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Summary
- Bonds are generally loans from an investor to a company or a government.
- There are several risks and reward tradeoffs associated with bond investing.
- Here we will discuss four principal bond management strategies that may help investors to invest in bonds wisely.
Bonds are generally loans from an investor to a company or a government. In return, investors receive periodic payments based on the interest rate at which the bond was sold.
However, bond investing is not that simple as it appears. There are several risks and reward tradeoffs associated with bond investing. Investors have various options in front of them to structure a bond portfolio.
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Here we will discuss four principal bond management strategies:
Passive bond management
Passive bond management or buy-and-hold strategy assumes that investing in bonds is safe. The strategy seeks to maximise the income-generating properties of bonds. According to this investing strategy, investors purchase and hold bonds till maturity. The income earned through interest could be used to meet external financing needs. The funds can even be reinvestment in the portfolio or other bonds or assets.
Investors generally do not make any assumption regarding future interest rates and yields. Thus, the debt may be bought at a premium or a discount while assuming that full par will be received upon maturity.
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Indexing bond strategy
The strategy is considered quasi-passive by design. The strategy aims to provide a return based on a targeted index. The risk characteristic is also linked to the index. Therefore, the strategy relatively has more flexibility compared to passive buy-and-hold, despite the two having same characteristics.
The indexing strategy is said to perform well in the case of an extensive portfolio due to the number of bonds needed to mimic the index.
Immunisation bond strategy
Immunisation bond strategy includes attributes of both active and passive strategies. An active investor makes bets on the future rather than settling for potentially lower returns via passive investing.
Under the immunisation strategy, a financial portfolio is invested for a specific return for a particular period irrespective of outside influences, including changes in interest rates.
Like indexing bond strategy, the opportunity cost of immunisation strategy is doing away with the upside potential of an active strategy. It comes with an assurance that the financial portfolio would deliver the intended desired return.
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Active bond strategy
As already discussed, active bond strategy includes making bets on the future rather than settling for potentially lower returns via passive investing. Instead, it is all about maximising returns. Interest rate anticipation, timing, valuation, and multiple interest rate scenarios are a few examples of the strategy.
What should investors do?
There are several investing strategies for making investments in debt. Investors can employ any of these based on their targets and risk profiles. While passive investing is for the ones seeking income and not willing to make predictions, indexation and immunisation offer some security and predictability. On the other hand, active strategy is about maximising returns, and not for casual investors.
Investors can choose any strategy they feel meets their calculations, but a detailed analysis of pros and cons is required before going forward.
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