Luxembourg
16 Boulevard Royal – L-2449 Luxembourg
 
Monday to Friday
8 am to 5 pm

So here we are, Autumn is upon us. People are getting colds again. Soon the pavements will be strewn with fallen leaves. As the greyness sets in, let’s take a trip to a sunnier destination, a few thousand miles away, a bit of a break, just for a couple of lines...

Starting of course with a journey. The pleasure of a seven-hour flight sitting next to someone may be tempered by the perfume they are wearing or how chatty they are. Assuming your ticket has cost the same (within a flight class), for an equivalent “investment”, a passenger three rows behind you could have a much pleasanter journey if he has the whole row to himself.

Everything is relative.

 

And even more so for an investment in bonds..

Luckily, when it comes to investing in bonds, you can decide, up to a certain point, about the quality of the journey you want to make:

  • relatively bumpy, if not “volatile”, with the hope of getting a maximum gain,
  • relatively calm and comfortable, with the aim of avoiding setbacks, and accepting the price tag,
  • a compromise between the two, from a range of possibilities.

The fact is, when it comes to investing in bonds, it is not only possible to choose your class and seat but also to choose the profile of the passenger you will be sitting next to for all those hours as you travel hopefully...

Put another way, for the same amount, you can choose your risk level (AAA or BBB, which is like the class you travel in) and select a specific issuer (your seat) within that risk category. So you have the chance to optimise your investment by identifying the issuer who will give you a better yield for a supposedly equivalent risk.

This is pretty much the same as a relative valuation process for the opportunities facing you: “Shall I go first class or economy? Sit on the left or the right? Next to the passenger who takes his shoes off or the one who keeps them on?” It boils down to the following questions: “Shall I invest in AAA or BBB (class of travel)? In class BBB, shall I go for Telefonica or Deutsche Telekom (your seat)? Do I want the issue in euros or dollars (your fellow traveller and their perfume)? Etc.”

 

 

Illustration of relative valuations:

1. The choice of quality (irrespective of currency):

Source : JP Morgan Government Bond Index Aggregate – october 2016

 

2. The choice between different debtors within the same economic zone, the eurozone:

Source : JP Morgan Government Bond Index Aggregate – october 2016

 

3. The choice between different issuers of similar quality (same sector, same currency) :

Source : JP Morgan - Bloomberg – october 2016

 

4. The choice between different country issuers (for dollar-denominated debt):

 

Source : JP Morgan - S&P - June 2016

 

5. The choice between issues with an equivalent rating (in different currencies):

Source : Bloomberg

 

Multiple opportunities which offer a host of possible combinations.

Whichever choice is made, there is always an implication: whether to assume a political risk, a currency risk, an unfavourable cycle for a particular sector, or simply, a higher price. In the latter case, selecting an issuer offering the highest yield, the US Treasury maturing in 2025, means you have a positive view of the future of the dollar and the yields on that market, for the next nine years...1 In example 4 above, the choice of Mexico over Poland could be qualified by the fact that there is a lesser quality issuer offering a similar yield to Mexico, Paraguay. This could offer a better performance if its rating were to be revised upwards. The investor could then expect a narrower yield differential due to the better rating (Paraguay’s bonds outperforming Mexico’s). All this needs to be qualified according to the investor’s expectations, tolerance to different risks, etc. Similar considerations could be applied to each of the possible choices presented above.

 

[1] Assuming the issue is held to maturity

Jean-Philippe Donge, Head of Fixed Income

Following his Master's degree in Business Engineering from the Louvain School of Management in Belgium, Jean-Philippe joined Banque de Luxembourg's Asset Management department in 2001. Three years in the Financial Analysis department convinced him of his ambition to become a fund manager. In 2003, he moved into portfolio management and currently he manages the bond funds of the BL-funds range, including BL-Global Bond, which has won a string of awards in Europe, including best euro-denominated bond fund in Europe.

Subscribe to
our newsletter
email