The recovery of bonds
is progressing
Bonds play an important role in an investment portfolio as a stabilising element with regular income. Compared to shares, they are considered low-risk and easy to plan. Price losses like those in 2022 are extremely rare. In this article, we shed light on how this came about and the speed at which the recovery of bonds can continue.
Bonds as an investment instrument
The key features of a bond are the interest rate, the term, and the solvency (credit rating) of the issuer (borrower), such as governments and companies. While the bond is repaid at 100% on maturity, it is subject to price fluctuations during its term. If interest rates fall, the price of a bond rises (positive); if interest rates rise, it falls (negative). The longer the remaining term of a bond and the lower its interest rate, the greater the negative impact on the price when interest rates rise.
The development of bond yields (1980 - 2023)
This effect and the high price losses of bonds in 2022 can be seen very clearly in the yield trend of the 10-year German government bond (see chart). After four decades of steadily falling interest rates, which bottomed out with zero and negative interest rates in the period from 2015 to 2021, interest rates rose sharply in 2022. To curb inflation, central banks around the world raised their key interest rates several times and in a very short space of time. While the "return of interest rates" had a positive effect for investors in the long term, the short-term consequence was a marked correction in bond prices. Due to the relative rise from negative territory to plus two to four per cent, the correction was particularly strong and of historic proportions. German government bonds with an average remaining term of more than 10 years suffered price losses of more than 30 per cent.
Source: Refinitiv Datastream, Colin&Cie
The first recovery in prices took place in the fourth quarter of 2023. The progressive weakening of inflation figures and the prospect of the first interest rate cuts in 2024 led to a downward correction in market interest rates. The following aspects must be considered regarding further recovery potential: The recovery of bonds towards a price of 100% is not linear but is only realised as the end of the term approaches. Due to the overall lower interest rate level, the recovery of bonds in Swiss francs is much slower than in euros. Bonds with a long remaining term and low interest rates recover more quickly when interest rates fall but have also previously recorded higher losses.
Recovery of bonds in Colin&Cie mandates
To reduce risk in the event of rising interest rates, Colin&Cie already focussed its portfolio on bonds with short residual maturities until 2026 in 2019. As a result, the negative performance of euro-denominated bonds (-10.5%) and CHF-denominated bonds (-11.4%) in 2022 was significantly lower than that of German government bonds with longer maturities. With a positive performance of plus 3.5% p.a. in 2023, part of the negative performance in 2022 has already been offset, particularly in the euro mandates. The recovery of bonds in the Colin&Cie mandates should continue successively over the next two to three years, largely irrespective of interest rate trends.
Realisation of the bond strategy at Colin&Cie
As liquidity in individual bonds is severely limited, we are bundling our bond purchases into a larger structure. This not only gives us better market access and more favourable purchase prices, but above all also significantly greater risk diversification (minimisation of default risk) with the same or higher yields.
In view of our interest rate forecast for 2024 - short-term interest rates will fall, while long-term interest rates could potentially rise slightly - we are continuing to focus increasingly on corporate bonds with good to very good credit ratings (investment grade, at least BBB rating) and a short residual term. They currently offer the highest yields (see chart).
We generally refrain from investing in bond funds, as the maturities of the underlying investments are generally longer, and forward transactions are also entered into. The risk profile of such investments is significantly higher compared to traditional bonds.
Chart: Bond market in Europe by maturity and credit quality:
(x-axis: remaining term to maturity in years; y-axis: yield in % p.a.)
Source: Refinitiv Datastream, Colin&Cie
Disclaimer - legal notice
This publication was produced by the Investment Office of the Colin&Cie Group. The information and opinions contained in this document are based on sources we believe to be reliable. However, we cannot guarantee the reliability, completeness or correctness of these sources. All information and quoted rates are only up-to-date at the time of this publication and are subject to change at any time without notice. The content is based on numerous assumptions made by the Colin & Cie Group. It should be noted that different assumptions can lead to materially different results. The forecasts and assessments are only current at the time this publication is prepared and can change at any time without prior notice. Past performance of an investment is not a guarantee of future results. Certain investments can experience sudden and substantial losses in value. This information and views do not constitute a solicitation, offer or recommendation to buy or sell investment instruments or to carry out any other transactions. We recommend interested investors to consult their personal advisor before making decisions on the basis of this document so that personal investment goals, financial situation, individual needs and risk profile as well as further information can be duly taken into account as part of a comprehensive consultation. The information contained in this publication is marketing material that is distributed for advertising purposes only.
