Fixed income investments, like bonds, offer investors the benefit of receiving fixed interest payments until the date of maturity. This can include both government and corporate bonds. This can play an essential role in preserving wealth but can be a bit boring and not generate high levels of wealth.
How do you remedy this? By leveraging your bond portfolio.
In this article, we will cover leverage and why you should consider leveraging your bond portfolio. If you have any questions about the topic covered below, or if you are looking to take your portfolio to the next level, contact Alpen Partners below.
What is leverage?
Leverage occurs when borrowed money is used to invest and expand a firm’s asset base and generate returns. Leverage is also the term used to describe the amount of debt a firm uses to finance assets. With this logic, when a property or investment is considered highly leveraged, the item has more debt than equity.
When the idea of leverage comes to mind, you may think of margin, a similar idea. Leverage and margin are not the same, despite being interconnected. Leverage is the act of taking on debt. Margin is the debt, or borrowed money, that is used by a firm to invest in other financial instruments.
With a margin account, an investor can borrow money from a bank for a fixed interest rate and purchase securities, futures, or options. These investors are highly anticipating high returns. With a margin, an investor can create leverage.
For example, if a manufacturing company borrowed money to build a new factory, it would be able to increase its production and its profits.
A leveraged portfolio operates the same way. An investor who uses borrowed money for some of their securities has a leveraged portfolio. There is some obvious risk in doing this because it could result in loss, and the investor would be responsible for repaying the borrowed capital. On the other hand, the invested security could result in a gain, and the investor would easily pay the debt and earn a profit.
Most investors aren’t going into debt in order to leverage. Many are utilizing the technique to manage their cash flow. Instead of using the entire upfront investment amount from their own money, they borrow some to invest. This way, the investor can use the remaining capital to make other investments and even diversify the portfolio.
Leveraging Your Bond Portfolio
Bonds are a tried and true part of any portfolio. There are many great benefits to investing in bonds. First, they create a steady income since the coupon payments are paid at fixed intervals. Also, bonds provide capital protection and are considered to be less volatile, and in the event that a company goes under, bond owners get preference over stockholders when getting paid. Further, since bonds and equities have an inverse relationship, bonds are considered a staple in diversification.
While bonds are a sturdy pillar in any portfolio, they are not very exciting and do not offer investors high returns. By leveraging your bond portfolio, you can generate a higher yield.
Leveraged bonds occur when an investor uses borrowed money and/or derivates to leverage their investment returns. For example, a bond fund that has $5 million in assets can earn an investor 6% of the assets, equaling $300,000 a year.
In typical leveraged bond funds, investment-grade bonds are used to create a portfolio. Investment grade bonds have a low credit rating, which means the chances of borrower default are low. High-yield bonds, however, have a higher inherent risk.
Some see high-yield bonds and think that leveraging is not worth the risk. In terms of ROI, some high-yield bonds can indeed offer the same returns as a leveraged bond fund. But looking past ROI, a leveraged bond fund often protects the investor from default. Recovery rates from leveraged bond funds are usually much higher than high-yield bonds. Most of the global leveraged bond funds market is built with top-grade secured obligations made up of corporate entities that are at the top of the capital structure. They are also created by governments of countries with stable economies and therefore offer better capital protection.
Are you on the fence about leveraging your bond portfolio? There has been some recent market uncertainty, so fixed-income strategies have been at the forefront of most investor’s minds. This is also the ideal time to diversify your portfolio. That’s why we say you should go for it! Leveraged bonds offer competitive yield and protect portfolios from unwanted risk. Investments are safe and guarantee returns since volatility is low. There are multiple options to choose from, so portfolio diversification is essentially promised.
Seek guidance from Alpen Partners
Portfolio optimization looks at an individual’s investment decisions through formal mathematics. Techniques include quadratic programming, nonlinear programming, mixed integer programming, and more. Modern portfolio theory is one of the most popular approaches. It involves categorizing the investment world based on risk and return. One then chooses which investments produce the desired return versus risk.
Just like in everything you do, when making an investment, you are opening yourself up to many financial risks, such as high inflation, volatility in capital markets, bankruptcy, recession, and more.
Our team examines an investor’s risk profile and creates a hands-on investment plan to grow and maintain their wealth. When looking for a wealth manager, don’t you want to know that your investments and wealth are in good hands? So do we. That is why Alpen Partners has chosen to register with the Securities and Exchange Commission as an investment advisor. SEC-registered advisors are certified and tested and can offer elite financial planning and investment advice.