My Name Is Bond…

Never in the history of my investment experience that I had seen such mass enthusiasm on bonds. It is understandable as we are in a rising interest rate environment, which favours short-term treasury bills, and the fear of a coming real recession, which bode well for longer term bonds as a safe haven. Suddenly, what is seen as a boring financial instrument is now generating so much attention.

Here is an interesting trivia: Did you know that the global bond (or fixed income) market is larger than that of equities? In 2021, the global fixed income outstanding stood at United States Dollars (USD) 126.9 trillion while the global equity market cap was at USD 124.4 trillion¹. Though by a narrow margin, this would likely be widened in 2022 when the equity market cap is facing a downward pressure.

 

Bonds usually fill in the role of the counterweight to equities, and these two would form the most basic of investment portfolios. The weightage of both varies, but the oft quoted one is the 60/40 equities/bond ratio, which is still used as the benchmark standard.

 

The reasons why bonds are added to a portfolio mix are due to its differing correlation with equities, and the traditional go-to asset class during bad market days. However, the correlation notion has been challenged as bonds do display high positiveness with equities at certain points in time. A rising interest rate setting is not good for bonds (especially longer-term ones) as it would lose their demand if the coupon rates were lower than that of the prevailing interest rates.

 

Regardless of the macro intricacies of bonds, correlation and rates, an investment portfolio should last at least 10 years (my minimum timeframe) or more, and we do see the usefulness of bonds in providing some sort of safety net and volatility dampener. The other way would be to diversify further with more asset classes, as what The Bedokian Portfolio added with real estate investment trusts (REITs), commodities (gold, silver and oil) and cash, to make the whole correlation thing more varied.

 

To end off this short post, do remember that the bonds that I had mentioned here are good quality bonds, i.e., issued with investment-grade credit ratings, typical of good government and corporate bonds.

 

1 – Kolchin, Katie, et al. 2022 Capital Markets Fact Book. SIFMA. July 2022. https://www.sifma.org/wp-content/uploads/2022/07/CM-Fact-Book-2022-SIFMA.pdf (accessed 28 Aug 2022)

 

Interest Rate Parity: A Simple Overview

With all the hype of interest rates going around, it is probably time for me to write about one little known relationship between interest rates of different countries and the currency exchange between the said countries. Introducing the concept of interest rate parity.

What Is Interest Rate Parity?

 

According to Investopedia, interest rate parity is “a theory according to which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate”¹.

 

Putting it simply, assuming a scenario of two countries (Country A and Country B) with interest rates of 5% in Country A and 3% in Country B, the currency exchange rate between the two will adjust by 2% in the future (either Country A’s currency would depreciate by 2% or Country B’s currency would appreciate by 2%).

 

Investors would go for “more bang for the buck”, so if a country’s interest rates are higher, they would naturally flock there with their capital to earn more. Eventually, all things would equalize out in the form of currency exchange rates. These happenings are, of course, theoretical, and certain conditions must be assumed, e.g., free flow of capital exists between the two countries. In the real world, things may not be that simple with all the microeconomic, macroeconomic and regulatory factors and circumstances at play.

 

Real World Applications

 

There are a few real-world scenarios where the theory of interest rate parity is applicable. A financial instrument called currency swap is one example, where the capital principal and/or interest rate could be exchanged with another currency, to obtain favourable loan interest rates. Currency swaps are also used to hedge against foreign exchange fluctuations, which a lot of multinational companies and real estate investment trusts utilise.

 

Forex traders also use the theory of interest rate parity to implement strategies and calculations to earn profits.

 

 

1 – Hayes, Adam. Interest Rate Parity (IRP). Investopedia. 5 Sep 2021. https://www.investopedia.com/terms/i/interestrateparity.asp (accessed 21 Aug 2022)

Treasury Bills: What Are They?

The rise in interest rates in recent months has seen yet another rise in interest (pun intended) generated, based on what I have read online (yes, the Bedokian does scour the WWW for information) and offline amongst my friends, acquaintances and colleagues. First, there was (and still is) the hype over Singapore Savings Bonds, or SSBs (which I had written a piece here). The upcoming buzzword is “treasury bills”, or T-bills for short.

Introduction Of The T-Bill

 

In fixed income nomenclature, bills are debt instruments, issued by a government, whose duration is one year or less. Hence in layman speak, they are bonds with a very short term.

 

Due to this short-term nature, the coupon rate of a T-bill tends to be similar with the prevailing interest rate as at the time of the former’s issuance. With a tenure of one year or less, it is akin to a form of fixed deposit that you will find in banks. You could sell the T-bill on the open market before maturity, but it would be subject to market forces and you may profit or lose some amount, so it is recommended to hold it till maturity.

 

Under The Bedokian Portfolio’s classification, the T-bill belongs to the cash asset class due to its two main characteristics: the short duration and the positive correlation to prevalent interest rates, from which how cash derives its returns. Liquidity wise, it is easy to just sell it on the open market and get back the principal, though as mentioned in the previous paragraph there are market risks involved.

 

The Workings Of The T-Bill

 

Unlike other debt instruments, where the coupon is paid half yearly or annually, the T-bill’s coupon is paid upfront. T-bills are issued at a discount below par value, and the difference is the coupon/interest paid out. For example, I had applied for a one-year T-bill at the minimum bid of SGD 1,000, and after the closing of the application, the T-bill is issued at SGD 950, and I will get back the SGD 50. This SGD 50 is the coupon/interest for the T-bill, which the yield works out to be 5% (50/1000). When the T-bill matures, the full SGD 1,000 sum is returned.

 

For retail investors like you and me, Singapore T-bills can be applied using cash, Supplementary Retirement Scheme (SRS) account and Central Provident Fund (CPF) account through the three local banks: DBS, OCBC and UOB (note: you could sell your T-bills over the counter at either one of these three banks). Applications using cash and SRS can be done online or through the automated teller machines, while in-person applications are required at the bank where the CPF investment account is at.

 

Once you had settled on using cash, SRS or CPF, the next step is to bid (or auction) for the T-bills, which is a bit more technical as compared to applying for SSBs. There are two ways to bid for it, competitive or non-competitive. Competitive bidding is where you will input an annual yield number (in percentage and up to 2 decimal places) and that number signifies your lowest acceptable yield. In non-competitive bidding, you just accept whatever yield you are getting. From here, you can see that using a non-competitive bid can almost guarantee issuance, while a competitive bid depends on what yield number you put in; if your submitted number is higher than the result, you would not get the T-bill. If you are in the know and can roughly guesstimate the prevailing yield, then you may want to attempt a competitive bidding.

 

Unlike SSBs, where there is a consolidated limit of SGD 200,000 per individual, T-bills (and other Singapore government bonds) limits are much higher (at least SGD 1 million) for each issuance. Also, you can submit as many bids as you want, whether through non-competitive or a series of competitive bids with different yield numbers.

 

The Bedokian Getting The Feet Wet

 

We had recently applied for the 6-month T-bill (BS22115F closed on 4 Aug 2022) using cash and through UOB online banking (see Figure 1). One non-competitive bid and one competitive bid (bid at 2.8%) were submitted for SGD 1,000 each (see Figures 1.1 and 1.2 respectively):

Fig. 1

Fig. 1.1

Fig. 1.2

 

Here is an excerpt of the results of the T-bill BS22115F from the Monetary Authority of Singapore (MAS) website (Figure 2):

Fig. 2

There are many numbers, but just look at the first two rows will do: the cut-off yield is applicable to competitive bids, where if you submitted any number above that, the bid is out. The cut-off price is the eventual amount of the T-bill, which is 98.577 (remember the T-bill is issued below the par value of SGD 1,000). Multiply this number by 10 and your T-bill is worth SGD 985.77, and the amount of SGD 1,000 – SGD 985.77 = SGD 14.23 is the coupon/interest.

 

Both of our bids were successful, and we had 2 x SGD 14.23 refunded on 4 Aug 2022 (see Figure 3). This refund is also the T-bill coupon/interest amount.

Fig. 3

Since this is a cash application, the T-bills appeared in the Central Depository account on 10 Aug 2022 (Figure 4).

Fig. 4

 

Conclusion

 

Even if not for investment purposes, the T-Bills are another good alternative to store your cash which you foresee not using for at least the next six months to a year.

 

References:

 

https://www.mas.gov.sg/bonds-and-bills/Singapore-Government-T-bills-Information-for-Individuals

The Bedokian Portfolio Blog’s Sixth Anniversary Post

Today marked the sixth anniversary of The Bedokian Portfolio blog.

My anniversary posts were usually filled with tips, advice and pointers; some current, some cliched and most of the time common sense. For this anniversary message, I would like to go into a recent occurrence and hope that there will be some lessons drawn from my opinions. That occurrence would be the crypto meltdown.

 

Crypto Meltdown

 

The first two weeks of May 2022 saw one of the largest events happening in cryptosphere. Known as the Terra-Luna collapse, investors around the world lost millions, if not billions, collectively. Consequently, there were a number of tragic happenings, ranging from big monetary losses to loss of life. 

 

And that is not all. As a result of the collapse, other cryptocurrencies began to fall in value, with Bitcoin, considered the “grandfather of all cryptocurrencies”, fell to a low of almost SGD 26,000 by mid-June 2022, sparking fears of what was called “crypto winter”.

 

While the dust was settling from the Terra-Luna downspiral, there were some aftermath stories emerging from stung Terra-Luna investors and traders, dictating the goings-on and providing learning points and lessons from the whole ordeal. The common points mentioned were the admission of greed and lack of diversification. This is the part where I will give my two cents’ worth (or maybe three cents due to inflation).

                   

The Bedokian’s Opinions

 

Hindsight is always 20/20, mentioned by so many people. Yet, people who are deemed to be highly experienced in the field of investing/trading would sometimes fall into greed and its by-product “all-in” (i.e., no diversification). It is an emotion, after all, and on occasions I do feel this greed coming into my mind, which could be tempting at times. If I could earn a fortune by just going all-in into a rapidly rising asset, why not?

 

Problem is, no asset is growing at a fast pace without retracing, even slightly, forever. If one’s investing/trading (or gambling, a word which I am tempted to use for this post) on a rapidly rising thing, one must know the music would stop eventually, question is when. I understand that one may feel being FOMOed (fear of missing out) by letting go an asset too early in its rise and had languished on the opportunity cost, but the feeling could be worse if the asset’s price come crashing down, hard. One of the advice given in my early trading days was to be satisfied as long as there are profits, and start to prospect for the next potential one.

 

Ideally, investing and trading follow a set of rules, which are different from one person to another. These rules can be changed depending on certain circumstances, but the one thing one must not include in are human emotions, except for using emotions to one’s advantage (e.g., market sentiment and going contrarian). Greed is one thing one must not factor in: if an asset had reached the target price (as per the rules), just sell it, do not arbitrary set another higher sell price on the spot. We do not know what will happen next, and if a bad event does happen, we may be too late to react to it, since we retail investors/traders do not have first-hand information coming in quick. Diversification, which I had harped on so often in my posts, is a must-have to counter big losses in the investment portfolio and the emotion of greed.

 

Stay calm, stay safe, stay diversified, and do not go all-in.

Brace For Impact

A brace, in football terms, is the achievement of scoring two goals in one game. The word brace also means to “prepare for” or “get ready to”. 

Building onto this wordplay, the title of this blogpost means to get ready for two big “goals” that are coming up soon, and they are the expected announcement of interest rate hikes by the United States (U.S.) Federal Reserve (28 July early morning Singapore time) and the results of the U.S. second quarter gross domestic product (GDP) (28 July evening Singapore Time).

 

Goal #1: Interest Rate Hikes

 

The U.S. consumer price index (CPI), commonly referred to as the inflation rate, for June 2022 was at a staggering 9.1%, and the U.S. Federal Reserve is expected to raise interest rates further to combat the rising inflation. Though the expected 75 basis points (0.75%) hike was bandied about, there were some quarters expecting a full 100 basis points (1%).

 

Goal #2: GDP Growth Rate And Technical Recession

 

The general consensus among governments, economists and analysts is a country is in a technical recession if its GDP undergoes two consecutive quarters of negative growth, though this is not really set in stone. The first quarter of 2022 saw the U.S. GDP growth rate at -1.6%, and many are expecting the second quarter will be in negative region as well, thus sparking the technical recession definition (though the U.S. government recently had reiterated that it is not really a recession¹). 

 

So What Now?

 

As of the time of my writing of this blog, the U.S. markets are heading southwards, partially due to the “brace” and the profit warning announced by Walmart. The next two days might see more downward pressure on the markets as the interest rate hike announcement and GDP figures release happen.

 

However, things may not be as bad as it seems as market participants could be expecting hikes and negative GDP growth, thus becoming a non-surprise and result in a not-so-sharp fall in the markets.

 

To me, these times are like shopping sprees as I can pick up bargains of fundamentally sound counters who are inadvertently dragged down along with the rest, therefore it is important that you have a “wishlist” in your mind on what to get. Alternatively, if researching on individual counters are a bit of a hassle for you, then you may consider using exchange traded funds (ETFs) of indices to get into the action. There are many ways to determine when you should enter, as I had described some here.

 

Welcome to the markets.

 

1 – Wingrove, Josh. Biden Team’s Take on ‘Technical Recession’: It’s Not Real. Bloomberg. 26 July 2022. https://www.bloomberg.com/news/articles/2022-07-25/biden-team-s-take-on-technical-recession-it-s-not-a-real-one (accessed 26 July 2022)

The Uniqueness Of The Singapore Savings Bond

The Singapore Savings Bond, or SSB, was introduced by the Singapore Government as a safe, long term and flexible means of investing. Unlike normal government bonds, in which a fixed coupon rate is paid at a prescribed pay date, the SSB rates steps up as each year goes by, thus it is more worthwhile to keep it long term. Also, the SSB is not subject to market volatility; once redeemed, you will get back the whole sum, plus any interest amount accrued.

It is this feature that led to me classifying the SSB as a form of cash-bond hybrid: cash in terms of depository mechanism, and bond if the cash is kept till the end, i.e., after 10 years. Though the redemption is not as instant as withdrawing cash from a savings account in a bank, the cash in the SSB could be withdrawn possibly in about slightly more than a week’s time, depending on which part of the month the redemption request was submitted.

 

Recently, I could see a lot of hype surrounding the SSB: from investment and non-investment social media chat groups that I am in; from a colleague with whom I had never discussed investing with before; and a relative of mine had suddenly popped me a question about it. This is naturally obvious as SSB are viewed as almost risk-free and the rates are moving up in the past months. The latter is mostly due to the rise of interest rates in the United States, which is positively correlated to our local interest rates, though this relationship is somewhat not so straightforward (and I had explained a bit on this here).

 

What’s the uniqueness, then, for the SSB? Well, I had already described three of the attributes in my above paragraphs. We shall have a look at them in detail below.

 

#1: Step-Up Annual Interest Rates

 

The first unique point about the SSB is the step-up interest rate structure, which is unheard of in other bonds. The rates are published right at the onset of the issuance, therefore you know how much you would be getting from the interest every year.

 

#2: Not Subject To Market Volatility

 

The SSB is traded between yourself and the issuer, the Monetary Authority of Singapore (MAS), and no one else. This means it is not subjected to the volatile forces of the market, where most of the risks are. As we know, bonds are susceptible especially to market (i.e., loss of principal/capital) and rate risks (i.e., bonds with higher coupon/interest rates are favoured over those with lower ones, causing the latter to lose their demand). 

 

The SSB does not have these two big risks: no capital loss (you will get back everything, minus the SGD 2.00 transaction fee if redeemed before maturity) and if the current rates are higher than the one you are holding, you could redeem it and apply again (though fresh funds may be needed as there is insufficient turnaround time to use the redeemed amount to buy the current SSB).

 

#3: It Is A Cash-Bond Hybrid

 

I came up with the conclusion of the SSB being a cash-bond hybrid (from The Bedokian Portfolio’s perspective) is due to the following reasons:

 

Cash – For The Bedokian Portfolio, cash served as a pool where injections, dividends, interest payments and returns are contained, and acts as a starting point to deploy to other asset classes. It is important that cash should not lose its value, which was why I advocated placing them at least in the safety of banks. SSB’s ability to preserve principal (as described in #2) qualifies it suitable to hold cash.

 

Cash as an asset class is dependent on interest rates for returns. For the SSB, its interest rates are based on the reference yield of the various tenures (1, 2, 5 and 10 years) of the Singapore Government Securities (SGS, commonly known as Singapore government bonds), which, through a series of connections, are positively correlated to U.S. interest rates.

 

Bonds – Unlike typical means of cash holdings where there is no expiry date, the SSB has a tenure of 10 years. Thus, if held for the full term, the SSB’s characteristic is akin to a bond asset class.

 

Conclusion

 

The SSB is a good investment vehicle to include in your portfolio, given the good credit ratings of SGS. The caveat is that an individual is only allowed to have a maximum of SGD 200,000 in SSB, so if you are adopting a 60/40 equities/bond portfolio and the size is above SGD 500,000, you would have to look for alternatives like other SGS, corporate bonds or bond exchange traded funds.

 

Disclaimer:

 

The Bedokian is vested in SSB.

The Dreaded “S” Word

By now you may have heard of the possibility of the dreaded “S” word taking over the markets and economies. Yes, that word is “stagflation”. It is a portmanteau of two words “stagnant” and “inflation”.

What is stagflation? Putting it simplistically, it is a situation where we have high inflation, high unemployment and a slow or stagnant economic growth. As you can see, it is a very difficult cycle to escape from once it rears its ugly head: high inflation leads to workers demanding higher wages, but with slow demand, companies find it difficult to do just that without hurting the bottom line. Worse still, companies may lay off workers so that they could keep themselves afloat, let alone giving in to raising pay. 

 

The most famous (and only) real life case of stagflation occurred during the 1970s in the United States, where a combination of factors such as high inflation and unemployment, coupled with the oil embargo by OPEC (Organization of the Petroleum Exporting Countries) that caused oil prices to skyrocket, created a period of stagflation that lasted until around the early 1980s. 

 

The threat of stagflation is not without justification: we are seeing high inflation rates now, coupled with hiking of interest rates which, according to basic market and economic principles, tames inflation but also brings about slow growth. Also, exacerbating the whole thing is the ongoing commodities shock and the global supply crunch. This is like history repeating itself, as what some analysts and economists commented, but others stated that policy makers and central banks would know what to do based on what they had learnt from history. There are also other arguments that the stagflation causes back in the 1970s were slightly different from the present variables that we are seeing.

 

Impact On Investment Portfolio

 

Stagflation is a combination of inflation and recession, and on the asset class level equities, bonds and cash would be negatively affected, with REITs maybe on the borderline (depending on the net result between inflation and recession). The preferable asset class is commodities, which thrive in inflationary environments as a hedge and recessionary environments as a safe haven. To really bulletproof further a portfolio during stagflation, we would need to look deeper within asset classes, like regions/countries and sectors/industries. 

 

Locations not heavily affected by stagflationary factors would be a good go-to place; China is an example where inflation and interest rates are still within economic growth level, coupled with the ability to get cheaper oil. Same goes for sectoral/industrial wise; goods and services which are still needed by the masses, e.g., consumer staples and utilities, can be considered.

 

Now comes the golden question: Will stagflation happen? My answer in seven words: Your guess is as good as mine. Regardless, one’s investment portfolio would be hit by stagflation. Diversification across and within asset classes is still the best defence in such times.

 

Stay calm, stay safe, stay invested.