Income investors: Time to lock in attractive bond yields for longer

In the US, two-year Treasury bond yields are trading around 4.0 – 4.5 percent, while 10-year Treasuries are around 3.5 – 4.0 percent.

Although bond yields are at multi-year highs, such lucrative yields may not last as the global tightening cycle approaches its end.

With further evidence of US inflation moderating, markets now believe that the US Federal Reserve (Fed) is likely to hike rates just once more in May before stopping.

A number of central banks in Asia have also paused on monetary policy tightening amid higher risks to global growth. In a surprise pivot, the Monetary Authority of Singapore (MAS) left its monetary policy unchanged after tightening it five times since October 2021 to combat rising inflation.

At the moment, a rate cut in 2023 is not the Fed’s base case.

That said, some analysts think the Fed will start cutting rates this year in the event of a deeper-than-expected recession. Recent data show US employment growth, retail sales and manufacturing production declining in March, suggesting that the economy is losing steam.

In addition, markets tend to move before policy changes, and bond yields are already starting to ease ahead of rate cuts. While still at attractive levels, US and Singapore bond yields have been trending down since February.

Against this backdrop, bond funds offer the opportunity to lock in today’s yields and reduce reinvestment risk. This is the risk that when their existing bonds mature, investors will receive a lower income from their subsequent bond investments due to a future drop in interest rates.

Given fears of an economic slowdown, bond funds can also act as a recession hedge by serving as a safe haven while still providing income.

In particular, investment-grade (IG) bond funds offer compelling risk-reward opportunities for investors by providing yield levels that would only have been possible previously by investing in riskier bonds. IG bonds receive higher ratings by credit rating agencies (BBB and above) and are seen to have a lower risk of default.

Here is the weighted long term average default rate for various bond ratings:

For conservative investors or those with a shorter investment horizon, the United SGD Money Market Fund and the United SGD Fund sit on the lower end of the risk-return spectrum.

Both funds invest primarily in high-quality, short-term securities issued by governments and companies with robust credit ratings. They also have short durations, which make them less sensitive to changes in interest rates. This means they tend to offer more stable returns compared to longer duration bond funds.

In terms of yields, the United SGD Money Market Fund and the United SGD Fund offer a weighted average yield to maturity (YTM) of 3.45 percent and 4.64 percent respectively, as of 31 March 2023. This is the weighted average YTM of all the bonds in a fund’s portfolio.

YTM is the annualised return that a bond would generate if held to maturity, assuming interest payments are re-invested. Note that a fund’s holdings can change and therefore, so can the YTM.

Here is what else to consider when evaluating the two bond funds.

As of 31 Mar 2023

·       Effective duration: 0.10 years

·       Credit rating: AAA

·       Weighted average YTM: 3.45 percent

Fund highlights:

·       Low risk: Invests mainly in Singapore Treasury bills (T-bills) and MAS bills to provide stable returns and capital preservation. During periods of volatility triggered by COVID-19 and the uncertain interest rate environment, the Fund experienced zero drawdowns.

Source: Morningstar, as at 31 March 2023, SGD terms. Performance is based on United SGD Money Market Fund Class Z SGD portfolio, on a NAV basis, with dividends reinvested if any.

Source: Morningstar, as at 31 March 2023. Performance is net of fees and is based on oldest share class, United SGD Money Market Fund Class Z SGD portfolio in SGD basis, on a Net Asset Value (NAV) basis, with dividends reinvested, if any.

·       No lock-up: The liquid and short duration nature of the Fund means investment proceeds can be quickly withdrawn and received within one business day.

·       Earn while you wait: The Fund is also ideal for investors who want to park their cash to wait for investment opportunities, but still earn some returns in the meantime.

As of 31 Mar 2023

·       Effective duration: 1.14 years

·       Credit rating: BBB+

·       Weighted average YTM: 4.64 percent

Fund highlights:

·       Stability: Holds high-quality, short-term investment grade bonds to preserve capital, and buffers against market instability with lower drawdowns compared to peer asset classes during market volatility.

·       Long-term track record: The United SGD Fund has delivered positive calendar returns for 22 out of 24 years since the fund was incepted in 1998.

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