This month, Charles Carpenter, of Ravenscroft, offers an insight into the ever-evolving world of bonds
The bond market, often referred to as the fixed-income market, is a fundamental component of the global financial system.
It provides a platform for governments, corporations and other entities to raise capital by issuing debt securities known as bonds. At its core, a bond is a debt instrument that represents a loan made by an investor to a borrower. When an entity issues a bond, it agrees to pay periodic interest, known as the coupon, to the bondholder over a specified period and the principal amount, or face value, is returned to the bondholder upon maturity.
The bond market encompasses various types of bonds, each with distinct characteristics. Government bonds, such as UK treasuries, also known as gilts, are considered low risk, as the issuing government backs them. Corporate bonds, on the other hand, carry higher yields but also higher risk, reflecting the creditworthiness of the issuing corporation.
Credit rating agencies evaluate the creditworthiness of bond issuers and assign ratings that help investors assess risk. Popular rating agencies include Standard & Poor’s, Moody’s and Fitch. Investment-grade bonds have higher ratings and are considered lower risk, while below-investment-grade, or “junk”, bonds are higher risk and can offer potentially higher returns.
Yield is a critical metric in the bond market and represents the return an investor receives on a bond. This is influenced by the bond’s coupon rate, current market price and time to maturity. The inverse relationship between a bond’s price and its yield is a key factor that influences market dynamics.
Bonds are particularly sensitive to changes in interest rates. When interest rates rise, bond prices generally fall and vice versa, resulting in most bonds falling below par value through the recent rate hiking cycle.
However, as investors anticipate rate cuts during 2024, appetite for bonds has been stronger, with January setting a record for bond sales, topping 293 billion euros, according to Bloomberg, as investors look to lock in yields before interest rates are cut.
The bond market’s significance extends beyond individual economies. It plays a crucial role in global finance, acting as a source of funding for governments and corporations worldwide. Movements in major bond markets, such as the US Treasury market, can affect interest rates and capital flows globally. The bond market facilitates capital allocation, risk management and economic development. Its diverse array of participants, broad spectrum of bond types and intricate market dynamics contribute to its complexity, making it a cornerstone of global finance.
Institutional investors such as pension funds, insurance companies and mutual funds allocate significant amounts of capital into the bond market. Retail investors also participate through individual bond purchases or bond funds. Many investors have exposure to bonds within their portfolios as they are typically less volatile than equities and generally provide reliable and consistent income.
For more information on how bonds can help you achieve your investment goals, please get in touch with Ravenscroft.