TLDR;
Master Leong discusses investing in bond funds, explaining what bonds are, the risks involved, and how bond funds work. He highlights the importance of understanding the risk-return trade-off and the potential downsides, especially during economic downturns. He advises investors to assess their risk tolerance before investing in bond funds, suggesting risk-free options like fixed deposits or Singapore savings bonds for those prioritizing capital preservation.
- Bonds are essentially a promise to pay back money, like lending to a company or government.
- Bond funds offer diversification but are not risk-free, especially during economic crises.
- Higher interest rates from bond funds typically indicate higher risk, often tied to non-investment grade bonds.
- During economic downturns, bond funds can experience significant declines in NAV.
- Investors should assess their risk tolerance and consider safer alternatives if they cannot withstand potential losses.
Introduction to Bond Funds [0:00]
Master Leong addresses questions about investing in bond funds, clarifying that while he's not a bond expert, he aims to provide a tutorial for understanding them. He encourages viewers to make informed decisions about investing based on the information provided. The discussion will cover the basics of bonds, their risks, and how bond funds operate.
Understanding Bonds [0:55]
A bond is a promise to repay borrowed money, similar to a fixed deposit where you lend money to a bank and earn interest. Investing in a Singapore savings bond means lending to the government with a guaranteed return. Corporate bonds involve lending to companies like Singtel, with the risk being the company's potential bankruptcy, which could result in the loss of the principal. Bondholders do not participate in the company's growth beyond the agreed interest.
Risks and Returns in Bond Investing [2:18]
The primary risk in corporate bonds is the company's bankruptcy, which can lead to the loss of the invested principal. While shareholders take the highest risk for potentially high returns, bondholders have a limited upside, mainly the interest payments. Trading bonds offers another way to profit, but it's typically done by institutional investors, not retail investors who usually hold bonds until maturity.
Diversification Through Bond Funds [3:54]
Bond funds mitigate risk through diversification, holding bonds from many different companies. This makes it unlikely that all companies will go bankrupt simultaneously. The net asset value (NAV) per share of a bond fund reflects its value, and it drops if the fund cannot recover its principal.
Assessing Risk in Bond Funds [5:00]
The risk-free rate in Singapore is 1.5% to 2%, based on fixed deposits and Singapore savings bonds. Investors often seek higher returns through bond funds, but it's crucial to understand the risk-return trade-off. Higher interest rates from bond funds indicate higher risk, depending on the underlying assets. Blue-chip companies with high credit ratings offer lower interest rates (2% to 2.5%), while riskier mid-cap companies offer higher rates (3% to 3.5%), and non-investment grade or junk bonds offer even higher rates (5% or more).
Bond Fund Composition and Potential Downsides [9:02]
Bond funds can consist of a mix of investment grades, determining the interest rate. Higher interest rates usually mean a greater proportion of non-investment grade bonds. During the 2008 global financial crisis, fixed income assets performed poorly; investment-grade corporate bond funds dropped 10% to 15%, and junk bond funds crashed 30% to 40%.
Economic Outlook and Bond Fund Risks [10:42]
Master Leong predicts a potential global recession in 2026 due to factors like Donald Trump's tariffs, which could lead to decreased consumer spending and economic activity. During economic downturns, investors often seek safety, selling risky assets like stocks and bonds. Cutting interest rates may not always increase bond fund prices, especially for corporate bonds, as investors prioritize the survival of the underlying companies.
Investment Strategies and Risk Tolerance [14:15]
During crises, investors prioritize safety over bond yields, potentially leading to significant losses in bond funds. If you're unwilling to accept a 15% to 40% paper loss, avoid bond funds. For 100% capital protection, stick to fixed deposits or Singapore savings bonds. Master Leong prefers REITs for higher passive income when willing to take risks.
Conclusion [16:19]
Master Leong concludes by expressing hope that the sharing has provided insights into bonds and bond funds, including their operation, potential downsides, and risk quantification.