Bonds are generally regarded as low-risk investment vehicles. Investors who do not wish to invest their entire assets in shares are generally invested to a large extent in precisely such “low-risk” bonds. This is lucrative for the bank or the provider, as it means that even the risk-averse client can be charged the full management fee. But does such an investment in bonds make sense for the customer in the current low interest rate environment? And what risks does the customer (unconsciously) shoulder? The following points shed light on this issue:
Yield to maturity
The yield to maturity of a bond indicates how much return the investor will receive per year if he holds the bond to maturity. In the current low interest rate environment, many bonds have a very low yield to maturity, and in the case of Swiss government bonds, often even a negative yield. In addition, the management fee or the fund fee of the bank or the provider must be deducted. In net terms (after costs), Swiss bonds generally yield a negative return, meaning that the customer makes a loss on maturity, while the provider collects the fee. On top of that, there are various risks.
Interest rate risk
Bond prices rise or fall depending on changes in the interest rate level. In simple terms, the price of an existing bond falls when interest rates rise, as newly issued bonds then have comparatively high coupon payments. To compensate for this, the valuation of existing bonds falls and they become correspondingly cheaper. As an investor, you therefore temporarily bear a price change risk due to changing interest rates if the bonds are not held to maturity or a change in strategy is made. The following chart shows this as an example for the 10-year CHF interest rate and the bond prices of Swiss government bonds.
In the past, bonds have experienced valuation gains for a long time due to steadily falling interest rates, but this has turned around in the last 2-3 years.
Falling interest rates can therefore also be seen as an opportunity to sell bonds at a higher price. For a long-term oriented investor, however, the question is whether in the current (negative) interest rate environment even lower interest rates are to be expected in the medium to long term or whether the scenario of rising interest rates is not rather seen as more realistic.
Possible interest rate changes can of course also be anticipated and “traded” in the short term – i.e. the investor tries to profit from falling interest rates and realizes short-term valuation gains. The fact that bond funds typically have high spreads speaks against this. Temporary entry and exit is therefore associated with comparatively high costs. This is also a problem with providers who do not offer a free and interest-bearing cash account – if a customer wants to temporarily take the risk out of his portfolio, this is associated with high spread costs when switching into bonds, which would not be the case with cash.
Inflation can make future interest payments worth less in real terms. The real return is the difference between the interest payment and the inflation rate. The higher the inflation, the lower the effective real return, the latter can thus also be negative. High inflation can also lead to monetary policy imposing key interest rate increases, which in turn can lead to falling bond prices.
In order to avoid the low interest rate level of CHF bonds, part of the assets are usually invested in foreign currency bonds. Since this should be a low-risk investment, many providers undertake foreign currency hedging. This means that the exchange rate risk of a USD bond, for example, is completely hedged. However, this currency hedging incurs costs that are roughly equivalent to the interest rate difference between USD and CHF – any higher interest rate level in the USD is therefore cancelled out by the hedging! The customer is often not aware of the fact that the hedging entails this cost effect – in the end, however, the customer ends up back at the CHF interest rate level, i.e. with a negative return after costs.
With bonds, there is always a default risk, since the debtor, i.e. the issuer of the bond, can default or even become insolvent. However, this risk is usually minimized by diversification via indexed funds.
Bonds are not suitable for long-term investment in the current low interest rate environment. In addition to an often negative yield to maturity after deduction of costs, the investor shoulders further risks of which he is often not even aware. At the same time, the bank or the provider continues to collect a management fee. VIAC does not use bonds in the standard strategies for exactly this reason! Instead, the money is invested free of charge in the interest-bearing account. VIAC deliberately forgoes fee income here in the interest of the pension recipients and does not force conservative investors to invest the low-risk part of the assets in negative-yielding bonds.