In his columns on investment platform IEX.nl underlined market commentator Arend Jan Kamp invariably that you should invest diversified, in order to limit the risk of loss. In other words: in safe government bonds (government bonds with a fixed term) and also in as many equities as possible, in other words from every nook and cranny of the world economy.
But if Kamp is honest, he himself has broken that rule. “I sold all my bonds, three or four years ago, and thus cheated. With that negative bond yield, it felt so pointless.”
Camp is not alone. “We have seen that move – away from government bonds – in many individuals who invest with us,” says Mary Pieterse-Bloem, head of investing at Rabobank and endowed professor of Financial Markets at the Erasmus School of Economics, which is part of Erasmus University Rotterdam. The yield on government bonds with a ten-year term has been falling for decades, dipped below 1 percent at the end of 2014 and only rose again this summer.
Interest is now rising again. So is it time to embrace government bonds again as a safe haven for investment, in case the stock markets plummet? Or would you be better off targeting corporate bonds, some of which offer much higher returns?
1 Does investing in government bonds really pay off?
The long-term stock market wisdom, for people who invest for their retirement, has always been: you should invest in stocks to grow your wealth and in bonds to preserve it. But will that kite still fly? Yes, anyone who now invests their money in a Dutch government bond with a term of ten years – pretty much the safest investment imaginable – will receive a so-called coupon rate of approximately 1 percent each year.
The coupon rate on the 10-year bond for example, which the Dutch state recently put on the market on August 8, is 1.3 percent. Last year, the interest rate was still negative or zero. Investors therefore made a loss by definition with such a bond. “Due to the higher interest rates, it is now more favorable to buy bonds,” says Arend Jan Velsink, director of investment at Brand New Dayprovider of very broadly diversified index funds.
But people who lend money to the Dutch government in this way still lose money. If there is even a little bit of inflation, says Pieterse-Bloem, your investment will be worth less. Let alone with the current inflation, which was more than 10 percent last month.
With a Dutch government bond, you will get your investment back when the term has expired. But by then you can buy much less with it due to inflation. In that case, there is no question of capital retention. In order to do this, interest rates would have to rise much faster, given inflation – although investing in bonds obviously still yields more than ‘just’ leaving it in the bank.
2 Should you have bonds as a buffer in your portfolio?
Generations of investors have been brought up with the idea that you should have stocks and bonds in your investment portfolio. After all, the two would usually move in opposite directions on the stock market. According to this so-called negative correlation theory, which professional investors such as pension funds have followed for decades, safe bonds protect you when stock prices fall. At that moment, the price of bonds actually rises, and that limits your loss. That is why pension funds usually invest according to the 60-40 formula: they invest 60 percent of the capital they manage in shares and 40 percent in bonds.
But in investor circles, some people are warning that those negative correlation no iron law that you can trust blindly. They point to periods in history when the value of stocks and bonds fell as well – albeit usually less sharply. That was roughly the case last century from the late 1960s to the late 1980s. This also happened at the beginning of the corona crisis, in the spring of 2020. The influence of the American central bank, the Federal Reserve, also played a part in this, which lowered interest rates and started buying even more bonds with the European Central Bank than in previous years.
However, Joost Tieland, commercial director at Brand New Day, says he “still believes strongly in the function of bonds within a portfolio. When there really is a lot of uncertainty in the world, you always see investors shifting their money from stocks to bonds.”
This also happened initially when the corona pandemic broke out. Tieland: “There is no alternative if you want to limit the risk of major loss.”
What has changed in recent years is the composition of bond funds. This often includes more and more corporate bonds – debt securities issued by companies.
3 Are corporate bonds a good alternative to government bonds?
Not only many private investors have exited government bonds, but also professional parties, including Rabobank. Pieterse-Bloem: “In the portfolios we manage for clients, we now invest a large part of the capital in corporate bonds – as an alternative to government bonds.” At Brand New Day, the global bond fund consists of 60 percent government and 40 percent corporate bonds. This entails more risk than a fund with only government bonds and the highest creditworthiness, such as bonds from the Dutch or German government.
Credit ratings for bonds range from AAA (the most creditworthy countries or companies) to DDD (for example, bankrupt companies). The exact classification varies slightly by rating agency, the largest of which are Standard & Poor’s, Moody’s and Fitch. But in general, BBB- is the lower bound of what is considered safe enough, the so-called investment grade.
Everything below (from BB+) has the stamp high yield, or high efficiency. If you buy such a bond, you know that you are taking a lot of risk.
Return and risk go hand in hand when investing. The higher the interest rate on a bond, the greater the risk. The interest is paid by the person who issues the bond as compensation for the risk.
With fund providers, the creditworthiness of the bonds withdrawn differs. Brand New Day’s global bond fund is at least investment grade, with an average rating of AA-. Meesman Index Investing only has bonds with a credit rating of AAA, AA or A (a little bit)”, says director Hendrik Meesman. At Meesman, this automatically limits the number of companies in the fund; few get an A stamp.
Some, including market commentator Arend Jan Kamp, believe that corporate bonds should in principle not belong in the bond portion of a portfolio. “Corporate bonds are easily too risky, while bonds are supposed to limit the risk. A fund manager should select a bond based on that, not on the yield.”
Meesman thinks that is a bit succinct: “Some corporate bonds are safer than those of certain governments. This applies, for example, if you buy bonds from pharmaceutical company Johnson & Johnson [AAA-rating] market against government bonds of Japan, China or Poland [landen met een A-rating].”
4 Are riskier, high-yield corporate bonds like Boxx’s a good idea?
Smaller companies that are not supervised by the Netherlands Authority for the Financial Markets (AFM) can also issue bonds. For example, the company Boxx, which rents out storage space at sixteen locations in the Netherlands, sometimes in NRC if it has issued a new bond. It recently did that for a bond with a five-year maturity and a coupon rate of 8.75 percent, for which subscriptions will take place from August.
In view of the high interest rates, Joost Schmets of investor association VEB thinks this corporate bond is far too risky for private pension investors. He also warns that Boxx in his ‘information memorandum’ about this bond “ultimately provides very little financial information. For example, about how much debt it has.”
Schmets also criticizes the ‘silent pledge’ on the storage location at Schiedam. According to Boxx, this serves as collateral for investors in case something goes wrong. Boxx wants to use the money that the company collects with the bond to further develop this location.
“Silent pledge sounds nice, but you have no idea what that location is worth,” says Schmets. “And you cannot recover damage from the Boxx Group, the party behind this – that has been legally boarded up.”
Because Boxx is not subject to the supervision of the AFM, it does not have to comply with the rules drawn up by the AFM to protect private investors. And Boxx does not have a credit rating that helps to estimate the risk of a bond. It’s too small for that.
5 How can you invest responsibly in corporate bonds?
When you’re professionally involved in investing, everyone asks you for tips. His mother-in-law, for example, approached Joost Tieland in May with the question whether it was a good idea to put money into Fastned. This producer of charging stations for electric cars had just issued new corporate bonds with a term of 4.5 years and a coupon rate of 5 percent.
Although Tieland thought the last two figures sound “pretty attractive”, he would not be quick to recommend it to private investors, he says. “Bonds are much more complicated than people think – that starts with the fact that their share price falls when market interest rates rise.”
His colleague Velsink agrees with him. “If you want to gamble on the stock market, put money in a fund with high yield bonds from a thousand different companies. If one of them falls over, at least you won’t lose all your money in one fell swoop.”
The two would rather see private investors opt for optimal risk diversification and select a fund with thousands of corporate and government bonds and different maturities. Because with bonds, the longer the term, the more can go wrong until the bond matures, and therefore the greater the risk.
You can also google an investment fund that passively tracks the Barclays Bloomberg Global Aggregate Index. That index is the benchmark for bonds – similar to what the MSCI World is for stocks. This way you can invest in the entire bond market in one go. In other words: in government and corporate bonds from 24 countries (including China), with a creditworthiness of at least investment grade and an average maturity of seven to ten years.
Looking for something even safer? Then adjust the selection criteria and look for a fund that only tracks bonds with a shorter maturity within this index.