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Stocks and bonds are two important asset classes that make up our portfolio. Often, a higher allocation to stocks and a lower allocation to bonds may reflect a riskier portfolio. On the other hand, a risk-averse investor may prefer a higher allocation to bonds and a lower allocation to stocks to have a low-to-moderate-risk portfolio.
If we are investing through a fund manager like UOB Asset Management (UOBAM), there will be a variety of portfolios, comprising stock-only portfolios, bond-only portfolios and multi-asset class portfolios, that we can choose from.
For retail investors, we can use the UOBAM Invest app to invest through a robo-portfolio created in accordance with our risk appetite and investment time horizon. We can also invest directly in a wide range of unit trusts.
Some investors, myself included, would sometimes prefer to self-construct our own investment portfolio. We put in the time to research a large number of stocks and are confident that the companies we pick can outperform the market index.
Even as we invest directly in stocks on our own, we must also recognise the importance of asset allocation. Regardless of how confident we feel about the stocks that we invest in, we shouldn’t put all our money into a single or a small handful of stocks.
Asset allocation is an investment strategy that aims to balance risk and reward by assigning a weightage to individual categories of assets, typically stocks and bonds, in an investment portfolio.
For example, an aggressive investor may wish to concentrate his portfolio largely in stocks to achieve higher returns but still maintain an allocation to bonds for diversification and to get a regular income stream. A conservative investor may also want to invest in stocks to get a higher return but may choose to allocate a greater proportion of his portfolio to higher-quality bonds to reduce the overall risk level of the portfolio.
Hitting Home Runs With Our Stock Selections
When we do our research on individual stocks, we dream of them being multi-baggers. This refers to stocks that can give us a 2 times, 3 times or even 10 times or more returns. For example, think of how Tesla’s share price has gone up nearly 6 times, from $29.53 (3 Jan 2020) to $179.82 (6 Dec 2022) in less than three years.
To quote a baseball reference, I call this a home run because we are swinging hard in the hopes of getting an extraordinary return from the individual stocks we invest in. Usually, we don’t see such exceptional performance, even in the short-term, when investing in an index-based equity exchange-traded fund or an equity unit trust.
This is why some of us may still prefer picking stocks to invest in.
By Design, Bonds Are Naturally Meant To Be Defensive Play
Unlike stocks, where investors can hope to score multi-baggers, we can’t expect such outcomes when investing in bonds. Bonds are naturally meant to be defensive plays in our portfolio.
Realistically speaking, when investing in bonds, the outcomes that we should aim for are to 1) generate stable returns via the coupon payments, 2) ensure we receive back our initial capital and 3) have bond returns that are un-correlated to our stock investments.
With these three reasons in mind, I would like to suggest that investing via a bond fund is likely to be a better investment strategy for self-directed investors as compared to investing in single bonds.
Diversification Is Vital For Bond Investing
We know diversification is important for stocks. When it comes to bonds, diversification is even more vital for investors.
Here’s a hypothetical scenario based on an investor who wishes to invest $10,000 in bonds.
Assume we have $10,000. We can choose to either invest all our money in a single bond or spread it across 100 different bonds via a bond fund. In both scenarios, we get a yield of 4%.
Ideally, we would get the 4% yield ($400 per year) from the bond investment and receive our capital ($10,000) when the bond matures. Preferably, this return should also be uncorrelated to our stock investments.
But what happens if the bond defaults?
If we invest in a single bond, the worst-case scenario that we may face is a complete loss of our investment amount of $10,000. However, if we invest in a bond fund and one of the bonds in the fund defaults, we would still receive coupon payments of $396 per year while losing a capital of just $100 instead of the entire $10,000.
The logic here for bond investing is simple. Since bonds usually can’t give us outsized returns, there is no point in putting all our eggs into one basket. If we only invest in a single bond instead of a diverse number of bonds, it also increases our risk.
Editor’s Note: Do note that the scenario above is only a hypothetical scenario meant to explain the benefits of diversification. Many bonds in Singapore can only be bought directly with a minimum amount of $250,000, unless the individual is an accredited investor (AI).
How Self-Directed Investors Can Use Bond Funds To Build Their Portfolios
For self-directed investors, the bulk of our time will likely be spent researching the stocks that we invest in – with the hopes that we can achieve outsized returns from some of our stock picks.
With bonds, such an approach to research and choose which bonds to invest in may not be a good use of our time. After all, we are not going to expect high returns from our bond investments. Rather, what we are fundamentally concerned about is the ability of the bond issuers to pay us the promised coupon payment and principal amount. Instead, a smarter use of our time would be to delegate the process of choosing the bonds we wish to invest in to an experienced asset manager that has expert insights on credit analysis, bond market trends and views on which direction interest rates may go.
This is why a bond fund would make more sense for us to gain exposure to bonds. An example of such a bond fund would be the United SGD Fund. Managed by UOBAM, the United SGD Fund is the flagship fixed-income fund from UOBAM, with a fund size of about S$1.59 billion (as of 31 August 2023). It has a strong track record of 24 years and is one of the most popular fixed income funds in Singapore, with its low-risk profile offering stable returns to investors.
The United SGD Fund is a short duration investment-grade bond fund. This means it invests into bonds that have a shorter maturity period. Short duration bond funds can be particularly attractive in a rising interest rate environment since the capital received from bonds that have matured can be reinvested into newer bonds for higher returns, thus increasing the overall return of the fund.
Based on the fund factsheet (as of August 2023), we can see that there are a total of 86 issues (i.e. bonds) that comprise of the fund, with no single company holding a weightage of more than 3%. The weighted average maturity is 1.25 years.
Source: UOBAM, United SGD factsheet, As of 31 August 2023
To reduce the impact of changing interest rates on the bonds, the fund invests in a series of investment-grade bonds with varied maturity dates across a three-year timeframe. This is vital, as having varied maturity dates help smooth out returns.
In a hypothetical example, let’s assume the average maturity of a bond fund is 2 years. This could mean one of two scenarios.
In scenario 1, the bond fund is only investing in bonds that mature in two years. What this implies is that all the bonds in the fund will mature at the same time, meaning that 100% of the capital would need to be reinvested at the same point in time. This could create interest rate risks for investors as they would be exposed to market interest rate at that point in time when the funds have to be reinvested.
In scenario 2, the fund invests in bonds with differing maturity dates, from a few months up to three years. While the duration for the fund is also 2 years, the varied maturity date means that any changes in interest rate would gradually change the yield for the fund, as opposed to a steep decline or increase.
For example, in a rising interest rate environment like what we are currently experiencing, the capital from the matured bonds in the fund gets re-invested into higher-yielding, shorter-dated bonds. This allows the fund to ride on the rising interest rate momentum to earn higher returns.
The current weighted average yield to maturity of the United SGD Fund is 4.65% (in SGD terms). If interest rates continue rising, this would continue increasing as well. This is why short-duration bond funds like the United SGD Fund are particularly attractive to invest in as interest rates have pushed yield to a high level not seen over the past decade.
Source: UOBAM, as at 30 September 2023
In a falling interest rate environment, the fund would stay invested in longer maturity bonds to earn higher returns since the longer duration bonds would tend to have higher yields than shorter duration bonds.
Source: UOBAM, as at 30 September 2023
As an individual investor, it would be extremely difficult for us to build such a bond portfolio by ourselves. Furthermore, given the high minimum amount required (usually about $250,000 per bond) to invest in individual bonds, it could be practically impossible for us to ensure adequate diversification in our portfolio. Imagine, needing 86 different bonds, with different maturity, in order to replicate a bond fund like the United SGD Fund.
Regardless of the interest rate environment, the key point to stress is that such a fund fulfils the three objectives we need from our bond investments.
Firstly, we get a steady income stream from the bond fund, with the returns being smoothed out due to the varied maturity dates of the bonds within the fund.
Secondly, with the bond fund investing in multiple bonds across different maturities, our investment capital is better protected, and a single default event (if it even happens) won’t adversely affect the performance of the fund.
Lastly, the fund can give us the bond exposure we need to complement our existing stock portfolio without us having to worry about which bonds to invest in or having to reinvest our money when the bond matures. In times of market instability, the fund can protect its downside and generally have lower drawdowns compared to other peer asset classes.
Through UOBAM Invest App, We Can Invest In The United SGD Fund
For investors who want to invest in the United SGD Fund or any other bond funds can do so directly through the UOBAM Invest app. Just download the UOBAM Invest app from the App Store (iOS) or Google Play (Android Users).
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Disclaimer: Distributions will be made in respect of the Distribution Classes of the Fund. Distributions are based on the NAV per unit of the relevant Distribution Class as at the last business day of the calendar quarter or month. The making of distributions is at the absolute discretion of UOBAM and that distributions are not guaranteed. The making of any distribution shall not be taken to imply that further distributions will be made. UOBAM reserves the right to vary the frequency and/or amount of distributions. Distributions from a fund may be made out of income and/or capital gains and (if income and/or capital gains are insufficient) out of capital. Investors should also note that the declaration and/or payment of distributions (whether out of income, capital gains, capital or otherwise) may have the effect of lowering the net asset value (NAV) of the relevant fund. Moreover, distributions out of capital may amount to a reduction of part of your original investment and may result in reduced future returns. Please refer to www.uobam.com.sg and the Fund’s prospectus for more information.
All information in this publication is based upon certain assumptions and analysis of information available as at the date of the publication and reflects prevailing conditions and UOB Asset Management Ltd (“UOBAM”)’s views as of such date, all of which are subject to change at any time without notice. Although care has been taken to ensure the accuracy of information contained in this publication, UOBAM makes no representation or warranty of any kind, express, implied or statutory, and shall not be responsible or liable for the accuracy or completeness of the information.
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This article was first published on 25 January 2023 and has been updated with the latest information