and is rated as AAA regardless of currencies held. The credit ratings of the underlying fixed income securities are determined by S&P or Moody’s, and where official credit ratings are unavailable, Nikko AM Asia’s internal credit ratings are used.
8 Weighted Average Yield to Maturity (%) is an average yield per annum calculated by weighting the yield of each bond presently held by the Fund at time of calculation with capitalisation and duration, and yield of a bond is the interest rate used to bring all future cashflows of the bond to its present value. The figure is for reference only and would vary from time to time due to market conditions and it does not represent the fund’s distribution yield or actual rate of return.
9 Weighted Average Duration (years) is an average duration weighted with capitalisation, and the figure is for reference only and would vary from time to time due to market conditions.
10 Bloomberg data as at April 12, 2022
11 https://www.mas.gov.sg/news/monetary-policy-statements/2022/mas-monetary-policy-statement-14apr22
Important Notice:
The performance of the ETF’s price on the Singapore Exchange Securities Trading Limited (“SGX-ST”) may be different from the net asset value per unit of the ETF. The ETF may also be suspended or delisted from the SGX-ST. Listing of the units does not guarantee a liquid market for the units. Investors should note that the ETF differs from a typical unit trust and units may only be created or redeemed directly by a participating dealer in large creation or redemption units.
The Central Provident Fund Ordinary Account interest rate is the legislated minimum 2.5 per cent per annum, or the three-month average of major local banks' interest rates, whichever is higher, reviewed quarterly. The interest rate for Special Account is currently 4 per cent per annum or the 12-month average yield of 10-year Singapore Government Securities plus 1 per cent, whichever is higher, reviewed quarterly. Only monies in excess of $20,000 in the OA and $40,000 in the SA can be invested under the CPF Investment Scheme. Please refer to the website of the CPF Board for further information. Investors should note that the applicable interest rates for the CPF accounts and the terms of CPFIS may be varied by the CPF Board from time to time.
This advertisement is purely for informational purposes only with no consideration given to the specific investment objective, financial situation and particular needs of any specific person. It should not be relied upon as financial advice. Any securities mentioned herein are for illustration purposes only and should not be construed as a recommendation for investment. You should seek advice from a financial adviser before making any investment. In the event that you choose not to do so, you should consider whether the investment selected is suitable for you. Investments in funds are not deposits in, obligations of, or guaranteed or insured by Nikko Asset Management Asia Limited (“Nikko AM Asia”).
Past performance or any prediction, projection or forecast is not indicative of future performance. The Fund or any underlying fund may use or invest in financial derivative instruments. The value of units and income from them may fall or rise. Investments in the Fund are subject to investment risks, including the possible loss of principal amount invested. You should read the relevant prospectus (including the risk warnings) and product highlights sheet of the Fund, which are available and may be obtained from appointed distributors of Nikko AM Asia or our website (www.nikkoam.com.sg) before deciding whether to invest in the Fund.
The information contained herein may not be copied, reproduced or redistributed without the express consent of Nikko AM Asia. While reasonable care has been taken to ensure the accuracy of the information as at the date of publication, Nikko AM Asia does not give any warranty or representation, either express or implied, and expressly disclaims liability for any errors or omissions. Information may be subject to change without notice. Nikko AM Asia accepts no liability for any loss, indirect or consequential damages, arising from any use of or reliance on this document. This advertisement has not been reviewed by the Monetary Authority of Singapore.
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