How does one profit from bonds?

I’m curious about the bonds available to “little people” such as me (less than €10,000 to invest). I looked at the Davy stockbrokers site and saw this:

davy.ie/other/pubarticles/BondFund.pdf

Excerpt: “Net Asset Value: The net asset value of the fund was 109.4635 as at 29th December 2006, in comparison with e109.2129 on the 24th November 2006. The fund return was 0.229% for the three months to the end of December versus a benchmark (EMU Broad Market Bond index) return of –0.032%.”

So, investing in bonds via the main Dublin stockbroker has provided NEGATIVE returns??!?

Boy, am I ignorant, I thought bonds were meant to provide a safe but modest income, not a loss.

Or am I simply misreading the link? Is the bond in question a better savings that I seem to read it as?

Are there any other places where small fry like me can reasonably hope to get more than 3% positive return on a bond investment of fewer than 10K?

Government bonds usually guarantee their return.

So how useless do you have to be to make a less than 0.3% return in a quarter, when 59% of the funds money is in gov’t bonds?

Were they all invested in Zimbabwe or something?

Well - as far as I know, bonds, once bought from the government, can be traded like any other instrument, so they are on the oipen market and can go up and down like anything else.
Best to read the small print :frowning:

Like Davec says, once a bond is on the market its value will fluctuate.

Can’t really answer your original question. You can buy bond tracking ETFs, but they’re not really suitable for long term holdings. Note that for US taxpayers bonds offer some tax advantages which is why they’re recommended so much in US websites & literature - the average Irish investor in my opinion is probably as well off in a high interest deposit account.

I was under the impression that proper bonds gave the holder a bare minimum of 3% cash per annum. More, depending on how risky the bond is, but never as low as 1.2% a year.

You’d have to buy them when they are issued to get guaranteed returns.

The weasel words in this publication are

  1. “fund”
    so it is not the issued bond price
  2. “managed portfolio”
    so you are paying someone to manage your money and they get paid first regardless of what the market does.

If you buy the bond yourself and hold it to maturity you get the IR plus capital back. At the moment risk /reward does not favour bonds. Yield curve is very flat so stick to cash with non equity portion of your portfolio unless you see a deflationary crash coming.
Avoid bond funds unless the expense ratio is low. If govt. bonds are paying around 4% and ER is over 1% you may be losing 25% of your return.
Regards

Here’s a dumbass newbie question: if there’s no ER (exchange rate), such as with German bunds, isn’t aroundabout 4% rather decent as a relatively, virtually, risk-free option?

If I’m a tad more daring, are there any German or French corporate bonds which promise more of a fixed income?

one of the risks you face with bonds is IR risk. If longterm IR rises the value of you bond falls. The longer the maturity of the bond, the more sensitive to IR changes the bond is. This is probably what happened to the bond fund you listed. IRs rose in 05 and 06 so the fund suffered a capital loss which cancelled out the income from the bonds.
Note the opposite can also occur. If IRs fall bonds will have a capital appreciation. If you look at the performance of the fund since 2002 it’s been quite strong as IRs were falling in 2002 to 2004. (I’m talking about longterm IR here).
Other risks you face with bonds are currency risk(as you rightly note not a problem if you stick with euro area bonds) and default risk.
Default risk is not a problem with european govt. bonds. Corporate bonds are rated for default by rating agencies like Moody’s, Fitches etc. In general greater default risk is associated with higher IRs.
In general the highest quality corporates behave like govt bonds but lower quality behave more like stocks. From what I’ve read recently the spread of corporates over govt and in particular the spread of low quality over triple AAA corporates is very narrow which means you may not be adequately compensated for the extra risk. Somebody else may have more recent information.
Inflation is the big enemy of bondholders as it eats away at the capital value of the principal and tends to push up IR. In general govt bonds do well in times of falling inflation and in particular in a recession/depression. Check out the relative performance of Japanese stocks and bonds from 1989 to 2002 and see how holding 40% in bonds would have protected a Japanese portfolio.
The arrival of the Euro has put Irish bond holders at a significant disadvantage for the last number of years. We got German IRs but Irish inflation rates!
Also note the income from a bond will be taxed at your marginal rate. That is one advantage of a bond funds.
Hope this is not too basic or an insult to your intelligence.
Regards

God, not too basic at all. You changed my whole conception of bonds.

I thought when you bought a €10,000 10-year bond from government X which promised an interest rate of 4% yearly, that is exactly what you got: 4% of the initial investment every year plus €10,000 after 10 years.

Clearly I’m clueless about this!

I had no idea that it was all so flexible.

What you’re saying is, if the market goes a certain way, the bond issuer might end up paying less than the expected 4% interest and/or pay less than the expected €10,000 on maturity.

Do I understand you correctly?

Not quite, the bond issuer will pay what is on the face of the bond, but they may receive more or less for their bond at initial auction.

Now you as holder of the bond will see the value of your bond go up and down. E.g. if in a low interest rate scenario you are holding bonds with a high payout, they will be in demand. As rates rise, your bonds will become less attractive and will decline in value. (Talking simplistically sorry). If the quality of your bond changes your bond will change in value (e.g. if you are holding Ford bonds, you will probably have seen value decline, as investors will demand a larger return for more risk).

I don’t quite agree that default risk is not an issue with Euro bonds. You’ll notice that there are small differences in bond values between say German and Italian bonds, even though they are all the same denomination. Why? Because the market is pricing in a (very) small risk that Italy may leave the EU and default on its obligations.

Pimco has the largest bond fund on the planet and has some good explanations of how bonds work.

So, provided I don’t trade my bond, and simply hold it until maturity, I will get the regular annual payment and the face value figure at maturity?

(Assuming there’s no default, that is).

Bonds only interest me because of the guaranteed-income aspect, not how well I might unexpectedly profit if markets change.

“I don’t quite agree that default risk is not an issue with Euro bonds. You’ll notice that there are small differences in bond values between say German and Italian bonds, even though they are all the same denomination. Why? Because the market is pricing in a (very) small risk that Italy may leave the EU and default on its obligations.”

Yes The spread between Euro govt. bonds is interesting. I put some of this down to liquidity. If you were a large pension fund holder interested in Euro bonds I presume you would put a premium on the greater liquidity and depth of German Bunds versus Irish gilts. But you are right, some of the spread may reflect fears about the breakup of the Euro.
Rock3r
I think you have it right. Unless you trade the bonds you won’t have a loss.
There are two reasons to hold bonds, for the income and to provide some stability to your portfolio. There are a lots of studies that show that historically holding a % in bonds greatly reduces volatility without greatly reducing overall returns. See the Japanese example I mentioned earlier.
I don’t like the risk/reward on bonds currently. IR are rising and spreads are narrow. But that will change. I especially don’t like bonds from an Irish perspective(German IRs, Irish inflation rates)
Most of all if you hold bonds directly don’t forget the tax issue. It greatly reduces your returns.
Regards

I’m finally off the street!

Congrats on your good news DD

If I were to buy up a load of bonds and live in Estonia (which I think might be tax-free as far as bond income goes) then I think I’d do OK, theoretically. I think the Euro fetches a handsome amount of Estonian kroon.

As inflation of goods in Euro terms is actually not as acute outside the Eurozone.

A person with a Euro income has actually experienced significant deflation in recent years in rupees, for example. Or zloty, or Kuna or whatever you’re having yourself.

Sounds like an interesting alternative to having to work for a living. :smiley: