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In this part, I evaluate bonds to add to the investment portfolio. This is a large investment universe. Just like equities: not only is it important to understand time horizon, investment objective and risk appetite but it is also important to assess the current stage of the interest rate cycle, the economic cycle and the impact it could have on the issuer or the price of the bond.
Specifically, I am looking to add Govt bonds in an attempt to hedge the volatility of the equity markets and earn a regular income (coupons).
With peak inflation likely behind us in 2022, there has been substantial interest in bond buying. After nearly a decade of low interest rates, insurance companies and pension funds have the opportunity to buy bonds at relatively higher yields and unwind their exposure to equities.
Among the Govt issued bonds, I am considering at the US, UK, Italy and India.
As a first step, the inflation trends in these countries:
Inflation in India is in a range between 5.5 and 7%.
In Italy and U.K, inflation has risen since 2021 and may have peaked in 2022.
While in the US, it looks more certain that inflation has peaked in 2022.
Solely from this perspective, US and India are likely to be the better choices.
Next, I look at recent (2022) Govt. revenues and spending information:
(1 USD = 82.5 INR, 1 GBP = 1.2 USD, 1 EUR = 1.05 USD)
Amounts in US$ Bn
India: Revenues: 267.2 Spending 387.23 Deficit (120.03)
Italy: Revenues 963.9 Spending 1071 Deficit (107.10)
U.K: Revenues 1129.2 Spending 1260 Deficit (130.80)
U.S: Revenues 4900 Spending 6270 Deficit (1370)
Next, the GDP of the country, its debt and its credit rating:
Amounts in US$ Bn
India: GDP 3310.03 Debt 1888.12 S&P Rating BBB-
Italy: GDP 2702.70 Debt 2994.56 S&P Rating BBB
U.K: GDP 3910.8 Debt 2988.00 S&P Rating AA
U.S: GDP 25020.00 Debt 30930.00 S&P Rating AA+
Next, the yield curve in these countries
We are probably not at the end of the interest rate hiking cycle in the US, nor EU. Bond markets are pricing in more hikes this year than previously estimated.
Given this scenario, I would prefer a 1-3 year horizon. This is expected to reduce the volatility in prices due to negative economic or rate shocks.
I would avoid Emerging Markets, since a 5% yield for a one year US Treasury is more attractive than a 7.2% for a one year Indian Govt debt.
I am going to avoid US Treasuries at this point since the Govt has 3 months to resolve the debt ceiling limit problem and avoid default. I am looking to reduce volatility in my portfolio and this does not help.
Between Italy and UK, I would prefer UK Bonds at this time and re-look at Italy at a later point. This will also provide some diversification in the investment portfolio from a currency exposure perspective.
In the next post, I evaluate the investment portfolio at the end of these six parts and Automotive Stocks as I look to add them to the portfolio.
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