Three Questions to ask to avoid bond mishaps
In the previous 3 issues of Search for Yields newsletter, the free weekly newsletter from INRBonds to help bond advisors and investors alike in investments in bonds and other fixed income investments, we introduced 3 questions to ask to avoid bond mishaps and we covered the first two questions. The questions were :
Will interest rates move up or down in the future?
What will guarantee my principal repayment?
Can I sell the bond if I see a threat to my investment?
In this issue we will cover the 3rd question, Can I sell the bond if I see a threat to my investment?
What is a threat to your bond investment?
At the time of investing in a bond, hold to maturity investors expect steady cash flows from coupon payments and receiving the principal back on maturity of the bond. Any factor whether internal or external that has the potential to disrupt cash flows and also place the principal in danger is a threat to your bond investment.
Apart from inherent threat to cash flows and principal, factors that can cause steep fall in value of a bond are also threat to your bond investment, as it would bring down the overall value of your savings and also generate steep losses in case you sell the bond for any immediate liquidity requirements.
How do you spot a threat to your bond investment?
Any signs of weakening in business and economic conditions, stress on financial markets due to external factors, disruptions to business from technology, political and regulatory changes could be a threat to your bond investments. Bond issuers taking on excess debt to grow business and then the business cycle turning is a key threat to bond investors.
Threats to bonds are usually seen when credit spreads rise. Credit spread is the difference between a bond yield and government bond yield. Rise in credit spreads indicate weakening issuer or market or economic fundamentals.
Can I sell the bond when I see a threat to my investment?
Unfortunately, bonds turn illiquid when threats act up. Normally liquid bonds can be sold but the impact cost of selling the bond can be high. Illiquid bonds can turn more illiquid and cannot be sold even at much lower prices.
It is important to judge the bond for liquidity as well as the quality of the bond issuer. Liquidity is seen in trading frequency and acceptability amongst a large section of investors. Quality is seen in the fundamentals of the issuer.
