What is the function of bonds in a portfolio, and why are they so hard to manage? Investors seem unwilling to pick a side.
“Bonds are frequently seen as a safe haven, yet even the most secure harbours have waves.” – Martin Leibowitz.
Like every other finance sector, the financial industry is rife with popular beliefs that are often incorrect and deceptive. It’s worth distinguishing truth from fiction if you don’t want to go from one mistake to another.
These are some of the most dangerous myths, as well as actions you can take if you want to trade bonds online.
Myth #1: You may join the Quantitative Easing bandwagon and profit from rising bond prices.
For almost a decade, central banks have led us to believe that we were in crisis. They used quantitative easing to drive bond prices upward, and they manipulated them. With so many investors raking it in, it’s been a wild ride. But we also have tremendous fiscal stimulus now; governments worldwide are doing everything possible to spend, spend, and spend.
The more money a government spends, the better your chances of recovering economically. And if you’re the only one left holding the bonds after QE comes to an end, prepare to shed a tear.
People have been buying bonds for a profit for hundreds of years. Money is scarce today, and people are asking God to provide capital gain from numerous bonds – which is only possible if QE continues, which relies on the worldwide economy remaining in lousy shape.
Myth #2: The bond market is small and illiquid
It’s not true. The worldwide bond market is valued at around $130 trillion, almost 100 times the size of the FTSE 100. Yes, there are plenty of tiny, illiquid and unlisted bonds out there, and when someone claims that debt is a bad investment, they focus on them.
Invest in robust, significant, liquid, and listed bonds, and you may buy and sell tens of millions of dollars, euros, or pounds to dozens of counterparties in a matter of seconds.
Myth #3: Bond prices all move in the same direction
Bonds usually go down in value and up when things are bad when the economy is doing well. It implies that bond investors are in trouble once the economy rebounds from the pandemic, doesn’t it? Wrong again.
The majority of the global bond market is composed of government bonds, which are often popular during periods of crisis since investors perceive them as low-risk safe-havens. The remaining portion of the bond market belongs to corporations. These bonds tend to rise (or fall far less than government bonds) since their credit risk decreases as the economy and earnings improve.
Myth #4: You don’t have to be concerned about currencies when buying bonds
Many investment funds lose or make the same amount of money as their underlying assets regarding currency. Many bond managers believe they can manage currency risk. After all, isn’t it simply a little bit of macroeconomics, the same as bond investing?
Unfortunately, this is not always the case. It’s simple to come up with an opposing viewpoint on currency: Brexit is bad for sterling, as an example, but if we want to sell sterling, we’ll need to acquire something else first. For instance, on a Brexit scenario, but tomorrow Angela Merkel steps down – it will derail the trade no matter whether the referendum outcome was correct. Currency fluctuations are affected by a lot of factors.
The worldwide bond market performed well in 2020. By 20 November, returns for euro investors had reached 4%. However, if the same investors had failed to hedge their currency risk, their return would have been just 1.8%. When purchasing bonds or a bond fund, ensure that you know what currency risk you’re actually taking on before it’s too late.