Friday, March 28, 2014

Why HNWs like to leverage on Bonds to earn the spread?

This is why a lot of HNWs are leveraging to buy bonds to earn the spread since 2009. But the priority banking customers are also getting into the act since 2012 (that's about the time i started hearing people in priority banking segment talk about leverage on bonds).

Best time to buy bonds is when there is some sort of crisis (these 4 years quite frequent) where the bonds prices will go down (ie yield goes up).

This is the example of carry-cost versus the coupon yield and the spread you getting (excluding any capital gain you might get from buying under-par bonds).

Remember to assess the company behind the bonds, the type of bonds offered and not to over-leverage. For safety sake, you can use 50% LTV instead of 80% or even 90%. But  the returns can be outsized(in the realm of 40% pa) if you take a 80% LTV, though i would advise carrying another 20% in cash in your portfolio to prevent margin call.

Again, try to buy bonds at PAR or preferably under-par (to get that capital gain component if it gets recalled). You can get equity-liked return without the pain of watching prices go on a roller-coastal ride if you find Fundamental good companies. Do not invest in junk bonds unless you are sure of what you are doing.

Some small/mid-cap companies in SGX are giving so little yield to compensate for the risk you are taking that you might be better off looking elsewhere. Corporate grade bonds in Australia (big four banks) and USA can give you 5% versus the risk you are taking(forex). Though forex risk can be minimized if you take a loan in their currency(for usd).

Also, you can see why banks like you to leverage? :) You take the risk of owning the bonds, they get the benefit of getting a steady stream of income from you.

Do consider everything from a portfolio allocation perspective. The percentage allocated to bonds, equities, cash and alternatives investment according to your risk profile.