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How savers find a solid investment with high returns

Security and high-interest rates are supposedly mutually exclusive. But in practice, savers can also achieve attractive returns with solid financial investments.

How savers find a solid investment with high returns

Achieving attractive returns with bonds or other interest-bearing investments has not been easy in recent years. The zero-interest rate policy and the bond-buying programmes of the central banks are to blame. Even government bonds from countries such as Greece or Italy recently offered hardly any more in returns than German federal bonds. Finding reasonably safe interest-bearing investments which also offer a noteworthy return seems like searching for the proverbial needle in a haystack. But this search is by no means hopeless. For savers who know how to assess opportunities and risks correctly, the market offers excellent opportunities for successful investments in interest-bearing securities. The key here is to properly comprehend the interplay between risk and return. The following factors essentially determine the yield opportunities of bonds:
  • Nominal interest rate of the bond
  • Market interest rate
  • Creditworthiness of the borrower
  • Maturity of the bond

According to conventional wisdom, safety and profitability are two ends of the same scale

As a rule with financial investments, the higher the chance of a high return, the less security they offer. So if savers invest in an asset that promises disproportionately high interest rates, these investors also run a higher risk of non-payment of interest or even default on repayment. The equation also applies in reverse: The more security an investment offers, the lower the expected return.
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Profitability schema

The constant tradeoff between risk and return

Not without reason do people say that interest rates contain a risk premium. Several factors determine the return on investment. The basis is the so-called risk-free interest rate. This refers to an investment where savers can be reasonably sure that they will not run the risk of losing their invested capital. The yields of federal bonds are often used as a reference value here. Another factor is the remaining term of an interest-bearing investment, for example, a bond. As a rule, the longer the remaining term of an interest-bearing asset, the higher the yield. Here, too, the risk is priced in. The further events lie in the future, the greater the uncertainty about future developments. Who can look into the future? And so with maturity, the same applies to other risk factors: more uncertainty equals more risk equals higher returns.
Investment trend schema
Effects of a change in the market interest rate on the stock market price of a German government bond with a remaining term of 5 years and a coupon of 2 %.

Scenario 1: If the market interest rate remains unchanged compared to when the bond was issued, the bond’s market price does not change either.

Scenario 2: If the market interest rate rises from 2 % to 3 %, the bond price falls. Investors who purchase a new bond achieve a higher return in the amount of the new market interest rate of 3% since they can enter at a more favourable market price and see price gains until maturity. Bondholders would have to accept price losses if they sold the bond.

Scenario 3: If the market interest rate falls from 2 % to 1 %, the price rises. Investors who purchase the bond anew have to pay this higher price at the time of purchase and have to accept a price loss until the end of the term, as the bond price gradually falls to 100% of the nominal value until the end of the term. The yield achievable on the bond until maturity is equal to the new market interest rate of 1 %. Bondholders could realise a price gain if they sell immediately.

How credit rating affects the price of a bond

Another factor is the credit rating of the debtor in question. German government bonds are considered risk-free because investors can almost certainly assume that the Federal Republic will pay its interest and settle its debts. This is not always so with other debtors, such as certain emerging markets or companies. Depending on the market’s assessment of their respective creditworthiness, they have to offer savers an interest rate premium – in other words, a risk premium.

And so it happens that bonds of a company that has done poorly in recent years and where investors fear that insolvency may be imminent are, from experience, much cheaper and thus offer more yield than bonds of a large group that is considered a market leader and whose business will do well for the foreseeable future

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Portfolio Analysis

Big opportunities from market inefficiencies

The market participants’ assessment of how secure the repayment and the expected interest payments of a financial investment are a crucial factor for the level of the expected return. The key to success for alert investors lies here in the word “assessment”. For the “market” can misjudge. This happens not at all infrequently, especially with corporate bonds. There are various reasons why.

One reason is that some prominent market participants, such as insurance companies or pension funds, are obliged to buy safer government bonds. They can therefore only act freely within a limited sphere and do not qualify as buyers for many corporate bonds. Due to this fact alone, government bonds are, on average, more expensive and offer lower yields than corporate bonds. Another reason is that big rating agencies like Moody’s or Fitch do not rate all bonds.

And even the analysts of large institutional investors only ever have an eye on a sub-segment of the huge bond market. Therefore, companies outside the large, observed mainstream have to offer higher interest rates to find investors for their bonds. However, this does not mean that these companies are less likely to pay their interest and return the money they borrowed via bonds to investors. There is just more uncertainty about it due to a lack of analysis. The formula here is: Less knowledge equals more uncertainty equals more return.

Credit rating does not tell everything about the safety of a bond

There is also an opportunity in the fact that “the market” often assesses companies by the wrong criteria. Suppose a company’s business does not run as “the market” expects. In that case, this usually means that the share price of the affected company falls. This is because profit forecasts must be adjusted downwards if business is disappointing. This lowers the company’s value – and thus its valuation on the stock exchange. However, the valuation of bonds is governed by different rules than those for shares. The crucial factor for bonds is only whether a company can make its interest payments and is able to repay its debts. Whether a company achieves higher or lower profits is of interest to bondholders only if insolvency is imminent.

Nevertheless, bond prices often also fluctuate with published business figures or rumours. Thus, cool-headed investors often find good investment opportunities in the interest rate market.

Which investment offers which return opportunity?

In the above examples, there is much talk about bonds. This is because almost every interest rate investment is based on bonds. After all, money deposited by investors in savings accounts at a bank or invested as fixed-term deposits is mainly invested in bonds by the banks. However, some of it is also invested in other asset classes that promise higher returns. The difference between the interest the bank pays investors and the earnings the bank makes on the capital market with the investors’ money goes to the bank as profit. For savers, it is therefore not uninteresting to know which investment classes there are and how much return they can offer.

The following investment classes can be distinguished:
  • Bank deposits such as cash, savings accounts, and time deposits
  • Real estate
  • Commodities
  • Fixed-income securities such as government bonds, mortgage bonds, and corporate bonds,
  • Stocks.
  • Investors have been able to achieve the following average returns with these asset classes over the past 30 years:
    • Bank deposits such as cash, savings accounts and time deposits: 0-3%
    • Real estate: 3-5fi%
    • Commodities: 1-3 %
    • Fixed-income securities such as government bonds, mortgage bonds and corporate bonds: 0-7 %
    • Stocks 7-10 %
    • Note: These returns must be seen against the background of falling interest rates over the past 30 years. Whereas savings accounts still paid up to 4% interest in the early nineties, today, these have fallen to as low as 0%. Whether and to what extent interest rates will rise again in the coming years is highly uncertain. Therefore, the following applies in principle: Investors should spread their risk and never put all their eggs in one basket when investing. The same is true for the asset class of bonds. But the rule also holds for a combination with other asset classes, such as equities, real estate, and commodities.

Stocks offer the highest returns.

The highest returns can be achieved with stock investments or dynamic investment strategies. In the short term, greater price fluctuations are possible than with other asset classes. In the long term, the pattern is different. For example, the longest period of losses for the DAX in the past 30 years was seven years, from 2001 to 2007. Investors who had invested in the DAX immediately before the dot.com bubble burst in March 2000 would have been back in the profit zone after six years. Mind you: this is just the worst-case scenario. At the same time, in the past 30 years, all other entry points than shortly before the crash in 2000 have led to significantly shorter loss phases or directly to profits. We are talking about gains of about 7-10% per year, depending on the calculation method.

Combining equities and bonds: The Genève Invest concept

Investors can manage their investment risk relatively well with a combination of equities and bonds. Bonds with a high credit rating can then be used as a stabiliser, while equities provide the return. If the principle of value investing – i.e., the search for undervalued equities and bonds – is followed for both asset classes, solid returns can be achieved sustainably. The Global Income – Interest & Dividend mixed fund (ISIN: LU0388926494) has regularly proven this in recent years. The mixed fund has achieved an average increase in value of more than ten per cent per annum since its launch in 2012.

“The highest returns can be achieved with stock investments”

Rented properties offer a steady capital flow

Comparatively high returns can also be achieved with rented real estate. Different rules apply here than with shares or bonds. Perhaps the most crucial difference is that, as the name suggests, property cannot be bought or sold quickly. The money invested is tied up and not readily available. Another major difference to shares or bonds is that the current value of a property can only be estimated. Buyers and sellers only find out how much a property is worth on the day the contract is signed.

Gold is considered insurance against major crises

When we talk about commodities as an investment, we are referring specifically to gold. All other types of investments in commodities are usually either hedging transactions or speculation. Such investments are not worthwhile for private investors. Gold is no long-term investment but a kind of insurance against crises. Gold pays no interest and no dividends. On the contrary, storing gold costs money.

The Genève Invest concept: performance and security

Below we briefly present our investment concept for stocks and bonds:
Value investing + megatrend focus in promising quality stocks
Higher-yielding corporate bonds with the best risk/return ratio
Value investing approach (according to Munger) + megatrends: companies with long-term and overlapping transformation processes, which concern social and technological changes
Systematic focus on niche themes and special events
Growing markets, such as technology, health, digitalization, and online consumption
A continuous and foreseeable flow of income
Firms need to be active in growing markets and have a technological advantage over their competitors
Legal protection for bondholders: focus on institutional and secured senior bonds
Proven (audited) strong performance results
Predictability & transparent communication with the corporate management
Searching for permanent competitive advantages and moat (protective wall)
Less fluctuation in value than shares and benefits of effective diversification
Focus on companies that achieve high margins and a high return on total capital
Fixed high-interest coupons & reduction of yield curve risk
Anti-cyclical actions
Additional income by exploiting the yield curve effect

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