“Neither a borrower nor a lender be,” wrote William Shakespeare. In the investment arena, well-known investors such as Sir John Templeton have echoed the same sentiment over the years. But sometimes things change.
In 2001, Sir John recommended buying bonds. At the time, he felt equities offered poor value in most regions of the world. So for the risk level, the rewards simply didn’t merit buying stocks.
We feel there are three reasons to buy bonds. First, buy them to hold future cash in a reliable investment that will become cash in timely fashion. In other words, to control your future cash flow.
Second, you may hold bonds to diversify your portfolio. Adding bonds to a portfolio of stocks will definitely take some of the volatility out of your portfolio. For many investors, that makes it easier to sleep at night — a worthwhile objective.
The third reason to hold bonds is to speculate on interest rates. When rates fall, bondholders enjoy windfall capital gains as the value of their securities rise. The opposite, of course, also holds. While speculating can be fun and at times highly profitable, we generally concur with Mark Twain, who once advised: “Whenever you feel the urge to speculate, lie down until the urge goes away.”
What to do about bonds now
Recent weakness in the equities markets has given new life to bonds. After retreating in the early part of September, bond prices are once again rising as investors take refuge from equities in what’s considered to be the relative safety of bonds. By mid-October, the FTSE TMX Universe Bond Index had returned a year-to-date gain of a fairly strong 6.8 per cent.
Clearly investors are willing to dismiss the expectation of higher interest rates for now. But administered rates are nonetheless expected to rise sometime next year, suggesting bonds are vulnerable to a setback at their current high levels.
We, therefore, consider the recent spike in bond prices as an opportunity to take profits on longer-term bonds. For instance, we advise that the June 1, 2033, Government of Canada bond, Coupon 5.33 per cent, be sold.
We also suggest a fixed-income allocation of about 35 per cent for a balanced portfolio, with an emphasis on securities with terms of five years or less.
Money Reporter, MPL Communications Inc.
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