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We associate the term ‘bond’ with mutual connection, whether the subject is chemistry (between atoms, ions, or molecules), personal relationships (between human beings), or finance (between borrowers and lenders). The latter is often thought to be difficult to understand and shrouded in complex mathematics. Actually, bonds can be quite a straightforward concept.
The world of investing can feel a daunting place. Industry jargon dominates the financial media and is riddled with acronyms and discussions around the outputs of complex models. These details need not concern the vast majority of investors, however. In fact most investors, both professional and amateur, would do better to ignore such musings. A basic grasp on some of the mechanisms of capital markets will generally suffice to enjoy a successful investing journey.
Investing is simple, but not easy. The decision to invest in the first place requires foresight, as well as the discipline to deny oneself spending today so that you don’t have to eat own-brand baked beans out of the tin in retirement. The second is deciding how much you want, need and are able to invest in equities, which will act as the drivers of positive portfolio returns, above inflation, that will help fund future spending goals. Getting this right is key and where good advisers can add value. Next an investor needs to decide the broad structure of their equity and bond components of their portfolio. A good place to start for equities is the structure of the global markets, which defines the basic country, sector and company weights and offers broad diversification. As Eugene Fama, who won the Nobel Memorial Prize in Economic Sciences, said in a recent webinar:
Modern society loves a ‘star rating’. Most know what to expect if they book a 5-star hotel stay for a business trip when compared to a 3-star bed-and-breakfast for a weekend away. The investment field is no different, with many institutions offering their own spin on star ratings and how to calculate them. Unlike the hotel industry, many of the rating systems that assess the funds used by investors are best ignored. In this short note, we investigate why.
If you have ever been fortunate enough to swim in the azure tropical waters of the Caribbean, or on Bondi Beach amongst the surfers, or in the chilly waters of Cape May (where the film ‘Jaws’ that scared the 1970s generation out of the water was filmed) in the back of your mind may have lurked the thought that a large shark might just be out there looking for lunch. What was that shadow? Yet most of us don’t think twice about the risks of sitting under a coconut tree, which urban myth suggests is far more likely to kill you from a falling coconut than a shark attack, as is the malaria-carrying mosquito that lands on bare flesh as the sun sets in paradise. Nor did we consider the risk of a deep vein thrombosis from the long-haul flight to get there. We fixate on the shark.
Leverage, often referred to in investing as a ‘double-edged sword’, is another word for borrowing money to own more of an asset. Much like a mortgage on a house, it enables individuals to own a higher value of an asset they would otherwise be unable to own, but it does run the risk that the value falls such that one ends up owing more than one owns (coined ‘negative equity’ in the housing world). This is never a good place to be.
Students have always been at the centre of activism around the important issues of the time, from the ‘Mai 68’ student riots in Paris, via the pressure put on Barclays and others to divest from apartheid-riven South Africa in the 1980s, to today’s Black Lives Matter movement and the existential threat of climate change. Their enthusiasm and conviction can often act as a powerful catalyst for change. Sometimes, however, a certain naivety accompanies their solutions. Complex problems rarely have simple, binary choices.
As an investor one is always learning. Our perception of investing is guided by our experiences: those old enough to have been investing in the 1970s will retain uncomfortable memories of rampant inflation and the impact that had on cash, bonds, and the general travails of life when prices spiral upwards. Others who lived through the birth of the internet and the boom and subsequent bust of the ‘dot.com’ era of the late 1990s and early 2000s, may also be living through a sense of déjà vu. For most investors, interest rates have been on a steady long-term decline making mortgages cheaper and supporting bond and equity prices. In the past twelve months, we have been reminded of some useful lessons that can – hopefully – make us all better investors.
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