Testimonials from savers who are dissatisfied with their so-called “super-cautious” portfolios are plentiful these days.
Among other things, this false adventure was reported by a portfolio manager, the story of a household who sold their house last fall and put the money into a seemingly risk -free fund.
This nest egg has shrunk by several tens of thousands of dollars, which is a bad start for buying new habitat.
In question: the stampede of bonds, deemed safe. I told you about it the other day. Now the question: can this torture last longer?
Basics of bonds
We don’t often talk about obligations. After decades without experiencing too much turmoil, we are convinced that bond securities are solid as a rock.
We should also say that in normal times, it doesn’t make for the most thrilling narratives. It is more interesting to narrate the hardships of publicly traded companies (and their components and their leaders) than to narrate the linear journey of a bond in Canada …
This stability has been broken since the beginning of the year. The largest FTSE TMX Canada Universe Bond Index has fallen more than 10% since Dec. 31. The bond market has been less damaged since the 1980s.
I mentioned this two or three times without going into explanation, the value of bonds changes in the opposite direction of interest rates. Here’s the mechanics (it’s mechanical), illustrated by a brief example, of a $ 100 bond that pays 2% interest per year, so $ 2.
Let’s say I want to sell it before it matures to get my principal back. Let’s say interest rates rise between the time I get my bond and the time I want to remove it. The investor I want to sell it to now has access to new bonds that yield 3%, while mine yield only 2%. For this investor to consider my offer, it must give him at least 3%. Therefore, I need to drop my bond to $ 66.67 for it to deliver this return ($ 66.67 x 3% = $ 2). The value of my bond has theoretically lost a third of its value.
I’m simplifying (you have to consider the benefit realized over the maturity of the bond), but that’s the principle.
Remember that the opposite is also true. When interest rates fall, bond prices rise. This is what happened at the beginning of the pandemic. Many bonds seem to struggle when they are just issuing.
What is happening to the funds?
Will you release a bond that has fallen 33% and crystallize your loss? I do not think so. You will keep it until maturity to get all your money back.
This is the same with a fund, except that it must reflect in the price of its units the changes in the price of the bonds it contains. Hence the decline, on paper, of the value of portfolios. As long as you don’t need your capital, it’s not a serious problem, but it’s frustrating when these denials happen when you need to withdraw, as is the case with retirees who believe in security in bonds.
Messy, but for how long?
With all of that, I still can’t answer the original question: how much longer can it last. You can imagine the answer, which is more flat: it depends.
Everything is based on the evolution of bond rates, which are not directly linked to the decisions of central banks. In an environment of high inflation, buyers of securities, which serve as lenders (in countries and companies that issue bonds) are asking for more interest. These are rates on 10-year Canada bonds from 1.75% to 3% since the beginning of the year, a significant and rapid jump.
Among bond portfolio managers, there are those who say inflation will be controlled sooner rather than later and rates are on the brink of stabilization. The most pessimistic on the contrary yields uncontrollable increases in consumer prices, so that interest rates are only at the beginning of their rise.
In such a situation, short-term bonds may offer better protection, as anything with a maturity of more than five years can still suffer a bit. The average maturity on the FTSE TMX Canada Universe Bond Index exceeds 10 years. As for high-grade “bond” mutual funds, I don’t know.
We end with a glimmer of hope. In an environment of higher interest rates, fewer assets are needed to generate the same income. Retirees may benefit eventually, but at the cost of a heartbreaking crossing.