New bond portfolio launch

May 2009

BONDS MAKE A COME BACK

Interest in corporate bonds is firmly on the rise and new issuances have reached record levels in the first months of 2009. While not a direct replacement for cash, in the current economic environment corporate bonds are looking a favourable alternative. Despite daily news headlines of “default” and “bankruptcy”, investors are not being deterred. It seems that an appetite for risk is making a comeback and with equities still a little too risky for many investors, corporate bonds appear to be the investment du jour. With the prospect of continued volatility and low interest rates in the foreseeable future, investors are considering alternatives to simply leaving all of their cash on deposit.

Bonds are basically a form of IOU and are a means by which companies, or governments, can borrow money from investors. The authorised bond-issuer, ie, the company or government, owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest – “the coupon” - and to repay the principal at a later date, termed “maturity”. It is a formal contract to repay borrowed money with interest at fixed intervals. Bonds are generally less risky than equities and while bond yields are not spectacular, they are much higher than investors are currently getting for cash. They can provide a relatively stable investment that can offer income that beats inflation, as well as the potential for capital growth. Whatever the purpose— school or university fees, a new home, increasing retirement income or any of a number of other financial goals—investing in bonds can facilitate financial planning and help achieve these objectives.  Fairbairn Private Bank can offer investors access to this asset class through its newly launched sterling bond portfolio.

Corporate bonds are issued by business organisations to raise capital and, in the world of bonds, they typically offer higher yields than most government bonds. However, the higher yield comes at a price and investors must be aware that corporate bonds typically have more risk, eg, default and / or credit risk, than, for example, government debt of developed countries. Corporate bond funds, as opposed to direct bond investment, offer access to expertise in credit analysis, interest rate risk management, diversification, economies of scale and buying power. Bond funds offer a convenient and affordable way to invest in a diversified portfolio of bonds and gain exposure to a strategy that is managed to pursue a specific investment objective. The portfolio might invest in a particular type of bond including government, agency, mortgage, investment grade corporate, high-yield, emerging market debt; or in a particular maturity range such as short-term (three years or less) intermediate term (three to 10 years) or long-term (usually 10 years or longer).

You should not consider corporate bonds unless you are prepared for some volatility. Following the crisis of confidence in credit markets, investment grade bonds are currently pricing in a risk of defaults in excess of 35% whereas the highest level of investment grade default ever recorded previously was 16%. Therefore, unless you foresee corporate failure at over twice the worst level ever experienced before, investment grade bonds currently offer good value. In addition, in the event of a company going bankrupt, corporate bondholders rank above shareholders when debts are being settled.

Sovereign debts, known as gilts in the UK, are similar in nature to corporate bonds but rather than being issued by banks and commercial companies to raise capital, they are issued to fund government spending requirements. In recent months, the Debt Management Office have announced an unprecedented increase in the gilt issuance schedule and, in 2009 alone, the UK government will sell a record £220 billion of gilts to help fund the budget deficit.

The new Fairbairn Private Bank sterling bond portfolio offers investors access to the fixed income market. Available as part of the bank’s discretionary investment management service, for clients with £250,000 or more to invest, the strategy aims to deliver returns in excess of cash. The portfolio has the flexibility to hold funds invested in sovereign (ie, government) and/or investment grade corporate debt and when appropriate, the mandate may also make satellite investments into emerging market and high yield debt. Fairbairn Private Bank has negotiatied preferential terms with virtually all the major fund management houses and in most cases access a fund with no upfront charge and pay a reduced ongoing management fee. These savings are all passed onto the client.

As with all investments, it is important to bear in mind there are risks involved in investing in bonds; the key points to consider are: what rate of interest will I be paid and will I get my money back? The greater the risk of not getting your money back, the higher the interest rate you should be paid. Also, given that a bond may not be redeemed, or reach maturity, for years – even decades – issuer default / credit risk is an important consideration. Default risk is the possibility that a bond issuer will be unable to make interest or principal payments when they are due, and if this is the case, the issuer is deemed to be in default.

As with any investment, the price of, value of, or income from your investments can fall as well as rise and you may not get back the original amount invested.

Fairbairn Private Bank © 2009.