November 26th, 2013
After a 33-year bond bull market, many investors believe that bonds remain the safe place to invest. Interest rates dropped over this time period and the value of bonds increased. As we have witnessed over the past six months, the reverse can happen as well. Not all bonds are the same. As interest rates rise, bonds with longer maturities and lower coupons are more adversely affected. This is known as interest rate sensitivity or interest rate risk.
The bond market has taken a step back over the past six months as evidenced by the results of the Barclays U.S. Aggregate Index, one of the most widely followed bond indices. The index is down 1.69% for the year as of November 20, 2013. How can this be if bonds are the “safe” investment?
A great example of declining bond value despite a healthy balance sheet is Apple. On April 30th Apple issued $17 billion of bonds, the largest non-bank corporate bond deal at the time. A benchmark issue in the offering was a 30-year maturity with a coupon of 3.85%. To many investors, these bonds were very appealing considering the company had more than 8.5 times the issuance amount in cash on its balance sheet. However, since the offering date, the bonds have lost significant value. Apple seems to be doing well as a company, so what led to the decline in value? The answer is interest rate risk, as rates have risen since the bonds were issued. Please click here to view an article by Golub Capital* for more details on what happened with Apple and some other major companies that issued debt in the spring of 2013.
In the current financial environment investors should think critically about fixed income securities. Traditional bond investment strategies may no longer be the answer. We recommend considering bonds with shorter maturities, higher coupons, and coupons that float in conjunction with the movement in interest rates to better protect against interest rate risk.
For more information, please contact Scott Craig or call 770.790.3721.
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