Risk Free Assets – To Bond Or Not To Bond ?

This post was written for www.hnworth.com, a site targeting high net worth individuals in Singapore.

Have fun reading !

********************************

Cannot keep up with what is happening in the sovereign bond markets ?

You are not alone.

The sovereign bond market that is supposed to be the rock in the tempest, the oasis in the desert and the calm in the storm. Instead of assurance, investors got whipped to what some describe as a state of crucifixion as half a trillion in value got wiped out at the peak of the sell down sometime mid last week.

Imagine our incredulity as the market managed to drive itself to the peak of negative yield madness  for most of Europe and Japan with Switzerland holding the crown for being the only country whose 10Y bond yielded a low of -0.21%, for the entire facade to come crumbling in a short span of 2 weeks ? To our relief, Switzerland 10 year papers are paying 0.025% now.

In the topsy turvy logic of central bank intervention, the asset classes that are safest have turned out to be those out of their reach – equities and commodities.

asset volsSource : Otterwood Capital Management

From the table above, the sovereign bond market volatility has outstripped even currency markets. And equities and commodities, the traditionally riskier assets, are producing swings that are less than half as wild as that as government bonds, that are the traditional risk-free asset class.

With the volatile bond asset class, the safest category of bonds have turned out to the high yield riskiest names, which have been seeing rather benign price swings of late, given that they are less sensitive to interest rate moves, evidenced in the chart below.

bond vols

This begets a fundamental question – should we change our conceptual mindsets about the existence of a risk-free asset class that sovereigns have always represented ?

Or will it be a permanent feature of QE monetary policies that Equities have become safe haven assets in portfolios ? Or will HY bonds be the new fad as Moody’s  notes that speculative grade corporate default rate eases to near record lows ?

Textbooks have always maintained that the risk-free rate is the backbone of bond market pricing and equity valuations too, to a smaller degree when evaluating returns.

Risk free, is as its name implies, zero risk but only to the extent of capital recovery i.e. zero chance of a default.

To continue reading ….