October 25, 2010
In Bond Frenzy, Investors Bet on Inflation
By CHRISTINE HAUSER
At a time when savers complain that they are earning almost no interest from their bank accounts, some investors on Monday bought United States government bonds that effectively had a negative rate of return.
Bizarre as it sounds, that is correct. In an auction of a special kind of five-year Treasury bond, investors paid $105.50 for every $100 of bonds the government sold — agreeing to pay the government for the privilege of lending it money.
The reason is that these types of bonds offer a guaranteed protection against inflation. So, if inflation soars — as some economists worry might happen, with the government seeking to give the economy a boost by flooding it with money — the value of the bonds would go up accordingly.
The investors who took part in the $10 billion auction are betting that inflation, now at about 1 percent annually, will rise to a level that more than compensates for the premium they paid.
The unusual auction on Monday “reflects a condition in the Treasury market that has been in place for months, chiefly that yields on shorter maturities have moved below the inflation rate,” Anthony Crescenzi, a senior vice president at the bond giant Pimco, wrote in a research note.
Guy LeBas, the chief fixed-income strategist for Janney Montgomery Scott, said there were about $28 billion worth of bids for the notes. About 40 percent were foreign buyers, 57 percent dealers and the rest were possibly retail investors, he said. The prediction is for a 1.58 percent rate of inflation, as measured by the Consumer Price Index.
“It was good demand considering the negative yields,” he said. “They are counting on the Fed to be successful in generating inflation.”
As strange as all this may seem, these investors were actually going along with conventional market wisdom. Many economists are concerned that if the economy continues to stagnate, there is a danger of deflation, or a decline in prices, that would be difficult to reverse.
Most analysts expect that the Federal Reserve, which has already lowered interest rates to near zero and bought Treasury securities in efforts to reinvigorate the economy, is about to pump even more money into the system. Such a move would probably increase the rate of inflation.
Fed officials have hinted at such action in recent appearances. In a speech in Boston on Oct. 15, the Fed chairman, Ben S. Bernanke, said that “there would appear — all else being equal — to be a case for further action.”
The markets interpreted that and other statements as unmistakable signals that the Fed was poised to act at its next meeting, on Nov. 2-3.
Mr. Bernanke couched his argument in terms of the Fed’s mandate to keep prices stable and maximize employment. He said that inflation had been running well below the implicit target of about 2 percent and that unemployment, at 9.6 percent, was too high.
Inflation-protected Treasury securities have already been trading at negative yields on the open market for some time, as professional and institutional investors have sought to hedge their portfolios against the risk of inflation. But Monday was the first time since the government began selling these so-called Treasury Inflation-Protected Securities in the 1990s that new ones were sold at a negative yield.
Buyers “believe we have reached the bottom of the inflation cycle and the next move is higher, not lower,” said Kevin H. Giddis, the executive managing director and president for fixed-income capital markets at Morgan Keegan & Company.
A growing aversion to risk has produced all manner of investment oddities in the last two years. At the height of the financial crisis, for example, the yield on ordinary short-term Treasury bonds turned negative for a brief time as people flocked to safe investments.
Even now, big investors are buying gold at levels unseen in decades, to protect against fluctuations in the value of currencies. Small investors are fleeing the stock market in droves, favoring bonds and even cash over equities. Companies have managed to sell bonds that do not pay off for 50 or even 100 years.
The remarkable auction occurred as stock indexes on Wall Street edged higher, buoyed by recent strong corporate earnings and a month-to-month rise in housing sales.
Sales of previously owned houses increased 10 percent in September from August, to a seasonally adjusted annual rate of 4.53 million units, above forecasts of 4.30 million, but they were still down 19 percent from September 2009. The National Association of Realtors said about a third of the sales last month were related to foreclosures.
On Monday, the Dow Jones industrial average rose 31.49 points, or 0.28 percent, to 11,164.05. The broader Standard & Poor’s 500-stock index gained 2.54 points, or 0.21 percent, to 1,185.62.
The Nasdaq composite index climbed 11.46 points, or 0.46 percent, to 2,490.85.
Bond prices fell, with the yield on the 10-year Treasury rising to 2.56 percent from 2.55 percent late Friday.
As equities advanced, the dollar declined over the weekend after promises by the world’s 20 biggest economies to avoid a currency war.
It was the latest sign that financial markets are positioning for a rise in inflation. Economists point to the fall in the dollar as a sign of budding inflationary pressures. Another is the recent sharp rise in the price of some assets, including commodities like gold.
Graham Bowley and Sewell Chan contributed reporting.
http://www.nytimes.com/2010/10/26/business/26bond.html?ref=business&src=me&pagewanted=print
Showing posts with label bonds. Show all posts
Showing posts with label bonds. Show all posts
Tuesday 26 October 2010
Tuesday 12 October 2010
Warren Buffett says in future Wall Street chiefs should go broke - and their wives
Warren Buffett, the billionaire investor, has hit out at pay practices on Wall Street, attacking the lack of reform despite two years passing since the financial crisis struck.
The 80-year old billionaire said: 'Wall Street does a lot of good things and then it has this casino.'
"People have a propensity to gamble, and it gets made easier and easier for them," Mr Buffett told a conference in Washington DC yesterday. "One of the problems we still have is we have unbalanced incentives for managers of huge financial institutions."
In future, chief executives of banks who need government assistance should "go broke", said Mr Buffett. Their wives "should go broke, too", he added.
The prospect of another round of bank bonuses is likely to inflame public opinion in the US, where the broader economic recovery is flagging.
Banks have been forced to split off some of their riskier trading activities because of the Dodd-Frank law - the financial reform act signed into law in the summer - but critics say it does little to remove the incentives to pursue short-term profits.
Mr Buffett's company, Berkshire Hathaway, is a major investor in American banks, with a stake in Goldman Sachs and Wells Fargo.
The 80-year old billionaire, who runs the company out of Omaha, Nebraska, with his long-term colleague Charlie Munger, said "Wall Street does a lot of good things and then it has this casino. It's like a church that's running raffles on the weekend."
As in Britain, banks are keen to counter an impression that they are failing to do enough for the recovery. Goldman Sachs, for example, last week began an advertising campaign designed to show its role in helping create jobs.
Despite the difference in the fortunes of those on Wall Street and many Americans in other industries, analysts have said that banks may decide to cut jobs in coming months as trading revenues decline. Meredith Whitney, for example, has forecast that up to 80,000 finance jobs could go over the next 18 months.
"It's quite clear that stocks are cheaper than bonds," Mr Buffett said. "I can't imagine anyone having bonds in their portfolio when they can own equities."
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8044789/Warren-Buffett-says-in-future-Wall-Street-chiefs-should-go-broke-and-their-wives.html
Banks have been forced to split off some of their riskier trading activities because of the Dodd-Frank law - the financial reform act signed into law in the summer - but critics say it does little to remove the incentives to pursue short-term profits.
Mr Buffett's company, Berkshire Hathaway, is a major investor in American banks, with a stake in Goldman Sachs and Wells Fargo.
The 80-year old billionaire, who runs the company out of Omaha, Nebraska, with his long-term colleague Charlie Munger, said "Wall Street does a lot of good things and then it has this casino. It's like a church that's running raffles on the weekend."
As in Britain, banks are keen to counter an impression that they are failing to do enough for the recovery. Goldman Sachs, for example, last week began an advertising campaign designed to show its role in helping create jobs.
Despite the difference in the fortunes of those on Wall Street and many Americans in other industries, analysts have said that banks may decide to cut jobs in coming months as trading revenues decline. Meredith Whitney, for example, has forecast that up to 80,000 finance jobs could go over the next 18 months.
Mr Buffett also told Fortune magazine's Most Powerful Women conference that investors are "making a mistake" if they chase a rally in bonds. The price of US two-year government bonds has raced to a record high this week as investors see little to spark a more robust recovery.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8044789/Warren-Buffett-says-in-future-Wall-Street-chiefs-should-go-broke-and-their-wives.html
Tuesday 5 October 2010
Now, super rich look at alternative asset classes
CHENNAI: Equities, mutual funds and FDs can longer satiate the super rich. Instead, they are channelling their wealth into start-ups, unlisted companies, realty-focused private equity funds, gold ETFs and art. The burgeoning breed of HNIS, or wealthy people, are exploring and investing in a whole new range of asset classes.
According to a recent report by Karvy Private Wealth, the wealth management arm of the Karvy Group, individual wealth in India stands at Rs 73 lakh crore and this is expected to double to Rs 144 lakh crore within the next three years. While the bulk of investment is still in direct equity (31.1%) and fixed deposits and bonds (30.3%), private bankers said there is a growing preference for alternative investments. Most HNIs have ridden on the mutual fund and equity wave as they went into the market early. They are now looking at different asset avenues, said Nitin Rao, executive vice-president (private banking group and third party products), HDFC Bank.
HNIs are classified as people with an investible surplus of at least $1 million . Over the years, the profile of HNIs has also rapidly undergone a change.
"We believe that individuals in India are under-invested in alternative assets. We believe this will be a huge area of investments in the next decade. PE, real estate funds, realty investment trusts and global investments are expected to be popular among HNIs," said the Karvy report.
Even with debt and equity, HNIs are exploring options that are offshoots in such classes. "They are looking at investing in unlisted equities, PE funds and in debt," said Rajmohan Krishnan, senior V-P, Kotak Wealth Management.
Read more: Now, super rich look at alternative asset classes - The Times of India http://timesofindia.indiatimes.com/business/india-business/Now-super-rich-look-at-alternative-asset-classes/articleshow/6680959.cms#ixzz11R1yExbE
According to a recent report by Karvy Private Wealth, the wealth management arm of the Karvy Group, individual wealth in India stands at Rs 73 lakh crore and this is expected to double to Rs 144 lakh crore within the next three years. While the bulk of investment is still in direct equity (31.1%) and fixed deposits and bonds (30.3%), private bankers said there is a growing preference for alternative investments. Most HNIs have ridden on the mutual fund and equity wave as they went into the market early. They are now looking at different asset avenues, said Nitin Rao, executive vice-president (private banking group and third party products), HDFC Bank.
HNIs are classified as people with an investible surplus of at least $1 million . Over the years, the profile of HNIs has also rapidly undergone a change.
- Older HNIs largely comprised members drawn from business families.
- Today, nearly 45% of private clients are first-generation entrepreneurs or self-employed, 15% comprise professionals, 20% are senior salaried executives, 5% are young celebrities, with property inheritors accounting for remainder.
"We believe that individuals in India are under-invested in alternative assets. We believe this will be a huge area of investments in the next decade. PE, real estate funds, realty investment trusts and global investments are expected to be popular among HNIs," said the Karvy report.
Even with debt and equity, HNIs are exploring options that are offshoots in such classes. "They are looking at investing in unlisted equities, PE funds and in debt," said Rajmohan Krishnan, senior V-P, Kotak Wealth Management.
Read more: Now, super rich look at alternative asset classes - The Times of India http://timesofindia.indiatimes.com/business/india-business/Now-super-rich-look-at-alternative-asset-classes/articleshow/6680959.cms#ixzz11R1yExbE
Tuesday 24 August 2010
Big investors moving away from stocks into gold and bonds
Published: Tuesday August 24, 2010 MYT 9:05:00 AM
Updated: Tuesday August 24, 2010 MYT 9:13:21 AM
Big investors moving away from stocks into gold and bonds
NEW YORK: The smart money has moved away from stocks. So is the era of stock investing over?
It's too early to tell, but one thing is certain: "Money goes where it is treated best, and that hasn't been in stocks," says Wade Slome, who advises high net-worth investors and runs a hedge fund at his firm, Sidoxia Capital Management in Newport Beach, California.
The overall stock market is down over the past decade, while the price of gold has more than quadrupled and corporate bond returns have doubled. Couple that with the slow economy, and hedge fund managers and institutional investors continue to shift money away from stocks to investments they think will be safer.
An estimated $170 billion has been put in bond funds this year, while $35 billion has been pulled from stock funds, according to the Investment Company Institute, a trade group for the mutual fund industry.
So much for buy and hold.
Analysts at Bespoke Investment Group say we're in a "drive-by market." Their take: Stock investors aren't anticipating or analyzing anything. They just react to the news of the day and then move on to the next thing.
Three months ago, the survival of European banks and economies was front and center. Now, it's barely mentioned. Same goes for the "flash crash" in May. News of strong corporate earnings one day can drive the market sharply higher, but a weak earnings report the next can send prices plunging.
"Investors look at what is in front of them at that minute, and that's it," says Paul Hickey, one of the founders of the investment research firm.
The volatility begets more volatility, which further unnerves investors who have been punished by losses over the last decade. The total return, including dividend, for the benchmark Standard & Poor's 500 index is down about 11 percent since August 2000, according to Bespoke.
That means an investor who put in $10,000 in an S&P index fund 10 years ago and held it now has less than $9,000 to show for it.
Billionaire investor George Soros is one of those who bolted out of stocks in the second quarter. His Soros Fund Management reduced its stock holdings by about 40 percent to $5.1 billion from April through June, according to a quarterly report filed Aug. 17 with U.S. securities regulators. The fund sold 93 percent of its stake in Pfizer and 98 percent of its stake in Wal-Mart during the quarter.
The fund's biggest holding is an exchange-traded fund in gold-related stocks. It represents 13 percent of its stock portfolio. The quarterly report does not detail the fund's holdings outside of stocks, and the fund declined to comment on its investments.
Other big-name investors with large positions in gold ETFs include John Paulson, who was made famous for his successful bet that the subprime mortgage market would blow up.
They are sticking with gold even though prices for the precious metal are up 9 percent this year to more than $1,200 an ounce. That's four times the $300 price of an ounce of gold in 2000.
There has been an equally bullish move into government and corporate bonds. The Federal Reserve has pushed down interest rates to almost zero to stimulate the economy. That has spurred a rally in Treasury bonds and notes. The benchmark 10-year Treasury yield is down to 2.6 percent, its lowest level since the height of the financial crisis in 2009. Prices and yields move in the opposite direction.
Lower rates should help companies because they make it cheaper to borrow money and allow them to refinance their existing debt. Corporate profits then go up, leaving more money to spend on expansion or workers.
That's why lower rates should help boost stocks, says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "But we are not seeing that at all right now."
Instead, investors are putting money into corporate bonds, even those that offer little guaranteed return. IBM was able to raise $1.5 billion by selling 3-year notes that pay a mere 1 percent in interest. That was only 0.30 percentage points more than the yield on comparable U.S. Treasurys.
Johnson & Johnson sold 10-year bonds this month with a 2.95 percent yield, even though it pays a dividend equal to about 3.7 percent of its stock price.
That means an investor who buys $10,000 in J&J bonds gets back $295 annually for 10 years, plus the principal. If that investor bought 166 shares of J&J stock at about $60 a share now and held it for a decade, the annual payout would be $360 a year, plus any price appreciation in the stock and increases in dividends. J&J has increased its dividend for 48 consecutive years.
Junk bonds are also attracting investors. They are being issued by companies at a record clip. Junk bonds are rated lower than other corporate debt because they have a higher probability of default. Investors are compensated for that risk with higher yields, which currently average around 9 percent.
Institutional investors like pension funds that are willing to take above-average risks to get above-average returns, says Ed Yardeni, who runs his own investment and economics consulting firm.
"Investors are fed up with stocks," Yardeni says. "But they are still diversified: Half their portfolio is in gold and half in bonds."
Of course, investing in bonds and gold aren't risk-free. Far from it. The dramatic rallies in both have some on Wall Street saying that bonds and gold could be nearing a bubble that's about to pop.
By taking those positions, investors are hedging their bets about what's to come with the economy. Gold is considered a protector against inflation, and bonds are good to hold in times of deflation.
As for stocks, they're getting the short shrift they deserve. - AP
http://biz.thestar.com.my/news/story.asp?file=/2010/8/24/business/20100824091246&sec=business
Updated: Tuesday August 24, 2010 MYT 9:13:21 AM
Big investors moving away from stocks into gold and bonds
NEW YORK: The smart money has moved away from stocks. So is the era of stock investing over?
It's too early to tell, but one thing is certain: "Money goes where it is treated best, and that hasn't been in stocks," says Wade Slome, who advises high net-worth investors and runs a hedge fund at his firm, Sidoxia Capital Management in Newport Beach, California.
The overall stock market is down over the past decade, while the price of gold has more than quadrupled and corporate bond returns have doubled. Couple that with the slow economy, and hedge fund managers and institutional investors continue to shift money away from stocks to investments they think will be safer.
An estimated $170 billion has been put in bond funds this year, while $35 billion has been pulled from stock funds, according to the Investment Company Institute, a trade group for the mutual fund industry.
So much for buy and hold.
Analysts at Bespoke Investment Group say we're in a "drive-by market." Their take: Stock investors aren't anticipating or analyzing anything. They just react to the news of the day and then move on to the next thing.
Three months ago, the survival of European banks and economies was front and center. Now, it's barely mentioned. Same goes for the "flash crash" in May. News of strong corporate earnings one day can drive the market sharply higher, but a weak earnings report the next can send prices plunging.
"Investors look at what is in front of them at that minute, and that's it," says Paul Hickey, one of the founders of the investment research firm.
The volatility begets more volatility, which further unnerves investors who have been punished by losses over the last decade. The total return, including dividend, for the benchmark Standard & Poor's 500 index is down about 11 percent since August 2000, according to Bespoke.
That means an investor who put in $10,000 in an S&P index fund 10 years ago and held it now has less than $9,000 to show for it.
Billionaire investor George Soros is one of those who bolted out of stocks in the second quarter. His Soros Fund Management reduced its stock holdings by about 40 percent to $5.1 billion from April through June, according to a quarterly report filed Aug. 17 with U.S. securities regulators. The fund sold 93 percent of its stake in Pfizer and 98 percent of its stake in Wal-Mart during the quarter.
The fund's biggest holding is an exchange-traded fund in gold-related stocks. It represents 13 percent of its stock portfolio. The quarterly report does not detail the fund's holdings outside of stocks, and the fund declined to comment on its investments.
Other big-name investors with large positions in gold ETFs include John Paulson, who was made famous for his successful bet that the subprime mortgage market would blow up.
They are sticking with gold even though prices for the precious metal are up 9 percent this year to more than $1,200 an ounce. That's four times the $300 price of an ounce of gold in 2000.
There has been an equally bullish move into government and corporate bonds. The Federal Reserve has pushed down interest rates to almost zero to stimulate the economy. That has spurred a rally in Treasury bonds and notes. The benchmark 10-year Treasury yield is down to 2.6 percent, its lowest level since the height of the financial crisis in 2009. Prices and yields move in the opposite direction.
Lower rates should help companies because they make it cheaper to borrow money and allow them to refinance their existing debt. Corporate profits then go up, leaving more money to spend on expansion or workers.
That's why lower rates should help boost stocks, says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "But we are not seeing that at all right now."
Instead, investors are putting money into corporate bonds, even those that offer little guaranteed return. IBM was able to raise $1.5 billion by selling 3-year notes that pay a mere 1 percent in interest. That was only 0.30 percentage points more than the yield on comparable U.S. Treasurys.
Johnson & Johnson sold 10-year bonds this month with a 2.95 percent yield, even though it pays a dividend equal to about 3.7 percent of its stock price.
That means an investor who buys $10,000 in J&J bonds gets back $295 annually for 10 years, plus the principal. If that investor bought 166 shares of J&J stock at about $60 a share now and held it for a decade, the annual payout would be $360 a year, plus any price appreciation in the stock and increases in dividends. J&J has increased its dividend for 48 consecutive years.
Junk bonds are also attracting investors. They are being issued by companies at a record clip. Junk bonds are rated lower than other corporate debt because they have a higher probability of default. Investors are compensated for that risk with higher yields, which currently average around 9 percent.
Institutional investors like pension funds that are willing to take above-average risks to get above-average returns, says Ed Yardeni, who runs his own investment and economics consulting firm.
"Investors are fed up with stocks," Yardeni says. "But they are still diversified: Half their portfolio is in gold and half in bonds."
Of course, investing in bonds and gold aren't risk-free. Far from it. The dramatic rallies in both have some on Wall Street saying that bonds and gold could be nearing a bubble that's about to pop.
By taking those positions, investors are hedging their bets about what's to come with the economy. Gold is considered a protector against inflation, and bonds are good to hold in times of deflation.
As for stocks, they're getting the short shrift they deserve. - AP
http://biz.thestar.com.my/news/story.asp?file=/2010/8/24/business/20100824091246&sec=business
Saturday 24 July 2010
S&P 500 Dividend Yield versus 10 Year Treasury Yield
The 10 year U.S. Treasury yield has been greater than the S&P 500 Index dividend yield since 1958. However, in November 2008 the roles reversed when the S&P 500 yielded more than 10 year Treasuries. The chart above compares these yields from November 1993 to November 2008. Why do stocks, as represented by the S&P 500 Index, now yield more than bonds, as represented by the U.S. 10 Year Treasury?
Experts differ on the reasons, but one reason is simply market forces. The 10 year U.S. Treasury yield has been driven down as investors have moved out of stocks and into the safety of U.S. Treasuries, driving bond prices up. Bond yields go down when bond prices go up. The S&P 500 dividend yield has increased due to the recent sharp declines in stock prices. Dividend yield represents the trailing annual dividend per share divided by the current share price. Current stock prices have dropped at such a sharp rate that when dividing trailing annual dividends by current price, the dividend yield increased.
http://www.icmarc.org/xp/rc/marketview/chart/2008/20081212SP500DividendYield.html
Sunday 25 April 2010
Common stock dividends, an old idea for retirement income, are in vogue again
And the challenge for many American retirees won't just be to generate income from their nest egg, but to generate rising income to keep up with inflation.
Looking for a strategy to fill that bill, some investment advisors are turning to a solution that was familiar to Eisenhower-era retirees but increasingly has been lost on generations since then: common stock dividends from big-name companies, which in this era means firms such as Johnson & Johnson, H.J. Heinz Co. and utility PG&E Corp.
"We're pushing this idea with clients now," said Rich Weiss, who as chief investment officer at City National Bank in L.A. oversees about $55 billion. "There's a great case to be made for it."
It isn't difficult to find shares of brand-name consumer products companies with annualized dividend yields of 3% to 3.5%. (A stock's yield is the dividend divided by the current share price.) Yields on utility shares average about 4.4%.
Those dividend returns compare with an interest yield of about 2.6% on a five-year U.S. Treasury note.
Yet the dividend story is likely to be a very hard sell with many people, for eminently understandable reasons.
Retirement is supposed to be about financial stability and reduced investment risk. After the stock market crash of late 2008 and early 2009 — the worst decline since the Great Depression — equities naturally seem dicier than ever to countless Americans.
That's why people have turned to bonds in huge numbers, pumping hundreds of billions of dollars into bond mutual funds over the last 15 months.
Agreed, bonds almost certainly will be a safer place for your money than stocks, particularly over any short time period. But if it's income you're going to need in retirement, bonds aren't the slam-dunk answer they may seem to be.
One reason is that, thanks to the Federal Reserve's cheap-money policies and investors' rush for havens over the last year, interest rates on many types of bonds are well below where they were for most of the last 15 years. So you're starting out with a smaller income reward.
More important is that once you buy a fixed-rate bond (or a bank CD, for that matter), your yield is set until the security matures.
As Kurt Brouwer, principal at financial advisory firm Brouwer & Janachowski in Tiburon, Calif., puts it: "The issuer of a bond is never going to call up and say, ‘We want to pay you more.' "
What about bond mutual funds? Fund investors' income can rise over time if market interest rates go up and the fund buys new bonds paying higher yields. But predicting future interest payments on a fund in a rising rate environment isn't easy because of all the variables involved — including the types of bonds the manager buys, their maturities and whether the fund has more cash leaving than coming in.
And of course you face the risk that higher market interest rates will devalue older, lower-yielding bonds in a fund, depressing the value of your shares.
Dividend-paying stocks, by contrast, can offer what individual bonds can't: the potential for rising income over time, offsetting or more than compensating for inflation.
Healthcare products company Abbott Laboratories, for example, has lifted its dividend 60% since 2005, from an annual payment of $1.10 a share that year to the current annual rate of $1.76. Johnson & Johnson's dividend has risen 71% in the same period; Heinz's payout is up 47%.
All three dividends far outpaced the U.S. consumer price index, which rose about 13% in that period.
But if only the dividend story were that simple, everyone would buy into it. Although your income may rise with a dividend-paying stock, there is the ever-present risk that the share price itself, in the short run or long run, could lose far more than any dividends you'll earn.
The other major risk is that companies can cut their dividends. Some very big firms, including General Electric Co., Macy's Inc. and CBS Corp., did exactly that in 2008 and 2009 as the recession devastated their earnings.
Worse, many banks either slashed or eliminated their payouts altogether. The financial industry had long been one of the favorite sectors of dividend-seeking investors.
So why take a chance on dividend-paying stocks now? Because amid the economy's recovery more companies are boosting their payouts. A total of 284 U.S. firms lifted their dividends in the first quarter, up from 193 in the year-earlier quarter, according to Standard & Poor's. And the number of firms reducing or omitting their dividends plunged to 48 last quarter from a horrid 367 a year earlier.
Also, the Obama administration has signaled that it wants to largely preserve the favored tax treatment of dividends as put in place by President George W. Bush. The Bush tax cuts expire at the end of this year, but Obama supports keeping the dividend tax rate at 15% for couples earning less than $250,000 a year.
For investors who own stocks and bonds outside of tax-deferred retirement accounts, the Bush tax cuts gave dividends a huge advantage over bond interest, which is taxed at ordinary rates.
Josh Peters, who tracks and recommends dividend-paying stocks for investment research firm Morningstar Inc. in Chicago, says his frustration at the moment is that he views most solid dividend-paying stocks as fairly priced, at best — meaning it's hard to find genuine bargains after the market's 13-month surge.
That means the same would be true of the dividend-focused mutual funds and exchange-traded funds that offer an easy way for small investors to invest for dividend returns, albeit without the level of control they'd have by building a portfolio of 15 to 20 individual stocks.
Still, Peters expects that some of his favorite dividend-growth plays, including Waste Management, food-service-industry products distributor Sysco Corp. and payroll-services firm Paychex, will be able to boost their dividends at least 7% a year over the next five years.
He believes that more investors nearing retirement will begin to focus the power of dividend growth in a diversified portfolio.
"I think baby boomers will realize that if they need growth of income they can't just do the bond thing," he said.
tom.petruno@latimes.com
http://www.latimes.com/business/la-fi-petruno-20100424,0,1332567,full.column
Thursday 1 April 2010
Buffett (1984): 'Investments in bonds' and 'Corporate dividend policies'
We saw Warren Buffett put forth his views on the concept of 'economic goodwill' and why he prefers companies that have a high amount of the same. Let us now see what the master has to offer in terms of investment wisdom in his 1984 letter to the shareholders.
While Buffett has devoted a lot of space in his 84' letter to discussing in detail, some of Berkshire's biggest investments in those times, but as usual, the letter is not short on some general investment related counsel either. In a rather simplistic way that only he can, the master gives his opinion on a couple of extremely important topics like 'investments in bonds' and 'corporate dividend policies'. On the former, he has to say the following:
"Our approach to bond investment - treating it as an unusual sort of "business" with special advantages and disadvantages - may strike you as a bit quirky. However, we believe that many staggering errors by investors could have been avoided if they had viewed bond investment with a businessman's perspective. For example, in 1946, 20-year AAA tax-exempt bonds traded at slightly below a 1% yield. In effect, the buyer of those bonds at that time bought a "business" that earned about 1% on "book value" (and that, moreover, could never earn a dime more than 1% on book), and paid 100 cents on the dollar for that abominable business."
Berkshire Hathaway in 1984 had purchased huge quantities of bonds in a troubled company, where the yields had gone up to as much as 16%. While usually not a huge fan of long term bond investments, the master chose to invest in the troubled company because he felt that the risk was rather limited and not many businesses during those times gave as much return on the invested capital. Thus, despite the rather limited upside potential, he went ahead with his bond investments. This is further made clear in his following comment:
"This ceiling on upside potential is an important minus. It should be realized, however, that the great majority of operating businesses have a limited upside potential also unless more capital is continuously invested in them. That is so because most businesses are unable to significantly improve their average returns on equity - even under inflationary conditions, though these were once thought to automatically raise returns."
Years and years of studying companies had led the master to conclude that there are very few companies on the face of this earth that are able to continuously earn above average returns without consuming too much of capital. Indeed, such brutal are the competitive forces that sooner or later and in this case, more sooner than later that returns for majority of the companies tend to gravitate towards their cost of capital. If we do a similar study on our Sensex, we will too come to the conclusion that there are not many companies that were a part of the index 15 years back and are still a part of the same index. Hence, while valuing companies, having a fair judgement of when the competitive position of the company, the one that enables it to consistently earn above average returns is likely to deteriorate. This will help you to avoid paying too much for the company's future growth.
After touching upon the topic of bond investments, the master then gives his take on dividends and this is what he has to say:
"The first point to understand is that all earnings are not created equal. In many businesses particularly those that have high asset/profit ratios - inflation causes some or all of the reported earnings to become ersatz. The ersatz portion - let's call these earnings "restricted" - cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas:
While the master is definitely in favour of dividend payments, he is also aware of the fact that not all companies have similar capital needs in order to maintain their ongoing level of operations.
He then goes on to add how his own textile company, Berkshire Hathaway, had huge ongoing capital needs and hence was unable to pay dividends. He also further adds that had Berkshire Hathaway distributed all its earnings as dividends, the master would have left with no capital at all to be put into his other high return yielding investments. Thus, by not letting the operational performance of the company deteriorate by retaining earnings and not distributing it as dividends, he was able to avoid a situation in the future where he would have had too put in his own capital in the business.
http://www.equitymaster.com/detail.asp?date=8/16/2007&story=1
While Buffett has devoted a lot of space in his 84' letter to discussing in detail, some of Berkshire's biggest investments in those times, but as usual, the letter is not short on some general investment related counsel either. In a rather simplistic way that only he can, the master gives his opinion on a couple of extremely important topics like 'investments in bonds' and 'corporate dividend policies'. On the former, he has to say the following:
"Our approach to bond investment - treating it as an unusual sort of "business" with special advantages and disadvantages - may strike you as a bit quirky. However, we believe that many staggering errors by investors could have been avoided if they had viewed bond investment with a businessman's perspective. For example, in 1946, 20-year AAA tax-exempt bonds traded at slightly below a 1% yield. In effect, the buyer of those bonds at that time bought a "business" that earned about 1% on "book value" (and that, moreover, could never earn a dime more than 1% on book), and paid 100 cents on the dollar for that abominable business."
Berkshire Hathaway in 1984 had purchased huge quantities of bonds in a troubled company, where the yields had gone up to as much as 16%. While usually not a huge fan of long term bond investments, the master chose to invest in the troubled company because he felt that the risk was rather limited and not many businesses during those times gave as much return on the invested capital. Thus, despite the rather limited upside potential, he went ahead with his bond investments. This is further made clear in his following comment:
"This ceiling on upside potential is an important minus. It should be realized, however, that the great majority of operating businesses have a limited upside potential also unless more capital is continuously invested in them. That is so because most businesses are unable to significantly improve their average returns on equity - even under inflationary conditions, though these were once thought to automatically raise returns."
Years and years of studying companies had led the master to conclude that there are very few companies on the face of this earth that are able to continuously earn above average returns without consuming too much of capital. Indeed, such brutal are the competitive forces that sooner or later and in this case, more sooner than later that returns for majority of the companies tend to gravitate towards their cost of capital. If we do a similar study on our Sensex, we will too come to the conclusion that there are not many companies that were a part of the index 15 years back and are still a part of the same index. Hence, while valuing companies, having a fair judgement of when the competitive position of the company, the one that enables it to consistently earn above average returns is likely to deteriorate. This will help you to avoid paying too much for the company's future growth.
After touching upon the topic of bond investments, the master then gives his take on dividends and this is what he has to say:
"The first point to understand is that all earnings are not created equal. In many businesses particularly those that have high asset/profit ratios - inflation causes some or all of the reported earnings to become ersatz. The ersatz portion - let's call these earnings "restricted" - cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas:
- its ability to maintain its unit volume of sales,
- its long-term competitive position,
- its financial strength.
While the master is definitely in favour of dividend payments, he is also aware of the fact that not all companies have similar capital needs in order to maintain their ongoing level of operations.
- Hence, in cases where businesses have high capital needs, a high payout ratio is likely to result in deterioration of the business or sooner or later will require additional capital to be infused.
- On the other hand, companies that have limited capital needs should distribute the remaining earnings as dividends and not pursue investments which drive down the overall returns of the underlying business.
- In a nutshell, capital should go where it can be put to earn maximum rate of return.
He then goes on to add how his own textile company, Berkshire Hathaway, had huge ongoing capital needs and hence was unable to pay dividends. He also further adds that had Berkshire Hathaway distributed all its earnings as dividends, the master would have left with no capital at all to be put into his other high return yielding investments. Thus, by not letting the operational performance of the company deteriorate by retaining earnings and not distributing it as dividends, he was able to avoid a situation in the future where he would have had too put in his own capital in the business.
http://www.equitymaster.com/detail.asp?date=8/16/2007&story=1
Sunday 31 January 2010
Reviewing the basics of interest-bearing investments
To have a good understanding of interest-bearing investments, learn and know the followings.
The risks of interest-bearing investments, for example:
The advantages of investing in this asset class, particularly
Some of the main interest-bearing investments in the market. These include:
You have to know about two new market places other than the stock market:
The risks of interest-bearing investments, for example:
- inflation,
- interest rate cycles and
- dubious borrowers with poor credit ratings.
The advantages of investing in this asset class, particularly
- the interest income on which you can rely.
Some of the main interest-bearing investments in the market. These include:
- cash,
- money market funds,
- bonds,
- participation mortgage bonds and
- voluntary purchased term annuities.
You have to know about two new market places other than the stock market:
- the money market, where short-term interest-bearing secuities are traded, and
- the bond market, where longer-term interest-bearing securites such as bonds are traded.
Mistakes to avoid when investing in interest-bearing instruments
Interest-bearing investments may be relatively stress-free, but they too have their pitfalls. Watch out for the following:
- Do not accept the first interest rate you are offered. Compare interest rates, negotiate where possible and find out more about fixed versus fluctuating interest rates and the term of fixed-interest investments.
- Do not think interest-bearing investments are safe, risk-free havens. Remember the impact of inflation.
- Do not forget about interest rate risk. When interest rates increase, bond prices will decrease, resulting in a loss on your investment. The longer the term of the bonds, the greater the drop in the market price.
- Do not invest in bonds without understanding the terms of the bonds and the interest rate environment. Invest in well-known and reputable bonds rather than in unknown corporate bonds.
More about another interest bearing investments: bonds
Bonds are fixed-income securities that governments and companies issue in order to borrow money. They pay interest to you for that privilege.
The maturity date is the date on which the full amount that was borrowed is returned to you .
The investment term is normally a fairly long period, say ten years or longer.
The coupon is the interest rate you receive.
Bonds are traded on the capital market in the same way that equities are traded on the stock market.
Bonds are medium-risk investments because the interest rate cycle has a definite impact on the value of bonds.
If you want to understand bonds, this is the most important thing to remember: when interest rates fall, bond prices rise; when interest rates rise, bond prices fall.
This is simply because the coupon on the bond is fixed, and the market value of the bond is adjusted to bring the coupon in line with the external interest rate.
Bonds are a very important part of a well-diversified portfolio. In difficult stock markets, bonds can provide a cushion to soften the blow.
The maturity date is the date on which the full amount that was borrowed is returned to you .
The investment term is normally a fairly long period, say ten years or longer.
The coupon is the interest rate you receive.
Bonds are traded on the capital market in the same way that equities are traded on the stock market.
Bonds are medium-risk investments because the interest rate cycle has a definite impact on the value of bonds.
If you want to understand bonds, this is the most important thing to remember: when interest rates fall, bond prices rise; when interest rates rise, bond prices fall.
This is simply because the coupon on the bond is fixed, and the market value of the bond is adjusted to bring the coupon in line with the external interest rate.
Bonds are a very important part of a well-diversified portfolio. In difficult stock markets, bonds can provide a cushion to soften the blow.
Saturday 30 January 2010
The calmer waters of interest-bearing investments: their risks and rewards
The interest-bearing investments include:
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- cash
- bonds
- the money market securities.
The focus of interest-bearing investments is not on the appreciation (increase) of the capital you have invested, but rather on the provision of a steady interest income - often at a fixed rate.
While shares offer you higher returns at a higher risk, interest-bearing investments offer you lower returns at a lower risk, making them a safe haven for many investors.
But this safe asset class is not safe from inflation.
Interest-bearing investments often do not generate the kind of return that beats inflation, and it is very important to remember that interest income is taxable. After taking tax into account, the return on interest-bearing investments often struggles to beat the inflation rate.
The reason for this is simple. Interest-bearing investments are normally money you lend to a bank, government, company or other institution with the undertaking that this exact amount will be paid back after a period of time.
In return for this, you earn interest.
Since you only get the same amount back after a couple of months or years, that amount is usually worth less as a result of inflation.
Your only real benefit is the income that you receive.
Interest-bearing investments also hold other risks.
- This asset class is subject to the ups and downs of the interest rate cycle. As interest rates increase or decrease, your cash flow can be affected - unless you have a fixed interest rate.
- Furthermore, you should beware of institutions with credit risk. A high interest rate is not everything: you must also be sure that your capital will be paid back.
Interest-bearing investments do, however, play an important part in an investment portfolio. Although inflation will still erode the capital value of your investment, these investments do have advantages, including:
- offering you a relatively safe and predictable income.
- offering you less risk and volatility than an investment in equities
- offering diversification in your portfolio in case stock markets collapse
- giving you instant access to cash when you need it.
Bonds - moderate risk
Bonds or gilts can be defined as interest-bearing securities issued by governments or companies in order to borrow money.
In essence, it is an IOU, in which they promise to pay you, the lender,
This asset class offers a moderate risk.
In essence, it is an IOU, in which they promise to pay you, the lender,
- interest and
- to pay back your capital sum on a specific date.
This asset class offers a moderate risk.
- The capital sum that you invest can fluctuate, while
- the interest payments can be higher than on cash.
Saturday 23 January 2010
Bonds
The Pros and Cons of some Basic Investments
Bonds
A bond is a glorified IOU.
When you buy a bond, you're simply making a loan.
The seller of the bond, also called the issuer, is borrowing your money, and the bond itself is proof that the issuer, is borrowing.
The biggest seller of bonds in the world is Uncle Sam. Whenever the US government needs extra cash (which these days is all the time), it prints up a new batch.
The government owes so much to so many that more than 15% of all the federal taxes goes to paying the interest.
The type of bond that young people are most likely to get involved in is the US Savings Bond. Grandparents are famous for giving savings bonds as gifts to their grandchildren. Over the years, the government pays back the money, plus interest - not to the grandparents, but to the grandchildren.
State and local governments also sell bonds to raise cash. So do hospitals, and airports, school districts and sports stadiums, public agencies of all kinds, and thousands of companies. Bonds are in abundant supply.
The main difference between bonds and CDs or Treasury bills is that with CDs and Treasuries, you get paid back sooner (the period varies from a few months to a couple of years), and with bonds you get paid back later (you might have to wait five years, ten years, or as long as thirty years).
The longer it takes for bonds to pay off, the greater the risk that inflation will eat up the value of your money before you get it back. That's why bonds pay a higher rate of interest than the short-term alternatives, such as CDs, savings accounts, or the money market. Investors demand to be rewarded for taking the greater risk.
All else being equal, a 30-year bond pays more interest than a 10-year bond, which in turn pays more interest than a 5-year bond, and so on. The buyers of bonds have to decide how far out they want to go, and whether the extra money they make in interest, on say, a 30-year bond is worth the risk of having their money tied up for that long. These are difficult decisons.
Stocks are riskier than bonds, and potentially far more rewarding.
The good thing about a bond is that even though you miss the gain when the stock goes up, you also miss the loss when the stock goes down.
That's why a bond is less risky than a stock. There's a guarantee attached to it. When you buy a bond, you know in advance exactly how much you will be getting in interest payments, and you won't lie awake nights worrying where the stock price is headed. Your investment is protected, at least more protected than when you buy a stock.
Still, there are 3 ways you can get hurt by a bond.
1. The first danger occurs if you sell the bond before the due date, when the issuer of the bond must repay you in full. By selling early, you take your chances in the bond market, where the prices of bonds go up and down daily, the same as stocks. So, if you get out of a bond prematurely, you might get less than you paid for it.
2. The second danger occurs when the issuer of the bond goes bankrupt and can't pay you back. The chances of this happening depend on who is doing the issuing. The US government, for example, will never go bankrupt - it can print more money whenever it wants. Other issuers can't always offer such a guarantee. If they go bankrupt, the owners of the bonds can lose a lot of money. Usually, they get something back, but not the entire investment. And sometimes, they lose the whole amount.
When an issuer of a bond fails to make the required payments, it's called a default. To avoid getting caught in one, smart bond buyers review the financial condition of the issuer fo a bond before they consider buying it. Some bonds are insured, which is another way the payments can be guaranteed. Also, there are agencies that give safety ratings to bonds, so potential buyers know in advance which ones are risky and which aren't. A strong company gets a high safety rating - the chance of defauting on a bond are close to zero. A weaker company that has trouble paying its bills will get a low rating. You've heard of junk bonds? These are the bonds that get the lowest ratings of all.
When you buy a junk bond, you're taking a bigger risk that you won't get your money back. That's why junk bonds pay a higher rate of interest than other bonds - the investors are rewarded for taking the extra risk.
Except with the junkiest of junk bonds, defaults are few and far between.
3. The third and biggest risk in owning a bond is: INFLATION. With stocks, over the very long term, you can keep up with inflation and make a decent profit to boot. With bonds, you can't.
Bonds
A bond is a glorified IOU.
When you buy a bond, you're simply making a loan.
The seller of the bond, also called the issuer, is borrowing your money, and the bond itself is proof that the issuer, is borrowing.
The biggest seller of bonds in the world is Uncle Sam. Whenever the US government needs extra cash (which these days is all the time), it prints up a new batch.
The government owes so much to so many that more than 15% of all the federal taxes goes to paying the interest.
The type of bond that young people are most likely to get involved in is the US Savings Bond. Grandparents are famous for giving savings bonds as gifts to their grandchildren. Over the years, the government pays back the money, plus interest - not to the grandparents, but to the grandchildren.
State and local governments also sell bonds to raise cash. So do hospitals, and airports, school districts and sports stadiums, public agencies of all kinds, and thousands of companies. Bonds are in abundant supply.
The main difference between bonds and CDs or Treasury bills is that with CDs and Treasuries, you get paid back sooner (the period varies from a few months to a couple of years), and with bonds you get paid back later (you might have to wait five years, ten years, or as long as thirty years).
The longer it takes for bonds to pay off, the greater the risk that inflation will eat up the value of your money before you get it back. That's why bonds pay a higher rate of interest than the short-term alternatives, such as CDs, savings accounts, or the money market. Investors demand to be rewarded for taking the greater risk.
All else being equal, a 30-year bond pays more interest than a 10-year bond, which in turn pays more interest than a 5-year bond, and so on. The buyers of bonds have to decide how far out they want to go, and whether the extra money they make in interest, on say, a 30-year bond is worth the risk of having their money tied up for that long. These are difficult decisons.
Stocks are riskier than bonds, and potentially far more rewarding.
The good thing about a bond is that even though you miss the gain when the stock goes up, you also miss the loss when the stock goes down.
That's why a bond is less risky than a stock. There's a guarantee attached to it. When you buy a bond, you know in advance exactly how much you will be getting in interest payments, and you won't lie awake nights worrying where the stock price is headed. Your investment is protected, at least more protected than when you buy a stock.
Still, there are 3 ways you can get hurt by a bond.
1. The first danger occurs if you sell the bond before the due date, when the issuer of the bond must repay you in full. By selling early, you take your chances in the bond market, where the prices of bonds go up and down daily, the same as stocks. So, if you get out of a bond prematurely, you might get less than you paid for it.
2. The second danger occurs when the issuer of the bond goes bankrupt and can't pay you back. The chances of this happening depend on who is doing the issuing. The US government, for example, will never go bankrupt - it can print more money whenever it wants. Other issuers can't always offer such a guarantee. If they go bankrupt, the owners of the bonds can lose a lot of money. Usually, they get something back, but not the entire investment. And sometimes, they lose the whole amount.
When an issuer of a bond fails to make the required payments, it's called a default. To avoid getting caught in one, smart bond buyers review the financial condition of the issuer fo a bond before they consider buying it. Some bonds are insured, which is another way the payments can be guaranteed. Also, there are agencies that give safety ratings to bonds, so potential buyers know in advance which ones are risky and which aren't. A strong company gets a high safety rating - the chance of defauting on a bond are close to zero. A weaker company that has trouble paying its bills will get a low rating. You've heard of junk bonds? These are the bonds that get the lowest ratings of all.
When you buy a junk bond, you're taking a bigger risk that you won't get your money back. That's why junk bonds pay a higher rate of interest than other bonds - the investors are rewarded for taking the extra risk.
Except with the junkiest of junk bonds, defaults are few and far between.
3. The third and biggest risk in owning a bond is: INFLATION. With stocks, over the very long term, you can keep up with inflation and make a decent profit to boot. With bonds, you can't.
Thursday 25 June 2009
Shortcomings of Bonds
A bond is a contractual agreement that means you have loaned money to some entity, and that entity has agreed to pay you a certain sum of money (interest) every six months until that bond matures. At that time, you will also get back the money you originally invested - no more, no less.
The two advantages of bonds are safety and income.
If you wait until the maturity date, you will be assured of getting the face value of the bond.
In the meantime, however, the bond will fluctuate, because of
Bonds don't have a particularly impressive record.
Also, bonds, even U.S. Treasuries, have an element of risk.
The two advantages of bonds are safety and income.
If you wait until the maturity date, you will be assured of getting the face value of the bond.
In the meantime, however, the bond will fluctuate, because of
- changes in interest rates, or
- the creditworthiness of the corporation.
Bonds don't have a particularly impressive record.
- Except for a year here or there, common stocks have always been a better place to be.
- Furthermore, the return on bonds today is not much better than the rate you can get on a money-market fund.
Also, bonds, even U.S. Treasuries, have an element of risk.
- They decline in value when interest rates go up.
- Long-term bonds, moreover, slide precipitously when rates shoot up.
Monday 16 February 2009
Classic Question: Annuities or Bonds?
Classic Question: Annuities or Bonds?
Sponsored by by Don Taylor
Saturday, February 14, 2009
provided by
Dear Dr. Don,
I have been considering an immediate annuity, but was wondering what the benefit is over buying a long-term corporate bond or bonds with a similar yield.
Assuming I seek 30 years of income, it seems the annuity is implying something like a 4.5 percent to 5 percent yield. Wouldn't I be better off buying a corporate bond that yields a similar amount? That way, I'd still have the principal to spend at maturity in case I lived longer than planned.
Am I not taking the same default risk with either investment since the insurance company could go out of business just like any other company? And finally, are there tax reasons that would make an immediate annuity better?
-- Laurence Longevity
Dear Laurence,
Yours is a classic question in retirement planning. To restate: "If you can invest at the same yield and the same risk as the immediate annuity, aren't you better off investing in the bonds versus buying the immediate annuity?"
For many the answer will be "no," but making it an apples-to-apples comparison is more difficult than just comparing the interest income from the bonds with the income from the annuity.
In addition, getting the risk levels equal is nigh impossible. State insurance commissions have reserve and other requirements that make an investment in an annuity from a highly rated insurance company safer than an investment in a highly rated corporate bond.
You purchase an immediate annuity with a lump sum and buy an income stream that lasts for your lifetime. The immediate annuity allows you to achieve a higher income stream than you could earn from living off the interest income paid by the bonds. That's because a straight life immediate annuity doesn't return principal when you die, and the annuity only lasts for your lifetime.
There are a multitude of options in how you structure the annuity. You can have it pay over your lifetime, over a joint lifetime or over a set time horizon. The payment can be indexed to inflation. There may or may not be a death benefit to a beneficiary. There may be a guarantee that you or your beneficiaries will at least receive in distributions the amount of money you have invested.
As soon as you start adding options, however, the value of the annuity payment declines because you have spent part of the purchase price to buy that option.
I used the annuity quote function on ImmediateAnnuities.com and assumed a $1 million investment for a 66-year-old male. (The annuity calculator on Vanguard.com is also recommended.) You can do your own calculation based on your age and the money you have available to purchase the annuity. The site will return almost two dozen different monthly payments based on typical annuity options.
I'm going to focus on the straight life annuity, which is the type of annuity that ensures a fixed income for the rest of the purchaser's life. The $1 million purchase secures a monthly income stream of $7,397. If you assume a 30-year life, it equates to a yield of roughly 8.4 percent (assuming the 66-year-old lives to 96). The longer you live, the higher the implied yield on the annuity.
A portfolio of 30-year, single-A rated corporate bonds isn't currently yielding in that ballpark. However, even if the two products were yielding a similar rate, the bonds are riskier than the annuities (for the reasons stated earlier).
I'm going to beg off on the tax discussion between the two investments and leave that to you and a tax professional. However, there's more to consider here than just taxes. Two other considerations are how the choice of an annuity versus the bond portfolio could impact your eligibility for Medicaid and potential estate-planning issues.
The bottom line is that the law of large numbers should allow an insurance company to pay a higher income stream on a single life annuity than you can earn off a similar amount invested in a high-quality bond portfolio.
This is true because the insurance company doesn't have to return your principal if you die sooner than expected, and dealing with a large pool of annuity owners means it can use mortality figures to estimate the average life of that pool to price the annuity.
Annuities are going to make the most sense for people who are worried about outliving their income and don't have a large retirement nest egg as a backstop.
Before signing an annuity contract, get a second opinion on the decision from a fee-only financial adviser. The National Association of Personal Financial Advisors maintains a listing of fee-only advisers.
Copyrighted, Bankrate.com. All rights reserved.
http://finance.yahoo.com/focus-retirement/article/106589/Classic-Question:-Annuities-or-Bonds?mod=retirement-post-spending
Sponsored by by Don Taylor
Saturday, February 14, 2009
provided by
Dear Dr. Don,
I have been considering an immediate annuity, but was wondering what the benefit is over buying a long-term corporate bond or bonds with a similar yield.
Assuming I seek 30 years of income, it seems the annuity is implying something like a 4.5 percent to 5 percent yield. Wouldn't I be better off buying a corporate bond that yields a similar amount? That way, I'd still have the principal to spend at maturity in case I lived longer than planned.
Am I not taking the same default risk with either investment since the insurance company could go out of business just like any other company? And finally, are there tax reasons that would make an immediate annuity better?
-- Laurence Longevity
Dear Laurence,
Yours is a classic question in retirement planning. To restate: "If you can invest at the same yield and the same risk as the immediate annuity, aren't you better off investing in the bonds versus buying the immediate annuity?"
For many the answer will be "no," but making it an apples-to-apples comparison is more difficult than just comparing the interest income from the bonds with the income from the annuity.
In addition, getting the risk levels equal is nigh impossible. State insurance commissions have reserve and other requirements that make an investment in an annuity from a highly rated insurance company safer than an investment in a highly rated corporate bond.
You purchase an immediate annuity with a lump sum and buy an income stream that lasts for your lifetime. The immediate annuity allows you to achieve a higher income stream than you could earn from living off the interest income paid by the bonds. That's because a straight life immediate annuity doesn't return principal when you die, and the annuity only lasts for your lifetime.
There are a multitude of options in how you structure the annuity. You can have it pay over your lifetime, over a joint lifetime or over a set time horizon. The payment can be indexed to inflation. There may or may not be a death benefit to a beneficiary. There may be a guarantee that you or your beneficiaries will at least receive in distributions the amount of money you have invested.
As soon as you start adding options, however, the value of the annuity payment declines because you have spent part of the purchase price to buy that option.
I used the annuity quote function on ImmediateAnnuities.com and assumed a $1 million investment for a 66-year-old male. (The annuity calculator on Vanguard.com is also recommended.) You can do your own calculation based on your age and the money you have available to purchase the annuity. The site will return almost two dozen different monthly payments based on typical annuity options.
I'm going to focus on the straight life annuity, which is the type of annuity that ensures a fixed income for the rest of the purchaser's life. The $1 million purchase secures a monthly income stream of $7,397. If you assume a 30-year life, it equates to a yield of roughly 8.4 percent (assuming the 66-year-old lives to 96). The longer you live, the higher the implied yield on the annuity.
A portfolio of 30-year, single-A rated corporate bonds isn't currently yielding in that ballpark. However, even if the two products were yielding a similar rate, the bonds are riskier than the annuities (for the reasons stated earlier).
I'm going to beg off on the tax discussion between the two investments and leave that to you and a tax professional. However, there's more to consider here than just taxes. Two other considerations are how the choice of an annuity versus the bond portfolio could impact your eligibility for Medicaid and potential estate-planning issues.
The bottom line is that the law of large numbers should allow an insurance company to pay a higher income stream on a single life annuity than you can earn off a similar amount invested in a high-quality bond portfolio.
This is true because the insurance company doesn't have to return your principal if you die sooner than expected, and dealing with a large pool of annuity owners means it can use mortality figures to estimate the average life of that pool to price the annuity.
Annuities are going to make the most sense for people who are worried about outliving their income and don't have a large retirement nest egg as a backstop.
Before signing an annuity contract, get a second opinion on the decision from a fee-only financial adviser. The National Association of Personal Financial Advisors maintains a listing of fee-only advisers.
Copyrighted, Bankrate.com. All rights reserved.
http://finance.yahoo.com/focus-retirement/article/106589/Classic-Question:-Annuities-or-Bonds?mod=retirement-post-spending
Wednesday 11 February 2009
Insight into bonds
Insight into bonds
Published: 2009/02/11
Find out what is a bond; why invest in it; and what to watch out for when investing in bonds.
MALAYSIAN retail investors have never participated actively in bond investing.
Some of you may have bought bond funds offered by the unit trusts, however, most of you may not know what a bond investment is really about and the effect it has on your investment portfolio.
So then… what is a bond?
A bond represents the debt owed by either government units or corporations.
By investing in bonds, you basically become the lender to the issuers and you will be paid a specified percentage of interest.
This percentage of interest is called coupon payment and it is given to you by the issuer because of the use of your money.
At the end of the maturity date, you will get back your principal.
An example to quote is the Bond Simpanan Merdeka 2008 issued by Bank Negara for the senior citizens, which has a three-year tenure and pays 5 per cent interest per year.
In Malaysia, the main issuers of public debt are the government of Malaysia,Bank Negara Malaysia), and quasi government institutions (Khazanah, Danamodal and Danaharta).
Private debt securities and asset-backed securities are issued by the National Mortgage Corporation (Cagamas Bhd), financial institutions and non-financial corporations.
The major investors in the Malaysian bond market are the Employees Provident Fund (EPF), pension funds, insurance companies and other financial institutions.
The price of a bond is determined by many factors, with the main drivers being interest rates, inflation, maturity and credit quality.
Interest rates
Bonds are highly sensitive to interest rate fluctuations.
When the prevailing interest rate goes up higher than the coupon rate, the prices of the outstanding bonds will fall below the principal value.
If you are buying a bond fund, higher interest rates will cause lower fund prices.
Inflation
During periods of rapid economic growth, we will see increasing inflation.
This will eventually lead to higher interest rates and cause a drop in the value of bonds.
Deflation, the opposite of inflation, may occur when there is a recession or prolonged periods or little or no growth and excess capacity, will eventually lead to zero or negative real interest rates, causing the value of bonds to rise.
Maturity
Due to the sensitivities to inflation and interest rate fluctuations, longer term bonds will face more uncertainties compared to shorter term bonds.
As such, longer term bonds should offer better interest payments as the additional risk premium for the investors.
Nevertheless, they will suffer larger price fluctuations as a result of the longer period they take to mature.
Credit quality
When we lend out our money, we want to make sure that we will be able to get it back.
Therefore, the credibility or credit quality of the bond issuers plays an important role in the bond price.
A corporate bond will have a higher yield than a government guaranteed bond due to the additional risk that the investor has to bear for facing the possibility of the corporate bond defaulting.
The recent global financial crisis was partly attributed to the decline in credit quality for certain corporate bonds.
Why invest in bonds
Investing in bonds offers an alternative to investors to diversify their investment portfolios because it is relatively lower risk compared to stock investing.
As bonds provide periodic interest payments and repayment of principal at the end of the maturity, it will be suitable for you if your investment objective is to preserve capital and receive a predictable stream of income.
Depending on your investment time horizon, you can choose to invest in short-, medium- or long-term bonds.
However, you must understand the factors that drive the price of the bond that you invest in.
As retailers, most of the time we will be investing in bond funds offered by unit trusts or commercial banks.
Bond funds are combinations of various bonds, therefore, the risk of investing in bond funds is relatively lower compared to individual bonds.
However, you must take note of the factors listed above while selecting an appropriate bond fund.
In addition, you will also need to know about the fund management companies and make sure that the approaches they take are suitable for your risk profile and investment objectives.
The timing of investing in bond funds is also very important.
What to watch out for when investing in bonds
Watch out for the interest rate especially if it is too low or unstable.
Avoid speculative bonds. Even when you are investing in bond funds, make sure that the bonds in the portfolio are investment grade, which carries a credit rating of “BBB” and above.
Bonds with rating of “BB” and below are considered “high yield” and below investment grade.
Don’t invest a large portion of your portfolio in bonds. It will limit your portfolio growth, as over time, inflation will erode the fixed income stream and principal.
Bonds are suitable to complement stock investing.
This article was written by SIDC and Ooi Kok Hwa, a holder of a Capital Markets Services Representative’s Licence to carry on the business of investment advice under the Capital Markets and Services Act 2007.
The information provided in this article is for educational purposes only and should not be used as a substitute for legal or other professional advice.
Securities Industry Development Corp, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission.
It was established in 1994 and incorporated in 2007.
http://www.btimes.com.my/Current_News/BTIMES/articles/20090211005643/Article/index_html
Published: 2009/02/11
Find out what is a bond; why invest in it; and what to watch out for when investing in bonds.
MALAYSIAN retail investors have never participated actively in bond investing.
Some of you may have bought bond funds offered by the unit trusts, however, most of you may not know what a bond investment is really about and the effect it has on your investment portfolio.
So then… what is a bond?
A bond represents the debt owed by either government units or corporations.
By investing in bonds, you basically become the lender to the issuers and you will be paid a specified percentage of interest.
This percentage of interest is called coupon payment and it is given to you by the issuer because of the use of your money.
At the end of the maturity date, you will get back your principal.
An example to quote is the Bond Simpanan Merdeka 2008 issued by Bank Negara for the senior citizens, which has a three-year tenure and pays 5 per cent interest per year.
In Malaysia, the main issuers of public debt are the government of Malaysia,Bank Negara Malaysia), and quasi government institutions (Khazanah, Danamodal and Danaharta).
Private debt securities and asset-backed securities are issued by the National Mortgage Corporation (Cagamas Bhd), financial institutions and non-financial corporations.
The major investors in the Malaysian bond market are the Employees Provident Fund (EPF), pension funds, insurance companies and other financial institutions.
The price of a bond is determined by many factors, with the main drivers being interest rates, inflation, maturity and credit quality.
Interest rates
Bonds are highly sensitive to interest rate fluctuations.
When the prevailing interest rate goes up higher than the coupon rate, the prices of the outstanding bonds will fall below the principal value.
If you are buying a bond fund, higher interest rates will cause lower fund prices.
Inflation
During periods of rapid economic growth, we will see increasing inflation.
This will eventually lead to higher interest rates and cause a drop in the value of bonds.
Deflation, the opposite of inflation, may occur when there is a recession or prolonged periods or little or no growth and excess capacity, will eventually lead to zero or negative real interest rates, causing the value of bonds to rise.
Maturity
Due to the sensitivities to inflation and interest rate fluctuations, longer term bonds will face more uncertainties compared to shorter term bonds.
As such, longer term bonds should offer better interest payments as the additional risk premium for the investors.
Nevertheless, they will suffer larger price fluctuations as a result of the longer period they take to mature.
Credit quality
When we lend out our money, we want to make sure that we will be able to get it back.
Therefore, the credibility or credit quality of the bond issuers plays an important role in the bond price.
A corporate bond will have a higher yield than a government guaranteed bond due to the additional risk that the investor has to bear for facing the possibility of the corporate bond defaulting.
The recent global financial crisis was partly attributed to the decline in credit quality for certain corporate bonds.
Why invest in bonds
Investing in bonds offers an alternative to investors to diversify their investment portfolios because it is relatively lower risk compared to stock investing.
As bonds provide periodic interest payments and repayment of principal at the end of the maturity, it will be suitable for you if your investment objective is to preserve capital and receive a predictable stream of income.
Depending on your investment time horizon, you can choose to invest in short-, medium- or long-term bonds.
However, you must understand the factors that drive the price of the bond that you invest in.
As retailers, most of the time we will be investing in bond funds offered by unit trusts or commercial banks.
Bond funds are combinations of various bonds, therefore, the risk of investing in bond funds is relatively lower compared to individual bonds.
However, you must take note of the factors listed above while selecting an appropriate bond fund.
In addition, you will also need to know about the fund management companies and make sure that the approaches they take are suitable for your risk profile and investment objectives.
The timing of investing in bond funds is also very important.
What to watch out for when investing in bonds
Watch out for the interest rate especially if it is too low or unstable.
Avoid speculative bonds. Even when you are investing in bond funds, make sure that the bonds in the portfolio are investment grade, which carries a credit rating of “BBB” and above.
Bonds with rating of “BB” and below are considered “high yield” and below investment grade.
Don’t invest a large portion of your portfolio in bonds. It will limit your portfolio growth, as over time, inflation will erode the fixed income stream and principal.
Bonds are suitable to complement stock investing.
This article was written by SIDC and Ooi Kok Hwa, a holder of a Capital Markets Services Representative’s Licence to carry on the business of investment advice under the Capital Markets and Services Act 2007.
The information provided in this article is for educational purposes only and should not be used as a substitute for legal or other professional advice.
Securities Industry Development Corp, the leading capital markets education, training and information resource provider in Asean, is the training and development arm of the Securities Commission.
It was established in 1994 and incorporated in 2007.
http://www.btimes.com.my/Current_News/BTIMES/articles/20090211005643/Article/index_html
Tuesday 20 January 2009
How to Profit From the Credit Crunch
JANUARY 17, 2009, 11:11 P.M. ET
How to Profit From the Credit Crunch
By MARK GONGLOFF
Investors shell-shocked by two nasty bear markets in stocks in less than a decade are starting to look elsewhere for good returns. In the wake of the worst credit crunch since the Great Depression, some analysts suggest they might take a look at, believe it or not, credit.
Their reasoning: Bonds and other credit instruments have arguably suffered much more than stocks during this downturn, meaning they could have further to climb when the economy starts to recover. What's more, as credit led the economy and stocks into the valley, it might have to lead them back out, meaning it could recover before stocks do.
Stocks "are historically first out of the block" in a recovery, says Binky Chadha, chief U.S. equity strategist at Deutsche Bank, "but given the credit crisis this time, credit has to recover before we can get equity returns."
Stocks took several steps back from a recovery last week, when the Dow Jones Industrial Average fell 3.7%. The blue-chip index is down 5.6% so far this year and 42% from its record high in October 2007. Last November, at the depths of the current bear market, the Dow was off 47% from its record, the worst decline since the 1930s.
But the suffering in the credit market has been unprecedented, as investors have come to avoid credit risk like poison. They have demanded record-high interest rates on debt, at levels that suggest a record wave of corporate defaults.
On the bright side, this offers investors a hefty yield -- even after a slight recovery in credit markets in recent weeks, which has pushed interest rates lower.
Many analysts say bonds still offer "equity-like" returns, but that may be underselling them: There is a chance some bonds can offer better returns than stocks.
'Astounding' Yields
For example, the yields on corporate bonds that ratings agencies consider below-investment-grade -- so-called junk bonds -- are 16 percentage points higher, on average, than yields on U.S. government debt of similar duration, according to Merrill Lynch data. A 10-year junk bond might yield 18%, compared with roughly 2% for the 10-year Treasury note.
That is an astounding gap; two years ago, junk bonds yielded just two percentage points more than Treasurys. This "spread" is not much lower than its record high of about 22 percentage points, set in November. Many analysts say this represents a much direr outlook for the economy and corporate bankruptcies than even the stock market does.
"Yield levels and the expected default rates they imply are way out of line with everything but a nuclear bomb," says Vinny Catalano, chief investment strategist at Blue Marble Research.
Safer debts have lower yields, just as more-creditworthy individual borrowers get lower rates when they apply for a loan. Bonds for companies with an "A" credit rating -- roughly middle of the pack for investment-grade bonds -- yield five percentage points more, on average, than Treasurys. Historically the spread is about one point.
Municipal bonds, which state and local governments use to pay for building bridges and libraries, yield nearly one percentage point more than Treasurys. Typically, given the rarity of municipal defaults and the tax-exempt status of their bonds, they yield slightly less than Treasurys.
These safer credit risks don't offer enormous returns, but if the stock market is flat, or worse, in 2009, then they could look much more appetizing. And despite a recent swoon, stocks could still be in store for a big disappointment if the economy fails to rebound sharply in the second half of the year, as many in the stock market still hope. Bonds, on the other hand, may already be priced for big disappointment.
No Certainty for Stocks
"We're really not even close to a point yet where we could state with confidence that equities will significantly outperform corporate bonds over the next six months," says John Lonski, managing director and economist at credit-rating agency Moody's.
But there are risks to wading into debt. If the economy roars back much more quickly than economists expect, bonds would still rally, but stocks might surge even more.
On the other hand, an economy that stays sluggish for a long time could spawn a growing wave of corporate bankruptcies that burn debt holders. What keeps policy makers awake at night is a worry that stimulus measures won't break the vicious cycle gripping the economy right now, in which tight credit hurts the economy, which hurts borrowers' ability to repay their debt and leads to still-tighter credit.
Even assuming some benefit from stimulus, Moody's expects high-yield-debt default rates to surge to 15% by the end of 2009, from just 4% at the end of 2008. That would be a record high for defaults in the modern era of junk bonds, which began in the 1980s.
Investment-grade default rates have been much lower, but will likely rise, as well. An economy that fails to respond to stimulus could push defaults still higher.
Meanwhile, some $758 billion in corporate debt is coming due in 2009, according to Standard & Poor's, meaning companies will have to either pay what they owe or refinance. Most of these debts were incurred five or 10 years ago, when rates were much lower, so refinancing will mean significantly higher borrowing costs for most companies. Less-creditworthy companies may not be able to get new financing at all. This increases the risk that companies won't be able to pay their debts.
In other words, very high yields on corporate bonds may be perfectly appropriate, given the risk that they could turn to dust in your hands. "It is still a very treacherous economic climate, and one has to proceed with caution" when buying debt, says Mr. Lonski.
Write to Mark Gongloff at mark.gongloff@wsj.com
How to Profit From the Credit Crunch
By MARK GONGLOFF
Investors shell-shocked by two nasty bear markets in stocks in less than a decade are starting to look elsewhere for good returns. In the wake of the worst credit crunch since the Great Depression, some analysts suggest they might take a look at, believe it or not, credit.
Their reasoning: Bonds and other credit instruments have arguably suffered much more than stocks during this downturn, meaning they could have further to climb when the economy starts to recover. What's more, as credit led the economy and stocks into the valley, it might have to lead them back out, meaning it could recover before stocks do.
Stocks "are historically first out of the block" in a recovery, says Binky Chadha, chief U.S. equity strategist at Deutsche Bank, "but given the credit crisis this time, credit has to recover before we can get equity returns."
Stocks took several steps back from a recovery last week, when the Dow Jones Industrial Average fell 3.7%. The blue-chip index is down 5.6% so far this year and 42% from its record high in October 2007. Last November, at the depths of the current bear market, the Dow was off 47% from its record, the worst decline since the 1930s.
But the suffering in the credit market has been unprecedented, as investors have come to avoid credit risk like poison. They have demanded record-high interest rates on debt, at levels that suggest a record wave of corporate defaults.
On the bright side, this offers investors a hefty yield -- even after a slight recovery in credit markets in recent weeks, which has pushed interest rates lower.
Many analysts say bonds still offer "equity-like" returns, but that may be underselling them: There is a chance some bonds can offer better returns than stocks.
'Astounding' Yields
For example, the yields on corporate bonds that ratings agencies consider below-investment-grade -- so-called junk bonds -- are 16 percentage points higher, on average, than yields on U.S. government debt of similar duration, according to Merrill Lynch data. A 10-year junk bond might yield 18%, compared with roughly 2% for the 10-year Treasury note.
That is an astounding gap; two years ago, junk bonds yielded just two percentage points more than Treasurys. This "spread" is not much lower than its record high of about 22 percentage points, set in November. Many analysts say this represents a much direr outlook for the economy and corporate bankruptcies than even the stock market does.
"Yield levels and the expected default rates they imply are way out of line with everything but a nuclear bomb," says Vinny Catalano, chief investment strategist at Blue Marble Research.
Safer debts have lower yields, just as more-creditworthy individual borrowers get lower rates when they apply for a loan. Bonds for companies with an "A" credit rating -- roughly middle of the pack for investment-grade bonds -- yield five percentage points more, on average, than Treasurys. Historically the spread is about one point.
Municipal bonds, which state and local governments use to pay for building bridges and libraries, yield nearly one percentage point more than Treasurys. Typically, given the rarity of municipal defaults and the tax-exempt status of their bonds, they yield slightly less than Treasurys.
These safer credit risks don't offer enormous returns, but if the stock market is flat, or worse, in 2009, then they could look much more appetizing. And despite a recent swoon, stocks could still be in store for a big disappointment if the economy fails to rebound sharply in the second half of the year, as many in the stock market still hope. Bonds, on the other hand, may already be priced for big disappointment.
No Certainty for Stocks
"We're really not even close to a point yet where we could state with confidence that equities will significantly outperform corporate bonds over the next six months," says John Lonski, managing director and economist at credit-rating agency Moody's.
But there are risks to wading into debt. If the economy roars back much more quickly than economists expect, bonds would still rally, but stocks might surge even more.
On the other hand, an economy that stays sluggish for a long time could spawn a growing wave of corporate bankruptcies that burn debt holders. What keeps policy makers awake at night is a worry that stimulus measures won't break the vicious cycle gripping the economy right now, in which tight credit hurts the economy, which hurts borrowers' ability to repay their debt and leads to still-tighter credit.
Even assuming some benefit from stimulus, Moody's expects high-yield-debt default rates to surge to 15% by the end of 2009, from just 4% at the end of 2008. That would be a record high for defaults in the modern era of junk bonds, which began in the 1980s.
Investment-grade default rates have been much lower, but will likely rise, as well. An economy that fails to respond to stimulus could push defaults still higher.
Meanwhile, some $758 billion in corporate debt is coming due in 2009, according to Standard & Poor's, meaning companies will have to either pay what they owe or refinance. Most of these debts were incurred five or 10 years ago, when rates were much lower, so refinancing will mean significantly higher borrowing costs for most companies. Less-creditworthy companies may not be able to get new financing at all. This increases the risk that companies won't be able to pay their debts.
In other words, very high yields on corporate bonds may be perfectly appropriate, given the risk that they could turn to dust in your hands. "It is still a very treacherous economic climate, and one has to proceed with caution" when buying debt, says Mr. Lonski.
Write to Mark Gongloff at mark.gongloff@wsj.com
Thursday 15 January 2009
The bond bubble is an accident waiting to happen
The bond bubble is an accident waiting to happen
The bond vigilantes slumber. As the greatest sovereign bond bubble of all time rolls into 2009, investors are clinging to an implausible assumption that China and Japan will provide enough capital to keep the happy game going for ever.
Ambrose Evans-PritchardLast Updated: 12:22PM GMT 12 Jan 2009
Comments 71 Comment on this article
They are betting too that debt deflation will overwhelm the effects of near-zero interest rates across the G10 and nullify a £2,000bn fiscal blast in the US, China, Japan, Britain, and Europe.
Above all, they are betting that the Federal Reserve chief Ben Bernanke will fail to print enough banknotes to inflate the US money supply, despite his avowed intent to do so.
Yields on 10-year US Treasuries have fallen to 2.4pc – a level that was unseen even in the Great Depression. This is "return-free risk", said bond guru Jim Grant.
It is much the same story across the world. Yields are 1.3pc in Japan, 3.02pc in Germany, 3.13pc in Britain, 3.26pc in Chile, 3.47pc in France, and 5.56pc in Brazil.
"Get out of Treasuries. They are very, very expensive," said Mohamed El-Erian, the investment chief at the Pimco, the world's top bond fund, in a Barron's article last week.
It is lazy to think that China, Japan, the petro-powers and the surplus states of emerging Asia will continue to amass foreign reserves, recycling their treasure into the US and European bond markets.
These countries are themselves bleeding as exports collapse. Most face capital flight. The whole process that fed the bond boom from 2003 to 2008 is now going into reverse.
Woe betide any investor who misjudges the consequences of this strategic shift.
Russia has lost 27pc of its $600bn reserves since August. The oil and metals crash has left the oligarchs prostrate. China's reserves fell $15bn in October. Beijing has begun to fret about an exodus of hot money – disguised as foreign investment in plant. The exchange regulator is muttering about "abnormal" capital flows out of the country.
China's $1,900bn stash of foreign bonds is a by-product of holding down the yuan to boost exports.
This mercantilist ploy is no longer necessary, since the currency is weakening. Beijing needs the money at home in any case to prop up the Chinese economy – now in trouble. Even Japan has slipped into trade deficit.
Clearly, the US and European governments cannot rely on Asia to plug the $3,500bn hole in their budgets this year.
Asians are just as likely to be net sellers of their bonds. Which implies that central banks may have to "monetize" our deficits.
James Montier, from Société Générale, has examined US bonds back to 1798. Yields have never been this low before, except under war controls in the 1940s when the price was set by dictate.
That episode is not a happy precedent. The Fed drove the 10-year bond down to 2.25pc, much as it is doing today with mortgage bonds. It helped America win World War Two, but ended in tears for bond holders in 1946 when inflation jumped to 18pc.
Mr Montier said yields have averaged 4.5pc over two centuries, with a real return of around 2pc. By that benchmark, the market is now banking on a decade of deflation.
Investors have drawn a false parallel with Japan's Lost Decade, when bond yields kept falling, forgetting that Tokyo waited seven years before resorting to the printing press. Mr Bernanke has no such inhibitions. He has hit the nuclear button in advance.
"Today's yields are woefully short of the estimated fair value under normal conditions. There maybe a (short-term) speculative case for buying bonds. However, I am an investor, not a speculator," he said
Of course, we may already be so deep into debt deflation that bonds will rally regardless. Fresh data suggest that Japan's economy contracted at a 12pc annual rate in the fourth quarter of 2008; the US, Germany, and France shrank at a 6pc rate, and Britain shrank at 5pc.
If sustained, these figures are worse than 1930, though not as bad as the killer year of 1931. The UK contraction from peak to trough in the Slump was 5pc. Gordon Brown will be lucky to get off so lightly.
The Fed's December minutes reek of fear. The Bernanke team is no longer sure that stimulus will gain traction in time.
The Fed's "Monetary Multiplier" has collapsed, falling below 1. This is unthinkable. We are in a liquidity trap.
So yes, printing money is not as easy as it looks, but to conclude that the Fed cannot bring about inflation is a leap too far.
The Fed has only just started to debauch in earnest, buying $600bn of mortgage bonds to force home loans down to 4.5pc. US mortgage rates have dropped 150 basis points in two months.
My tentative guess is that Bernanke's blitz will "work" – perhaps later this year. Markets will start to look beyond deflation. They will remember that the Fed is boosting its balance sheet from $800bn to $3,000bn, and that it sits on an overhang of bonds that must be sold again.
"The euthanasia of the rentier" will wear off, to borrow from Keynes. That is when the next crisis begins.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4218210/The-bond-bubble-has-long-since-burst-investors-ignore-this-at-you-peril.html
The bond vigilantes slumber. As the greatest sovereign bond bubble of all time rolls into 2009, investors are clinging to an implausible assumption that China and Japan will provide enough capital to keep the happy game going for ever.
Ambrose Evans-PritchardLast Updated: 12:22PM GMT 12 Jan 2009
Comments 71 Comment on this article
They are betting too that debt deflation will overwhelm the effects of near-zero interest rates across the G10 and nullify a £2,000bn fiscal blast in the US, China, Japan, Britain, and Europe.
Above all, they are betting that the Federal Reserve chief Ben Bernanke will fail to print enough banknotes to inflate the US money supply, despite his avowed intent to do so.
Yields on 10-year US Treasuries have fallen to 2.4pc – a level that was unseen even in the Great Depression. This is "return-free risk", said bond guru Jim Grant.
It is much the same story across the world. Yields are 1.3pc in Japan, 3.02pc in Germany, 3.13pc in Britain, 3.26pc in Chile, 3.47pc in France, and 5.56pc in Brazil.
"Get out of Treasuries. They are very, very expensive," said Mohamed El-Erian, the investment chief at the Pimco, the world's top bond fund, in a Barron's article last week.
It is lazy to think that China, Japan, the petro-powers and the surplus states of emerging Asia will continue to amass foreign reserves, recycling their treasure into the US and European bond markets.
These countries are themselves bleeding as exports collapse. Most face capital flight. The whole process that fed the bond boom from 2003 to 2008 is now going into reverse.
Woe betide any investor who misjudges the consequences of this strategic shift.
Russia has lost 27pc of its $600bn reserves since August. The oil and metals crash has left the oligarchs prostrate. China's reserves fell $15bn in October. Beijing has begun to fret about an exodus of hot money – disguised as foreign investment in plant. The exchange regulator is muttering about "abnormal" capital flows out of the country.
China's $1,900bn stash of foreign bonds is a by-product of holding down the yuan to boost exports.
This mercantilist ploy is no longer necessary, since the currency is weakening. Beijing needs the money at home in any case to prop up the Chinese economy – now in trouble. Even Japan has slipped into trade deficit.
Clearly, the US and European governments cannot rely on Asia to plug the $3,500bn hole in their budgets this year.
Asians are just as likely to be net sellers of their bonds. Which implies that central banks may have to "monetize" our deficits.
James Montier, from Société Générale, has examined US bonds back to 1798. Yields have never been this low before, except under war controls in the 1940s when the price was set by dictate.
That episode is not a happy precedent. The Fed drove the 10-year bond down to 2.25pc, much as it is doing today with mortgage bonds. It helped America win World War Two, but ended in tears for bond holders in 1946 when inflation jumped to 18pc.
Mr Montier said yields have averaged 4.5pc over two centuries, with a real return of around 2pc. By that benchmark, the market is now banking on a decade of deflation.
Investors have drawn a false parallel with Japan's Lost Decade, when bond yields kept falling, forgetting that Tokyo waited seven years before resorting to the printing press. Mr Bernanke has no such inhibitions. He has hit the nuclear button in advance.
"Today's yields are woefully short of the estimated fair value under normal conditions. There maybe a (short-term) speculative case for buying bonds. However, I am an investor, not a speculator," he said
Of course, we may already be so deep into debt deflation that bonds will rally regardless. Fresh data suggest that Japan's economy contracted at a 12pc annual rate in the fourth quarter of 2008; the US, Germany, and France shrank at a 6pc rate, and Britain shrank at 5pc.
If sustained, these figures are worse than 1930, though not as bad as the killer year of 1931. The UK contraction from peak to trough in the Slump was 5pc. Gordon Brown will be lucky to get off so lightly.
The Fed's December minutes reek of fear. The Bernanke team is no longer sure that stimulus will gain traction in time.
The Fed's "Monetary Multiplier" has collapsed, falling below 1. This is unthinkable. We are in a liquidity trap.
So yes, printing money is not as easy as it looks, but to conclude that the Fed cannot bring about inflation is a leap too far.
The Fed has only just started to debauch in earnest, buying $600bn of mortgage bonds to force home loans down to 4.5pc. US mortgage rates have dropped 150 basis points in two months.
My tentative guess is that Bernanke's blitz will "work" – perhaps later this year. Markets will start to look beyond deflation. They will remember that the Fed is boosting its balance sheet from $800bn to $3,000bn, and that it sits on an overhang of bonds that must be sold again.
"The euthanasia of the rentier" will wear off, to borrow from Keynes. That is when the next crisis begins.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/4218210/The-bond-bubble-has-long-since-burst-investors-ignore-this-at-you-peril.html
Tuesday 28 October 2008
Major types of Investments
Major types of Investments
Main types
1. Stocks or equities
2. Bonds or fixed income securities
3. Money market investments
Derivatives
1. Options
2. Futures
Unit trusts
1. Money market funds
2. Bond funds
3. Equity funds
---------
Bonds or fixed income securities
Bonds are loans issued by companies and governments to borrow money, and they have two main characteristics:
1. They have lifespan greater than 12 months at the time of issue.
2. They typically promise to make fixed interest payments according to a given schedule.
Bonds are hence also called fixed income securities.
Bonds have their own unique terms: Suppose you buy bonds with a face value of $10,000. These bonds mature in 2 years and pay 4% interest annually. The 4% interest equates to $400 a year. The face value of the bond, or the principal amount of $10,000 will be returned to you when the bond matures in 2 years.
-----------------------
Money market securities
Money market securities are similar to bonds except that they are short-term investments. They have two main characteristics:
1. They are loans issued by companies and government to borrow money.
2. They mature in less than a year from the time they are sold, which means that the loan must be repaid within a year.
Some of the most common money market securities include
Main types
1. Stocks or equities
2. Bonds or fixed income securities
3. Money market investments
Derivatives
1. Options
2. Futures
Unit trusts
1. Money market funds
2. Bond funds
3. Equity funds
---------
Bonds or fixed income securities
Bonds are loans issued by companies and governments to borrow money, and they have two main characteristics:
1. They have lifespan greater than 12 months at the time of issue.
2. They typically promise to make fixed interest payments according to a given schedule.
Bonds are hence also called fixed income securities.
Bonds have their own unique terms: Suppose you buy bonds with a face value of $10,000. These bonds mature in 2 years and pay 4% interest annually. The 4% interest equates to $400 a year. The face value of the bond, or the principal amount of $10,000 will be returned to you when the bond matures in 2 years.
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Money market securities
Money market securities are similar to bonds except that they are short-term investments. They have two main characteristics:
1. They are loans issued by companies and government to borrow money.
2. They mature in less than a year from the time they are sold, which means that the loan must be repaid within a year.
Some of the most common money market securities include
- Treasury Bills (issued by the government and considered the safest investments around),
- fixed deposits,
- bank savings accounts and
- certificates of deposits.
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