We track 22 different types of bonds here at DSWP plus several models made up of combinations of bonds.

Recently, a new client asked me ‘What is the best type of bond to own?’ I responded that although there are all kinds of bonds from treasury to junk, it’s good to keep an understanding of what a bond actually is. And, what it actually is…is a loan. The issuer of the bond enters into a loan agreement with the buyer of the bond. The most basic parts of the agreement are the term (length) of the loan and the percent of interest that will be earned by the lender.

So, now that we are reminded that all bonds are debt instruments in which you, the investor, lend money to some government entity, company, etc. let’s take a quick look at some of the underlying mechanics of the deal: the borrowing entity pays interest to you, usually yearly or quarterly, and then sometime in the future, will typically refund the actual purchase price of the bond. In this way, all bonds are similar. However, bonds vary greatly in what they do – and what they do can be greatly influenced by the economic environment existing within the life of the loan – a.k.a. the term of the bond. Some fare better in a higher inflationary environment and others fare better in a deflationary environment.

At this point our client leaned forward and then she narrowed the question: ‘Say over the past 5 years, what type of bond would have returned the most ‘total return’?  OK, that’s a good question.

I ran some numbers and came up with an answer, which was: ‘Over the past 5 years the best type of bond to own for total return would have been a convertible bond.’

So, let’s talk about convertible bonds. This will get a teensy bit technical, but stay with me.

First, a definition: a convertible bond is a bond issued by an entity, such as a company, that (unlike a regular bond) gives the bondholder the option to trade in the bond for shares of stock in the company that issued the bond. This gives the bondholder a fixed-income investment with interest payments plus the possibility to gain from an increase in the company’s stock price. (If this goes well it could be the best of both worlds!)

A convertible bond will list the interest rate and the maturity date on the bond when it is issued. It will also list the conversion option information. In other words the number of shares one would receive if it is converted.

Here’s an example to see how that can work. Let’s consider a bond that; a) sells for $1,000, b) has an annual interest rate of 5% and, c) can be converted into 100 shares at any time. Each year the bondholder receives $50 ($1000 x 5%) as long as the bond has not been converted to shares.  If the bondholder converts to shares, he will no longer receive the interest payment and the value of the investment moves with the price of the company’s stock.

If we look at the number of shares that will be received on conversion and the price paid for the bond, we can calculate the share purchase price.

In my example, the effective price the bondholder pays for the shares would be the price paid divided by the number of shares he could receive i.e. $10 per share ($1000/100 = $10). The investor will only convert the bond into shares if the current share price is higher than the effective share price when he bought the bond.

Now suppose the share value rises to $20. He would convert the bond to 100 shares at the then-current value of $20 or a total of $2,000 for a $1,000 gain. On the other hand, if the share price dropped to $5, he would not convert as the 100 shares of stock he would get would have a market value of $500. He would continue holding the bond and collecting the yearly $50 (and probably hope to see the share price of the company stock go higher).

One of our very useful tools here at DSWP is our fact data sheet from Dorsey-Wright Corp, it helps keep track of the performance of bond returns. Using it I can quickly look up, for example, that a Barclay’s Convertible bond held for the past 5 years would have returned 11.63% annually on average.

Other bonds fare better in other environments, but that convertible had a pretty decent return over the past 5 years.

 

Market Minute 6/9/2017 – Surprise in the UK and possible surprise from Financials and Smallcaps in the USA

Much to the surprise of most of us, the Conservative party didn’t fare very well in the British election. Nevertheless, today’s markets are showing the British market is UP and looking healthy and the Eurozone is also up and looking good. Perhaps it’s just that markets don’t like indecision. Now we know who won, and markets seem to approve, at least at the moment. 

On our side of the Atlantic, this week has shown that smallcaps and financials are appearing to push through their overhead resistance. (Resistance is a price level of a stock or bond or index that seems to act as a ceiling. Prices typically bounce up against that ceiling and then back down again.) Often, once a price breaks through the overhead resistance it means that price levels will continue on their way up. This is a positive technical indicator and positive news for US markets as it may indicate that higher prices are on their way. Hurray for now!

 

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk
www.denkinvest.com
10000 N. 31st Avenue, Suite C-262
Phoenix, AZ 85051

This weekly article reflects news, commentary, opinions, viewpoints, analyses and other information developed by Denk Strategic Wealth Partners and/or select but unaffiliated third parties. DSWP provides Market Information for illustrative and informational purposes only. If you wish to receive this weekly commentary by email please contact us at 602-252-8700 or by e-mail at info@denkinvest.com.

Ronald Denk is an Advisory Representative offering services through Denk Strategic Wealth Partners, A Registered Investment Advisor. He is also a Registered Representative, offering investments through Lincoln Financial Securities Corporation, Member FINRA/SIPC.

Denk Strategic Wealth Partners is not affiliated with Lincoln Financial Securities Corporation. Information in this commentary is the sole opinion of Denk Strategic Wealth Partners. Past performance is no guarantee of future returns. All market related investments involve various types of risk, which include but are not restricted to, credit risk, interest rate risk, volatility, going concern risk, and market risk.

The Update provides information of a general nature regarding legislative or other developments. None of the information contained herein is intended as legal advice or opinions relative to specific matters, facts, situations or issues. Additional facts, information or future developments may affect the subjects addressed in this document. You should consult with an attorney, accountant or DSWP planner about your particular circumstances before acting on any of this information because it may not be applicable to your situation.

Lincoln Financial Securities and Denk Strategic Wealth Partners and their representatives do not offer tax advice. Please see your tax professional regarding your individual needs.

*The indices are representative of domestic markets and include the average performance of groups of widely held common stocks. Individuals cannot invest directly in any index and unlike investments, indices do not incur management fees, charges, or expenses, therefore specific index returns will be higher. Past performance is not indicative of future results.

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