Question

A bond investor, who is your client, asked you to list and describe three strategies for investing in bonds. Could you please also present an example for each of them?   

Answer 1

A bond investor, who is your client, asked you to list and describe three strategies for investing in bonds. Could you please also present an example for each of them?

Like with any other investment decision, having a bond investment goal is crucial to understand if the investment is giving the results you expected. Also, you can go a step further by using some proven strategies that will help you reach your goals faster while enjoying the benefits of a regular income stream and minimum risk of this fixed income investment segment.

As investors, you can go beyond just selecting the most secure bonds or NCDs and highest yield. From minimizing risk to faster liquidity, getting a bulk sum on maturity or just diversification of your investment portfolio, there’s a lot of possibilities available in this segment.

Here’s a list of some of the most commonly used investment strategies in the bonds:

1. The Bond Ladder Strategy

The bond ladder strategy is when you invest in multiple bonds with similar investment amounts and staggered maturity dates. This strategy allows you to invest at regular intervals, in turn minimizing interest rate fluctuation risk and reinvestment risk.

For example – If Michael invests Rs. 5,00,000 equally across 5 bonds with different maturity dates and each bond maturity after every 2 years, then at the end of every 2 years Michael has the opportunity to either reinvest in a new bond or take out the money and invest elsewhere.

This is a good strategy for first-time bond investors with minimum risk appetite and ideal for senior citizens and homemakers or individuals looking for stable returns on an ongoing basis.

2. The Barbell Strategy

The barbell strategy is when you divide your investment amount equally between short-term and long-term bonds with no intermediary bonds. The long-term investments are in bonds with higher coupon rates with the short-term bonds providing the opportunity to reinvest in case the bond market takes a downturn. This strategy is useful when the interest rates are rising. This strategy provides liquidity and the provision to cater to emergencies. While on the other hand, the investor will have to continually keep an eye on the short-term investments to replace those that are maturing.

3. Bond Swap

A bond swap is when you sell one bond and immediately invest the amount in another bond. This is usually done when the value of the bond you’ve invested in has gone down while there is another high-performing bond available for investment in the market. While you may incur small losses while selling the bond, the potential of good returns is much higher. Bond swaps are common among professional bond investors who understand this segment well.

Conclusion

These are some of the popular bond investment strategies for investment in the secondary bond market. However, there are several other strategies that can be implemented once you get familiar with this space.