The global bond market is down almost 2 trillion dollars since the election. Over the last year, I saw quite a few articles, mostly in local papers, about fixed income portfolio managers achieving record returns in their portfolios (comparatively speaking). A little hubris was observed among some fixed income securities fiduciaries of state pools, cities, counties, banks, credit unions, hospitals, mutual funds, family offices, and individuals that our company spoke with when they compared their returns to others. The 30-year bull market coming to an abrupt end has a way of humbling the most seasoned of investors. The old saying, pride comes before the fall, still rings true.
Building a fixed income securities technology that helps guide the decision process is tough when a bull market is making so many ‘genius’ investors. While many saw the merits of how our online BPV® tool brings a disciplined workflow and great internal control for compliance, auditors, and regulators, others couldn’t see it. After all, there is no motivation to change in a bullish bond market.
Our incentive for purchasing our tool was always the same–better-informed and better-educated bond buyers make better investment decisions. This should, in turn, lower risks and improve returns. Knowing the risks and the pricing history and having the ability to negotiate a better deal levels the playing field in what some might say is a nontransparent market.
“Risk? These are fixed income products. We only buy ‘safe’ investments,” we were told by more than a few investors. We would get the standard platitudes, “Well, it doesn’t matter if the value goes down; we hold to maturity,” or “We have been doing this for the last 6 years, and it has worked out just fine,” or another justification for keeping with the status quo.
The one response that always makes me scratch my head is, “We always hold to maturity.” If that is the case, I wonder, “Why did you sell those notes with the capital gain?” If it is called, you can’t hold it to maturity. Finally, if the hold-to-maturity strategy is true, hold every investment as long as you possibly can because it would secure the best return.
On the day of the election, the 10-year treasury yield was at 1.88. On December 14, 2016 (as of the writing of this), it was a 2.54 yield. To put this into perspective, if you went to your broker before the election and bought a 10-year bond; then, spent $1,000,000 today on the same, your bank would show the new value of the bond you just bought at only $941,800, down $59,200. Now, that doesn’t mean you can sell it for that much, and you need to consider the commissions and transactions costs built into the price of the bond. Losing 6% in 6 weeks is painful, but when you have a fiduciary responsibility, it is extra painful because safety of principal is so important to the person or entities that you oversee.
So why would someone take on so much risk in what is supposed to be a safe investment? The answer is simple–investors buy a 10-year treasury because they want the higher return. When they think about safety, they only think about 1 of the 12 potential risks, which is default or credit risk. The treasury will probably not default. However, the risk they didn’t consider is a risk called ‘interest rate risk.’ Interest rate risk means that when the market rates rise, the value of the bond falls.
What would happen if we consider the same scenario with a 5-year treasury instead? The 5-year treasury was at a 1.34 yield on the day of the election. Today, December 14, 2016, it is at a 2.02 yield. A $1,000,000 investment would be valued at $967,500–still a big hit and painful, but better than losing 6% in a little over a month.
A two-year treasury yield was at 0.87, and today, it is 1.27. Therefore, a $1,000,000 treasury note is worth $992,100; you will break even in about a year.
Since the election, the global bond market lost a few Trillion Dollars, seriously! If we look at all the bonds in states, counties, municipalities, school districts, hospitals, banks, credit unions, nonprofits, and corporations, we are going to find losses in what are supposed to be ‘safe’ investments. Board members, alderman, investment committees, and all overseers are going to be taking a serious look at internal controls when it comes to investing in bills, notes, bonds, agencies, muni’s, and corporates.