Investing in bonds: how to do it and when it is convenient

Investing in bonds is particularly advantageous due to the still high interest rates. The current environment allows for attractive returns compared to those that may be available in the future, after an easing of monetary policy. When interest rates fall, as expected, future bond yields will be lower than today’s.

Therefore, seizing the opportunity to invest in bonds now means locking in higher returns before rates start to fall. This period offers the possibility of obtaining more solid and secure gains. Taking advantage of this situation allows you to capitalize on current returns and prepare for changing market conditions.

What are bonds and what types should you know about

Bonds are debt securities issued by public or private entities to raise funds. In exchange, the issuer undertakes to pay a fixed or variable interest to investors and to return the capital at maturity.

Here are the main types of bonds:

• government bonds: sovereign debt securities issued by governments to finance public debt. Generally, government bonds are considered among the safest investments in the world, thanks to the state guarantee that supports them;
• corporate bonds: issued by companies to raise capital;
• supranational bonds: issued by international organizations such as the World Bank;
• indexed bonds: linked to economic indices such as inflation;
• zero coupon bonds: issued at a discount and without periodic coupons, such as BOT and CTZ;
• fixed coupon bonds: pay a regular fixed interest, like BTP;
• step-up and step-down bonds: with coupons that increase or decrease over time. The BTP Valore is an example of yields characterized by the step-up mechanism;
• convertible and cum warrant bonds: can be converted into shares or include conversion rights;
• covered bonds: guaranteed by specific assets of the issuer.

How and where to buy bonds

Buying bonds is a relatively simple process, but it requires attention.

Investors can buy bonds:

• in the process of being issued: through public auctions organized by the Ministry of Economy and Finance (MEF);
• in the secondary market: through financial intermediaries, such as banks and online trading platforms.

To get started, you need to open a securities deposit account at a bank or an authorized broker. Bonds can be purchased at bank branches or through home banking services if enabled.

When deciding to invest in bonds, it is important to take into account some limits and key factors:

• minimum investment amount: bonds often require a minimum amount for purchase, which can vary depending on the type of bond and the intermediary chosen. This requirement is essential to consider in order to plan your investment properly;
• transaction costs: the purchase of bonds can involve various transaction costs, including purchase and sale commissions, as well as costs for managing the securities deposit account. It is essential to find out about the associated costs in advance to avoid surprises and optimize your investment;
• risk assessment: before purchasing bonds, it is crucial to assess the inherent risks, such as credit risk (the possibility that the issuer will not be able to honor the debt) and interest rate risk (the impact of changes in interest rates on the value of bonds). A careful analysis of the characteristics of the securities and the financial situation of the issuer will contribute to a more informed and aware decision.

Being well informed about these aspects allows you to better manage your investment in bonds, maximizing the benefits and reducing potential risks.

How to invest in bonds: here are which ones to buy today

Here is a selection of bonds with attractive yields and favorable characteristics that can represent excellent investment opportunities:

BTP:

• ISIN IT0005425233: Coupon of 2.42%, expiry September 1, 2051, yield 4.43%.
• ISIN IT0005438004: Coupon of 2.04%, maturity April 1, 2045, yield 4.40%.
• ISIN IT0005441883: Coupon of 3.05%, maturity March 1, 2072, yield 4.20%.

BTP Valore:

• ISIN IT0005583486: Coupon of 3.25%, maturity March 5, 2030, yield 3.59%.
• ISIN IT0005565400: Coupon of 4.10%, maturity October 10, 2028, yield 3.48%.

BTP Futura:

• ISIN IT0005425761: Coupon of 0.60%, maturity November 17, 2028, yield 3.38%.
• ISIN IT0005415291: Coupon of 1.15%, maturity July 14, 2030, yield 3.61%.

CCT:

• ISIN IT0005428617: Coupon of 4.362%, maturity April 15, 2026, yield 3.78%.

BOT:

• ISIN IT0005603342: Maturity July 14, 2025, yield 3.34%.

Corporate Bonds:

• BP: Coupon of 4.375%, next call June 2025, yield 5.85%.
• Volkswagen: Coupon of 4.625%, next call June 27, 2028, yield 4.89%.
• Eni: Coupon of 2%, next call February 11, 2027, yield 4.74%.
• Enel: Coupon of 6.375%, next call April 16, 2028, yield 4.61%.

Is investing in bonds worth it? How much can you earn?

Investing in bonds can be an excellent strategy to obtain predictable returns with lower fluctuations than other types of investments.

The main benefits of bonds include:

• predictable returns: Bonds pay regular coupons that provide a stable income stream.
• lower volatility: Compared to stocks, bonds tend to be less volatile and therefore less risky.
• capital protection: Bonds, especially government bonds, offer greater security of the capital invested.

In an environment of high interest rates, bonds can offer higher returns than in periods of low rates. Buying bonds now can be particularly advantageous, as returns could fall with future interest rate cuts by the ECB.

Example
Suppose you invest 10,000 euros in a BTP maturing in March 2034 and paying a coupon of 4.20%. If purchased in November 2023 at a price of 99.00 euros and sold today at 103.99 euros, here is how the profit could be calculated:

• Purchase cost: 10,000 * 99.00 / 100 = 9,900 euros
• Market value: 10,000 * 103.99 / 100 = 10,399 euros
• Capital gain: 10,399 - 9,900 = 499 euros
• Annual coupon: 10,000 * 4.20% = 420 euros
• Total gain: 420 euros (coupon) + 499 euros (appreciation) = 919 euros

If the European Central Bank (ECB) were to cut interest rates by 25 basis points, the price of the BTP could increase further.

Suppose the price increases to 105.00 euros:

• Market value: 10,000 * 105.00 / 100 = 10,500 euros
  The capital gain would become:
• Capital gain: 10,500 - 9,900 = 600 euros

Compared to other forms of investment, such as stocks, bonds offer greater predictability of cash flows. This can be particularly advantageous for investors seeking regular income or who wish to protect capital.

However, it is also important to evaluate the transaction costs and credit risk associated with each type of bond.

Are bonds safe? Here are the zero-risk opportunities

Investing in bonds does carry some risks, but there are instruments with a relatively low risk profile that offer interesting opportunities for prudent investors. Here are some rules to follow to minimize the risks associated with bonds.

Bond Risks

• Credit Risk: This risk occurs when the bond issuer is unable to honor coupon payments or repay the principal at maturity. Bonds issued by entities with high credit ratings, such as governments of developed countries, tend to have very low credit risk.
• Interest Rate Risk: Changes in market interest rates can affect the value of bonds. When interest rates rise, the price of existing bonds tends to fall and vice versa. Fixed-rate bonds are more exposed to this risk than floating-rate bonds.
• Liquidity risk: This risk involves the difficulty of selling a bond before its maturity without incurring significant losses. Bonds traded on well-regulated secondary markets tend to be more liquid.

Low-risk investment opportunities
To minimize the risks associated with bonds, it is advisable to consider instruments with high credit quality and those backed by specific assets.
Here are some of the best options from a safety perspective:

• Supranational bonds: issued by supranational entities such as the World Bank or the European Investment Bank, these bonds have high credit quality and are considered among the safest.
• Developed country government bonds: government bonds issued by countries with stable economies and high credit ratings, such as US Treasuries or German Bunds, are among the safest options.
• Covered Bonds: these bonds are backed by specific assets, such as mortgages or loans. In the event of the issuer’s insolvency, investors can recover their investment by selling the underlying assets. Covered bonds are an example of this type of instrument.
• Short-Term Bonds: bonds with short maturities, such as BOTs, offer lower interest rate risk than long-term bonds. In addition, credit risk is reduced for short-term bonds issued by entities with high credit quality.

Examples of Safe Bonds

• BOT (Buoni Ordinari del Tesoro): these short-term Italian government bonds are among the safest options for investors. BOTs offer high liquidity and low interest rate risk.
• US Treasuries: bonds issued by the US government are considered among the safest in the world due to the country’s economic strength and high credit rating.
• German Bunds: german government bonds are another safe option, supported by Germany’s economic stability and a high credit rating.

Bond Investment: Future Outlook (and Forecast)

The outlook for bond investments in the coming months is highly dependent on the evolution of global monetary policy and macroeconomic conditions. Decisions by major central banks, such as the Federal Reserve (Fed) in the United States and the European Central Bank (ECB), will have a significant impact on bond yields.

1) Trends and Forecasts
Currently, both the Fed and the ECB are considering cutting interest rates to support economic growth and counteract any recession risks. A cut in interest rates would have the effect of increasing the price of existing bonds, thus making bond investments more profitable.
Example
Suppose we have a BTP 2072 with a modified duration of 23.62. If interest rates were to fall by 25 basis points, the price of the BTP could increase significantly, rising above 65.50 euros.

2) Economic Stability
The forecast of moderate economic stability and low inflation could push investors towards high credit quality bonds, such as government bonds of developed countries and supranational bonds. This trend could continue to offer attractive opportunities for investors seeking safety and stable returns.

3) Portfolio Diversification
In a context of economic uncertainty, investors may be inclined to diversify their bond portfolio, including a combination of short- and long-term bonds, high-quality corporate bonds and supranational bonds.
Example
A diversified portfolio could include short-term BOTs with a yield of 3.34%, BTPs with a medium-long term maturity and a coupon of 3.25%, and corporate bonds such as those of Eni with a coupon of 2% and a maturity in 2027, offering an attractive overall return with a balanced risk profile.

|DISCLAIMER
The information and considerations contained in this article should not be used as the sole or primary basis for making investment decisions. The reader maintains full freedom in his investment choices and full responsibility in making them, since he alone knows his risk propensity and his time horizon. The information contained in the article is provided for information purposes only and its disclosure does not constitute and is not to be considered an offer or solicitation to the public savings.|

Original article published on Money.it Italy. Original title: Investire in obbligazioni, come farlo e quando conviene