On May 17, BondSavvy founder Steve Shaw sat down with Richard Carter of Fidelity Investments for an exclusive webinar: "The case for a more active approach
to bond investing". Fidelity recently posted a recording of the webinar online that can be viewed.
Many investors believe the best way to invest in bonds is to build a bond ladder and then hold bonds to maturity. The problem with this approach is that, during the life of a bond, its price can often move significantly -- sometimes 30 points for longer-dated bonds. The below chart shows price movements of the HP Inc. 6% '41 bond:
Price Performance of HP Inc. 6% 9/15/41 Bond
An investor who bought this HP Inc. bond in February 2016 would have achieved 31.5 points of capital appreciation over the following 20 months. At that point, his annualized rate of return (including interest earned and capital appreciation) would have been 29%. This is a much stronger return than the 8% yield to maturity the investor would have received if he held the bond until maturity. We therefore advocate selling bonds that have achieved a significant amount of capital appreciation to maximize returns.
Why Is This Important?
Bond prices and stock prices behave differently. If you buy a stock at $25, it can increase without an upper limit. You can just keep holding it, and your annualized return can increase. Bonds, on the other hand, generally have price ceilings and floors as shown in the below chart, which shows a distribution of bond prices from a recent investment-grade corporate bond search.
* Corporate bond search conducted on Fidelity.com on March 29, 2018. Bonds are quoted as a percentage of their face value.
The largest portion of bonds, 35%, is priced between par and 109.99. There is then a fairly even split of bonds above and below these levels. Only a very small portion of bonds ever trade above 125, and as a bond's price increases, the chances it keeps increasing are generally low. The ceiling on corporate bond prices, in this example, is just above 150**.
This is why it is so important to monitor the performance of bonds in your portfolio, as locking in capital appreciation is a big part of maximizing investment returns. Bond prices can go down as easily as they go up, and holding a bond too long after it has risen materially in price is a mistake investors should avoid. This is especially true for lower-yielding corporate bonds, which can make it difficult to 'out-yield' a fall in a bond's price.
** The face value of a bond is $1,000. Since bonds are quoted as a percentage of face value, a bond quoted at 150 is worth $1,500.