How To Generate Portfolio Return Of 8% Consistently
Investors can generate portfolio return of 8% consistently from a leverage bond portfolio.
After Mr Trump was elected as the new President of United States, US 10 year yield shot up to 2.55%.
There are various opinions if this rally in bond yield will continue:
Goldman forecasts US Fed to hike interest rate 4 times:
www.cnbc.com/2016/11/30/goldman-forecast-trump-rally-to-spike-then-fade-as-fed-hikes-4-times.html
Stanchart calls to buy bonds:
myasiaprivatebank.blogspot.sg/2016/12/bond-market-offers-good-opportunity.html?m=1
But we have seen that Fed tends to raise interest rate hike expectation and then underperformed:
myasiaprivatebank.blogspot.sg/2016/12/track-record-of-fomcs-projections.html?m=1
As an investor, the conservative approach is to assume worst case scenario and reviews if the portfolio can manage that risk.
Some investors like to buy maturity of bonds at 5 years or less. This may not be a good strategy when you are drawing loans to buy bonds. Yield to maturity of such bonds rated investment grade is only 3%+. If US interest rate is raised aggressively next few years, the loan interest may end up higher than yield of the bonds.
In the example of a leverage bond portfolio below, there are various ways to manage interest rate risk:
- Bonds with shorter duration will be lesser sensitive to interest rate hike. In the portfolio below, all the 3 bonds have duration of less than 7.5 years.
- Bonds with investment grade rating are less vulnerable to default risk. All the 3 bonds are rated investment grade.
- Advance margin of the bonds are 75%. But only 60% loan is used. This means that the portfolio will be at risk of margin call only if the portfolio value drops by 15%.
- At private banks, the current borrowing rate of USD is 1.70%. But interest rate of 2.50% is used for the calculation. This means that this loan interest had factored in 3 interest rate hikes.
Leverage yield of the portfolio is 8.97%:
- Capital outlay is USD227,675. Annual net coupon received is USD20,429. Hence leverage yield is 8.97%.
- This means investor will be getting the yield of high yield bonds without taking additional credit risk.
- This is an equity-like return. Very few equity investors can consistently achieve 8% return on a yearly basis.
- You just need 9 years of 8% return to double your money.
- This portfolio is definitely not risk free despite all the rationale above but risk reward ratio looks favourable.
To further reduce interest rate risk, investors can switch USD loan to Euro loan when FX rate is more favourable.
After Mr Trump was elected as the new President of United States, US 10 year yield shot up to 2.55%.
There are various opinions if this rally in bond yield will continue:
Goldman forecasts US Fed to hike interest rate 4 times:
www.cnbc.com/2016/11/30/goldman-forecast-trump-rally-to-spike-then-fade-as-fed-hikes-4-times.html
Stanchart calls to buy bonds:
myasiaprivatebank.blogspot.sg/2016/12/bond-market-offers-good-opportunity.html?m=1
But we have seen that Fed tends to raise interest rate hike expectation and then underperformed:
myasiaprivatebank.blogspot.sg/2016/12/track-record-of-fomcs-projections.html?m=1
As an investor, the conservative approach is to assume worst case scenario and reviews if the portfolio can manage that risk.
Some investors like to buy maturity of bonds at 5 years or less. This may not be a good strategy when you are drawing loans to buy bonds. Yield to maturity of such bonds rated investment grade is only 3%+. If US interest rate is raised aggressively next few years, the loan interest may end up higher than yield of the bonds.
In the example of a leverage bond portfolio below, there are various ways to manage interest rate risk:
- Bonds with shorter duration will be lesser sensitive to interest rate hike. In the portfolio below, all the 3 bonds have duration of less than 7.5 years.
- Bonds with investment grade rating are less vulnerable to default risk. All the 3 bonds are rated investment grade.
- Advance margin of the bonds are 75%. But only 60% loan is used. This means that the portfolio will be at risk of margin call only if the portfolio value drops by 15%.
- At private banks, the current borrowing rate of USD is 1.70%. But interest rate of 2.50% is used for the calculation. This means that this loan interest had factored in 3 interest rate hikes.
Leverage yield of the portfolio is 8.97%:
- Capital outlay is USD227,675. Annual net coupon received is USD20,429. Hence leverage yield is 8.97%.
- This means investor will be getting the yield of high yield bonds without taking additional credit risk.
- This is an equity-like return. Very few equity investors can consistently achieve 8% return on a yearly basis.
- You just need 9 years of 8% return to double your money.
- This portfolio is definitely not risk free despite all the rationale above but risk reward ratio looks favourable.
To further reduce interest rate risk, investors can switch USD loan to Euro loan when FX rate is more favourable.
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