Bond capabilities at DSP  

DSP can offer bond expertise in a wide range of markets. Bonds can be used in to achieve specific objectives (for example, as an alternative to cash where they may offer superior returns) or as part of a wider investment portfolio to provide income and/or diversification. Possibilities could range from a global portfolio to a much more focussed single currency short-dated government bonds. Exposures to bonds can be taken either through bond funds or through direct investments.

What is a bond?

For an initial purchase cost, an investor will generally receive income on an annual or half-yearly basis over their lifetime at a prescribed rate and then receive a redemption amount when it reaches their maturity date. Payments are made by the issuer of the bond. For example, the gilt 4% of 2016 is issued by the UK Government and for each £100 nominal of the bond owned, the investor will receive £2 every 7^th March and 7^th September until the last one on 7^th September 2016 which will be accompanied by the Redemption value of £100. The annual income payment, in this case 4% is called the coupon. The price of the bond will vary over its lifetime as markets react to economic developments etc. As the bond approaches maturity the price will usually converge towards the redemption value (generally 100).

Which types of bonds?

The choice of appropriate bonds will vary according to the requirements of each investor. The list of possibilities would include bonds issued by governments, supranationals, government agencies, companies and asset backed securities. Further choice comes from conventional bonds or inflation linked bonds where returns are linked to inflationary developments and offer protection in an environment of rising inflation.  Investment in bonds issued in other currencies can further add to the opportunities for enhancing returns and such investments can be made on a currency hedged or unhedged basis.  

A source of secure (?) income

For an issuer such as the UK Government, one of the highest rated credits, the chances of these payments not being made are considered highly unlikely. For lesser quality credits the chances of failing to pay will increase although in many cases still remain very low. To make their bonds more attractive to investors, the yields on offer need to be higher (so for identical income streams and redemption proceeds, the initial cost would be lower than for the UK Government). In buying bonds one needs to judge the balance between higher yields and higher risks. As with equities, when buying lower quality bonds one has to consider diversification of issuers in a portfolio.

What maturity?

Bonds can be bought with a final maturity ranging from just a few days to 50 years in the case of gilts (UK Government bonds) and in some cases there is no set maturity date. For an investor looking to use bonds as an alternative to cash, the chosen maturities should be short dated as returns on longer bonds are more volatile. Pension funds would however tend to use long bonds because the liabilities they are trying to cover with cashflows from the bonds are the payments of pensions.

Does the coupon matter?

The coupon is the annual rate of interest payable on a bond. So for example, in the gilt market there are currently two gilts which mature in 2011, one with a coupon of 9% (i.e. it pays 9% of its nominal value in two instalments of 4.5%) and one with a coupon of 4.25%. To compensate for the higher income stream on the 9% bond, the 9% bond trades at a higher price (111.4 compared with 94.95 for the 4.25% gilt on 4^th July 2007). The yields on the two bonds are almost identical, to a zero rate tax payer so for such investors the coupon probably doesn’t matter. However, for tax payers the after-tax yields can be significantly different. Capital gains on gilts are free of tax to individuals whereas income is not usually and so lower coupon bonds, where capital gains make a larger contribution to overall return, are usually more attractive to individuals.