Figuring out which bonds to buy

Figuring out which bonds to buy:

There’s a massive amount of bonds out there and it can be pretty difficult to figure out, what makes sense to invest in. While there’s a wide range of things to consider, two of the more prominent are 1) what currency do you want to invest with and 2) are you looking for low risk or high returns?

We have added a few general suggestions below. None of it should be seen as advice, but merely as guidance towards overall categories of asset classes that could be relevant for investors to look at depending on their risk profile and time horizon(s).

USD investors: 1-2 year liquid corporate debt of investment grade

EUR investors: 1-2 year liquid corporate debt of investment grade

GBP investors: 1-2 year liquid investment grade corporate debt

DKK investors: Same as above for EUR investors (Note: this means some currency risk for the Danish investor, although the DKK has been essentially pegged to the German Mark and then the EUR since the early 1980’s – and is only allowed to trade in a very narrow band, officially 2.25% but has only fluctuated about 0.3% either side of the average for the last 20 years.)

Note: You can use the Bond screener in your Saxo Platform to choose specific bonds, including those with a smaller minimum trading amount. Note that any bond yielding significantly more than 50-75 basis points (0.50%) above the safest government bond rates is likely edging toward a non-investment grade cut-off.

What to buy if only considering the lowest-risk bonds

To earn income on idle cash/un-invested funds: Investors can choose very low risk government bonds that mature in 1-2 years, or even buy some 3-6 month bills* if convinced that interest rates may rise further still and then reinvesting the funds at maturity, while leaning more toward 2-year bonds if convinced that interest rates may cool over that time frame.

USD investors: 1-2 year US Treasuries or T-bills*

EUR investors: 1-2 year core EU bonds (Germany, Netherlands, France, etc)

GBP investors: 1-2 year Gilts (UK Government bonds)

DKK investors: 1-2 year Danish Government bonds, 1-2 year Danish Mortgage Bonds

The table below offers specific ISIN numbers for shorter maturity government bonds and for Denmark, Danish Mortgage bonds, from those maturing in approximately six months to up to three years, depending on your currency region. Further below you can find links for instruction on how to find and trade these specific bonds in Saxo’s platforms - the easiest way is to simply copy and paste the ISIN number for the bond into the Instrument Search box in your Saxo platform.

*Bills and T-bills: See the appendix below on the difference between a bill and a bond – the end result in yield terms is effectively the same as a standard coupon bond. Somewhat confusingly, the world’s most liquid bonds, US government bonds, are called treasuries, or Treasury Notes/T-notes when issued for 2-20 year maturities, Treasury Bonds/T-Bonds for the longest, 30-year maturity and Treasury bills/ T-bills for maturities of one year or less.

What to buy if considering slightly higher yielding, but “investment grade” bonds

Those willing to take slightly more risk in order to achieve somewhat higher yields can consider corporate bonds of investment grade, which offer higher returns than less risky government securities, although the very highest rated corporate bonds, like USD bonds from Apple, hardly yield more than US treasuries.  Corporate debt is available from an enormous variety of companies of varying financial solidity. The term investment grade refers to corporate bonds that have been given a credit rating above a certain level by the main bond ratings agencies like Moody’s and S&P, depending on the issuer's perceived credit risk. There is a generally sliding scale from the lowest yielding, top-rated "AAA" rated corporate bonds down to the somewhat higher yielding, lower-rated (but still investment grade) corporates. The bonds rating agencies call anything below investment grade a high yield bond. Sometimes there is a significant drop in a bond’s value if the bond is ranked at the very lowest investment grade level and is placed on "negative watch" for a further downgrade or actually downgraded by any of the major bond ratings agencies. This is because many large bond funds are not allowed to hold bonds that are not designated investment grade. A rough illustration below shows the sliding credit rating scales of the major bond ratings agencies and a general description of the risk level for each rating.

What to buy if looking for higher yielding bonds

Investments in high-yield bonds is beyond the scope of this article. Formally speaking, “high yield” corporate debt is debt rated below investment grade by the bond ratings agencies and is only an option for more risk willing investors. In times of an improving economic outlook or times of falling yields and stable to improving credit markets, high yield bonds can offer far better returns than higher rated debt, but are of course more risky in general and the most risky when the economy is heading into a rough patch or recession, when default events can occur and bond holders may only recover a portion of their initial investment. High yield bond prices for longer maturity bonds of five years or more can be extremely volatile, easily fluctuation 10% within a month. Risk-willing investors can consider high yield bond investments, but should do their due diligence on the risks of investing in this space, as well as understanding the credit risk of any single company before purchasing its bonds. The higher the implied yield of the bond, the worse the credit rating and higher the presumed default risk.

Special considerations for Euro Zone sovereign debt

If you are investing with either EUR or DKK, there’s a few relevant notes below about the Euro zone.

The EU, with its monetary union is an awkward construct, given that each EU member government in the monetary union must fund itself from domestic revenue in theory, with the ECB as the single central bank. As individual members have no power over the central bank itself, this has generated concern that peripheral EU countries with weak growth and that are highly indebted, especially Italy and Greece, may one day default on their Euro-denominated bonds. This concern drove a disorderly sell-off in Italian, Greek and other peripheral bonds during the EU sovereign debt crisis of 2010-12. In response, the ECB eventually moved aggressively to purchase enormous quantities of EU sovereign debt and more recently has even tilted its purchases more toward the peripheral debt from Italy and elsewhere to avoid “fragmentation” of its monetary policy. This year, the ECB aims to stop purchasing debt entirely and even sell it, a process know as quantitative tightening or QT that will reduce the size of the ECB’s balance sheet. Still, even while maintaining a policy of QT, the ECB may shift its legacy holdings and still be a net purchaser of the most fragile nations’ debt while its overall balance sheet shrinks. Most other developed market central banks, Japan a prominent exception, started the QT process last year. Still, the foundational problem in the EU of one central bank and multiple sovereigns will mean that there is some residual risk that a country without control of its currency may leave the euro and default on its bonds. That is why, as of this writing the Italy 10-year BTP, Italy’s sovereign bond, trades with a yield of 4.55%, while the German 10-year Bund, trades at 2.7% as of this writing.