How savers find a solid investment with high returns
- 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
The constant tradeoff between risk and return
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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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.
Combining equities and bonds: The Genève Invest concept
“The highest returns can be achieved with stock investments”
Rented properties offer a steady capital flow
Gold is considered insurance against major crises
The Genève Invest concept: performance and security
Value investing + megatrend focus in promising quality stocks | Higher-yielding corporate bonds with the best risk/return ratio |
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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 |
