10/15/23, 1:51 PM MoneyWeek - 2023-10-13

16 Investment strategy
Simple but not easy
Bond yields are starting tolook a little UK ten-year government bond yield
Guru watch
Aswath
Damodaran,
professor of
finance,
more interesting, but volatile rates Yield to maturity (%)
17.5
New York
University
imply there’s littlemargin for error 15 “Ultimately,
12.5 technology doesn’t
Cris Sholto Heaton 10 make our lives more
Investment columnist Average = 7% economical… but just
7.5 delivers things in different
5 packages,” says Aswath
Investing in conventional bonds is simple in Damodaran, professor of

theory. You’ll get a fixed-interest payment at
regular intervals and a fixed amount of principal
on maturity. The key risks are that the borrower
doesn’t pay what they owe or inflation erodes the
value of what you get by more than you expect.
In our MoneyWeek exchange-traded fund
(ETF) portfolio, we normally hold only high-
grade government bonds, effectively eliminating
the credit risk. We don’t think that corporate
bonds bring much to the kind of strategy we are
following. If they became exceptionally cheap,
we could invest opportunistically, but right now
the extra yield you get for taking extra risk in
corporate bonds remains remarkably low.
So the risk we care about is whether yields are
enough to compensate for likely inflation. Until
recently, the answer was clearly no, but rates have
risen in the past year and UK and US ten-year
yields are back to 4.4% and 4.6% respectively.
If inflation is set to drop back to the same level
we saw for the past decade (less than2%),
government bonds would now be attractive.
Still, it’s worth noting that these yields are not
back to their average over the last 60 years (which
we can view as representing the modern financial
era). The 2010s really look like an anomaly on
the chart above. One doesn’t have to believe that
inflation and yields will get back to 1970s levels to
feel that we may be only at the lower end of likely
yields for the next decade.
A shifting yield curve
Of course, there are complications. Our simple
scenario applies when you buy a bond and hold
it to maturity. If interest rates change along the
I wish I knew what a bond yield was,
gro.defsiuolts.derf :ecruoS
2.5 finance at the Stern School o
0 Business at New York
University, who is regarded
1960 1970 1980 1990 2000 2010 2020 as one of the leading experts
in valuing investments. It’s
way, that will affect the market value of the bond. important to remember that
That doesn’t affect what you get at the end, but if when assessing claims that a
you want to sell the bond before maturity, your hot new technology will
return could be very different to the prospective revolutionise the world, he
yield to maturity (see below) at which you bought. tells Bloomberg. “The histor
Changes in interest-rate expectations will affect of technology seems to be
bonds of different maturities and coupons in displacing the status quo wit
different ways (broadly, longer-dated bonds are what they claim is a cheaper
more sensitive, as we’ll discuss next week). alternative. But then over
time, that cheaper alternative
If you are investing in certain bond funds, it gets more and more
could get even trickier. Assume you own an ETF expensive and ends up
that holds bonds with a remaining maturity of becoming more expensive
between five and ten years. Longer-term bonds than the status quo.”
will enter the portfolio as their maturity drops Disruptors may up-end an
to ten years; they will leave it as they drop to five industry, but this doesn’t
years. Say that market expectations for rates always benefit consumers.
change: traders now expect rates to be higher than Take video streaming:
previously forecast in five years and lower in ten services such as Netflix and
Disney+ originally promised
years. That means the ETF will be buying ten-year cheaper alternatives to
bonds that have recently risen in price (because traditional media sources, bu
ten-yield yields are now expected to be lower and “when you look at what
so existing bonds on higher yields are worth a bit you’re spending across your
more) and selling five-year bonds that have recently different streaming
fallen (the opposite). Over several years, it may platforms, you’re already
make cumulative capital gains or losses by doing spending more than you
this – or the effect may simply wash out. used to for that old cable
So you can see how an era of volatile rates network”. However, that
doesn’t mean that investors
could be very different to the past 40 years of benefit either, since these
steadily declining yields. Next week, we’ll look new business models may
at some bond ETFs and how these factors would earn less attractive returns fo
affect our choice if we feel it’s time to buy. companies than the ones tha
they replaced.
correct measure of the total
return you can expect if you
Consider the hype around
artificial intelligence (AI), he


but I’m too embarrassed to ask
A bond yield is a measure of the
return that an investor will
receive on their capital. There
are several different ways in
which bond yields can be
defined, depending on what
you are trying to measure.
The nominal yield (also
called the coupon rate or
coupon yield) is the annual
interest rate set when the bond
is issued. For most coventional
bonds, this does not change
(floating-rate bonds, where the
interest resets periodically to
reflect some reference rate, are
an exception). Unless you are
buying the bond at face value
(eg, when it’s first issued),
nominal yield doesn’t reflect
any return you receive. But it
13 October 2023
can tell you something about
the properties of the bond and
how it may behave in different
market conditions.
The current yield (also known
as running yield, income yield
and market yield) is the annual
interest divided by the current
market price. This tells you the
regular income you will receive
if you purchase at this price.
However, this is not the same as
the total return you’ll make over
the life of the bond.
The yield to maturity (also
referred to as the redemption
yield) is the bond’s annual rate
of return if an investor holds it
until it matures. It takes account
of all interest payments and the
principal. This makes it the
don’t sell before maturity.
To see how these fit
tells Forbes India. AI will
create some winners, but
 will be
history suggests there
together, consider a bond
with a face value of £100 that relatively few of them: only a
was issued with a 5% interest handful of firms such as
rate (the nominal yield) and Amazon, Google and Cisco
matures in two years. It now have been long-term
trades at £95, meaning that successes from the dotcom
its current yield is 5.26% (£5 / boom, with many others
£95). An investor who holds fading away. Now everybody
to maturity gets £5 in interest wants to be on the AI
each year and principal of bandwagon and they’ll spen
£100. That’s a total of £110, a lot of money on AI tools,
giving an annualised return consultants and advisors,
of 7.61% on £95 invested now with little to show for it. “I
(the yield to maturity). don’t see how this is going to
Alternatively, assume that make a retail business or a
the same bond was trading at grocery business more
£105. It would still have a profitable,” even though the
nominal yield of 5%, but its management of US grocery
current yield would be 4.76% chain Kroger talked about AI
and its yield to maturity eight times during their last
would be just 2.35%. earnings presentation.
moneyweek.c

https://www.yumpu.com/news/en/issue/166066-moneyweek-2023-10-13/read?page=17 1/2
10/15/23, 1:51 PM MoneyWeek - 2023-10-13

16 Investment strategy
Simple but not easy
Bond yields are starting tolook a little UK ten-year government bond yield
Guru watch
Aswath
Damodaran,
professor of
finance,
more interesting, but volatile rates Yield to maturity (%)
17.5
New York
University
imply there’s littlemargin for error 15 “Ultimately,
12.5 technology doesn’t
Cris Sholto Heaton 10 make our lives more
Investment columnist Average = 7% economical… but just
7.5 delivers things in different
5 packages,” says Aswath
Investing in conventional bonds is simple in Damodaran, professor of

theory. You’ll get a fixed-interest payment at
regular intervals and a fixed amount of principal
on maturity. The key risks are that the borrower
doesn’t pay what they owe or inflation erodes the
value of what you get by more than you expect.
In our MoneyWeek exchange-traded fund
(ETF) portfolio, we normally hold only high-
grade government bonds, effectively eliminating
the credit risk. We don’t think that corporate
bonds bring much to the kind of strategy we are
following. If they became exceptionally cheap,
we could invest opportunistically, but right now
the extra yield you get for taking extra risk in
corporate bonds remains remarkably low.
So the risk we care about is whether yields are
enough to compensate for likely inflation. Until
recently, the answer was clearly no, but rates have
risen in the past year and UK and US ten-year
yields are back to 4.4% and 4.6% respectively.
If inflation is set to drop back to the same level
we saw for the past decade (less than2%),
government bonds would now be attractive.
Still, it’s worth noting that these yields are not
back to their average over the last 60 years (which
we can view as representing the modern financial
era). The 2010s really look like an anomaly on
the chart above. One doesn’t have to believe that
inflation and yields will get back to 1970s levels to
feel that we may be only at the lower end of likely
yields for the next decade.
A shifting yield curve
Of course, there are complications. Our simple
scenario applies when you buy a bond and hold
it to maturity. If interest rates change along the
I wish I knew what a bond yield was,
gro.defsiuolts.derf :ecruoS
2.5 finance at the Stern School o
0 Business at New York
University, who is regarded
1960 1970 1980 1990 2000 2010 2020 as one of the leading experts
in valuing investments. It’s
way, that will affect the market value of the bond. important to remember that
That doesn’t affect what you get at the end, but if when assessing claims that a
you want to sell the bond before maturity, your hot new technology will
return could be very different to the prospective revolutionise the world, he
yield to maturity (see below) at which you bought. tells Bloomberg. “The histor
Changes in interest-rate expectations will affect of technology seems to be
bonds of different maturities and coupons in displacing the status quo wit
different ways (broadly, longer-dated bonds are what they claim is a cheaper
more sensitive, as we’ll discuss next week). alternative. But then over
time, that cheaper alternative
If you are investing in certain bond funds, it gets more and more
could get even trickier. Assume you own an ETF expensive and ends up
that holds bonds with a remaining maturity of becoming more expensive
between five and ten years. Longer-term bonds than the status quo.”
will enter the portfolio as their maturity drops Disruptors may up-end an
to ten years; they will leave it as they drop to five industry, but this doesn’t
years. Say that market expectations for rates always benefit consumers.
change: traders now expect rates to be higher than Take video streaming:
previously forecast in five years and lower in ten services such as Netflix and
Disney+ originally promised
years. That means the ETF will be buying ten-year cheaper alternatives to
bonds that have recently risen in price (because traditional media sources, bu
ten-yield yields are now expected to be lower and “when you look at what
so existing bonds on higher yields are worth a bit you’re spending across your
more) and selling five-year bonds that have recently different streaming
fallen (the opposite). Over several years, it may platforms, you’re already
make cumulative capital gains or losses by doing spending more than you
this – or the effect may simply wash out. used to for that old cable
So you can see how an era of volatile rates network”. However, that
doesn’t mean that investors
could be very different to the past 40 years of benefit either, since these
steadily declining yields. Next week, we’ll look new business models may
at some bond ETFs and how these factors would earn less attractive returns fo
affect our choice if we feel it’s time to buy. companies than the ones tha
they replaced.
correct measure of the total
return you can expect if you
Consider the hype around
artificial intelligence (AI), he


but I’m too embarrassed to ask
A bond yield is a measure of the
return that an investor will
receive on their capital. There
are several different ways in
which bond yields can be
defined, depending on what
you are trying to measure.
The nominal yield (also
called the coupon rate or
coupon yield) is the annual
interest rate set when the bond
is issued. For most coventional
bonds, this does not change
(floating-rate bonds, where the
interest resets periodically to
reflect some reference rate, are
an exception). Unless you are
buying the bond at face value
(eg, when it’s first issued),
nominal yield doesn’t reflect
any return you receive. But it
13 October 2023
can tell you something about
the properties of the bond and
how it may behave in different
market conditions.
The current yield (also known
as running yield, income yield
and market yield) is the annual
interest divided by the current
market price. This tells you the
regular income you will receive
if you purchase at this price.
However, this is not the same as
the total return you’ll make over
the life of the bond.
The yield to maturity (also
referred to as the redemption
yield) is the bond’s annual rate
of return if an investor holds it
until it matures. It takes account
of all interest payments and the
principal. This makes it the
don’t sell before maturity.
To see how these fit
tells Forbes India. AI will
create some winners, but
 will be
history suggests there
together, consider a bond
with a face value of £100 that relatively few of them: only a
was issued with a 5% interest handful of firms such as
rate (the nominal yield) and Amazon, Google and Cisco
matures in two years. It now have been long-term
trades at £95, meaning that successes from the dotcom
its current yield is 5.26% (£5 / boom, with many others
£95). An investor who holds fading away. Now everybody
to maturity gets £5 in interest wants to be on the AI
each year and principal of bandwagon and they’ll spen
£100. That’s a total of £110, a lot of money on AI tools,
giving an annualised return consultants and advisors,
of 7.61% on £95 invested now with little to show for it. “I
(the yield to maturity). don’t see how this is going to
Alternatively, assume that make a retail business or a
the same bond was trading at grocery business more
£105. It would still have a profitable,” even though the
nominal yield of 5%, but its management of US grocery
current yield would be 4.76% chain Kroger talked about AI
and its yield to maturity eight times during their last
would be just 2.35%. earnings presentation.
moneyweek.c

https://www.yumpu.com/news/en/issue/166066-moneyweek-2023-10-13/read?page=17 2/2