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Until the start of this year, interest rates had been suppressed at near-zero levels for more than a decade. But as its domestic inflation soared higher (and globally), the US central bank reacted by raising interest rates at an unprecedented pace. To date, it has raised interest rates six times, pushing the benchmark rates from 0.00% – 0.25% to 3.75% – 4.00%.
The higher interest rate environment has made fixed-income investments like Singapore Savings Bonds (SSB) and Singapore Government Securities (SGS) bonds, which were previously overlooked, more appealing for investors looking for higher returns in safe assets.
Yet, these are not the only options that are available to investors seeking capital protection from large market swings. Short-duration bond funds, also known as short-term bond funds, are a type of investment product that allows investors to earn higher returns than individual bonds when interest rates are going up. This makes them an attractive choice of investment in this rising interest rate environment.
What Are Short Duration Bond Funds?
A short duration bond fund invests in a diversified portfolio of securities that have a maturity period of one to three years and offer high liquidity. It is made up of high-quality and investment-grade institutional bank fixed deposits and government and corporate debt instruments.
Short duration bond funds have higher risk than cash and money market funds but are generally considered to be low-risk investment products. They usually carry a low single-digit downside risk, which is measured by the fund’s effective duration.
Short Duration Bond Funds Generate Returns In Both Rising And Falling Interest Rate Environments
One major consideration when investing in bonds is interest rate risk. Typically, when interest rates rise, bond prices fall. The lower bond price simply translates into a higher yield, which puts it on par with new bond issues that pay higher coupon rates.
When we invest in individual bonds like the SSB or SGS bonds, we are locked in at the coupon rate determined at the point of issuance. If interest rates continue to trend higher, we will not stand to benefit. In fact, not only will our yields be lower than newer bond issues, but also our bond investments would drop in value – to reflect a higher interest rate in the market. Of course, if interest rates trend lower, the converse may be true – locking in a higher rate and potentially seeing its market value rise.
On the other hand, when we invest in short term bond funds like the United SGD Fund, it uses a laddered investment strategy to smooth out the effects of fluctuating interest rates. The Fund invests in a series of investment-grade bonds with varied maturity dates across a three-year timeframe. This helps to spread the maturity period of the bonds and enhance the overall return, ensuring we do not lock in interest rates at any point in time.
For example, in a rising interest rate environment, the capital from the matured bonds in the Fund would get re-invested into higher-yielding, shorter-dated bonds. This allows the Fund to ride on the rising interest rate momentum to earn higher returns.
Source: UOBAM
(Screenshot taken on 16 November 2022)
In a falling interest rate environment, the Fund would stay invested in longer maturity bonds to earn higher returns since the longer duration bonds would tend to have higher yields than shorter duration bonds.
Source: UOBAM
(Screenshot taken on 16 November 2022)
Using this approach, short duration bond funds like the United SGD Fund are able to generate attractive returns in different market conditions compared to individual bonds.
Short Duration Bond Funds Carry Low Risk By Investing In Liquid Investment-Grade Funds
A second factor to consider when investing in bonds is the credit rating of the issuer. It is used as an indicator to determine the creditworthiness of a borrower and the likelihood of default.
For the SSBs and SGS bonds, they are issued and backed by the Singapore government, which has the highest credit rating of AAA/Aaa.
Short duration bond funds carry low investment risk as they typically invest in high-quality, investment-grade short-term instruments.
You could also look at the bond fund’s effective duration, which indicates the sensitivity of the bond fund to every 1% change in interest rates. Usually, short duration bond funds have a low single-digit effective duration. For example, the United SGD Fund has an effective duration of 1.33 years (as of November 2022). This means for every 1% increase in interest rates, the United SGD Fund would fall by 1.33%, and vice versa.
The United SGD Fund also has a track record of weathering several market crises since 2005. This includes the Global Financial Crisis in 2008 and the market selldown in 2020 due to the spread of COVID-19. At the same time, it has also done better than its benchmark by generating cumulative returns of over 100% since its inception in 1998.
The graph below further illustrates the United SGD Fund’s ability to provide a buffer against market instability compared to other asset classes. Depicted in navy blue, the United SGD Fund typically lost between 1% and 1.9% during periods of large market volatility compared to the global equity fund (in brown) and a global bond fund (in green), which lost between 5.2% and 35.6% and 0.9% to 6.8%, respectively.
This may suit investors who want capital preservation or asset diversification to reduce their overall portfolio risk.
Investments In Short Duration Bond Funds Have No Limits And Can Be Easily Bought (And Sold)
The last factor to consider when investing in bonds is the ease of buying and selling.
For instance, the SSBs have a 10-year loan tenor, are issued monthly for a minimum investment of S$500, and have an individual maximum holding limit of S$200,000. You can redeem the bonds any time before their maturity, which will be paid out with accrued interest on the second business day of the following month. The downside to the SSBs is that if there’s an oversubscription for any issue, you may not get your full application amount as the SSBs are allocated on a quantity ceiling format. This not only limits your investment applications in SSBs but also makes them unpredictable.
As for the SGS bonds, they have varying maturity periods of between 2 and 50 years and a minimum investment amount of S$1,000. Unlike the SSBs, the SGS bonds do not have an individual maximum holding limit, but they are also not easily encashed before maturity. The liquidity on the secondary market (the Singapore Exchange) for SGS bonds tends to be thin, causing the spreads to be wide.
In contrast, although short duration bond funds require a minimum investment amount, there is often no maximum investment amount. To illustrate using the United SGD Fund again, it has a minimum investment amount of S$1,000 with subsequent incremental investments of S$500. You can also buy and sell the funds easily through UOBAM’s Invest App, without worry of getting your trade orders filled.
The United SGD Fund Has A Weighted Average Yield To Maturity (In SGD Terms) Of Over 5%
Established in 1998 and with a fund size of S$1.91 billion, the United SGD Fund is the flagship fixed income fund from UOB Asset Management Ltd. (UOBAM. Investment research firm Morningstar has also placed a four-star rating (out a possible five) on the United SGD Fund.
The United SGD Fund aims to achieve higher yields than Singapore dollar deposits by investing in money market and short-term interest-bearing debt instruments and bank deposits. It currently holds a diverse portfolio of 83 bond issues with a focus on companies that have good access to capital markets and defensive business models.
The United SGD Fund (Class A) currently offers a 5.62% weighted average yield to maturity (in SGD terms) and an annualised yield distribution of 2.13%* (as of November 2022). *Distributions (in SGD) are not guaranteed. Distributions may be made out of income, capital gains and/or capital. This relates to the disclosed distribution policy as set out in the Fund’s prospectus.
For investors looking for yield in the current interest rate environment, this is a higher return compared to the latest December SSB (GX22120S) issue, which has an average return of 3.47%, and the 10-Year SGS bond (NX22100W), which has a coupon rate of 2.625%.
You can invest in the United SGD Fund directly on the UOBAM Invest app, which you can download from the Apple App Store and the Google Play Store. Aside from the United SGD Fund, you can invest in up to 15 bond funds using the Fund Direct service within the UOBAM Invest app. While there is usually a sales charge of up to 2%, it is waived when you invest through the UOBAM Invest app. Moreover, investing via the UOBAM Invest app allows you to conveniently view your portfolio and monitor your fund’s performance.
As an added incentive to start growing your bond portfolio today, the first 3,000 new users who sign up for a new UOBAM Invest account will receive a one-time credit of S$10 to their account. So, download UOBAM’s Invest app and grow your bond portfolio today!
Disclaimer
Distributions will be made in respect of the Distribution Classes of the Fund. Distributions are based on the NAV per unit of the relevant Distribution Class as at the last business day of the calendar quarter or month. The making of distributions is at the absolute discretion of UOBAM and that distributions are not guaranteed. The making of any distribution shall not be taken to imply that further distributions will be made. UOBAM reserves the right to vary the frequency and/or amount of distributions. Distributions from a fund may be made out of income and/or capital gains and (if income and/or capital gains are insufficient) out of capital. Investors should also note that the declaration and/or payment of distributions (whether out of income, capital gains, capital or otherwise) may have the effect of lowering the net asset value (NAV) of the relevant fund. Moreover, distributions out of capital may amount to a reduction of part of your original investment and may result in reduced future returns. Please refer to www.uobam.com.sg and the Fund’s prospectus for more information.
All information in this publication is based upon certain assumptions and analysis of information available as at the date of the publication and reflects prevailing conditions and UOB Asset Management Ltd (“UOBAM”)’s views as of such date, all of which are subject to change at any time without notice. Although care has been taken to ensure the accuracy of information contained in this publication, UOBAM makes no representation or warranty of any kind, express, implied or statutory, and shall not be responsible or liable for the accuracy or completeness of the information.
Potential investors should read the prospectus of the fund(s) (the “Fund(s)”) which is available and may be obtained from UOBAM or any of its appointed distributors, before deciding whether to subscribe for or purchase units in the Fund(s). Returns on the units are not guaranteed. The value of the units and the income from them, if any, may fall as well as rise, and is likely to have high volatility due to the investment policies and/or portfolio management techniques employed by the Fund(s). Please note that the graphs, charts, formulae or other devices set out or referred to in this document cannot, in and of itself, be used to determine and will not assist any person in deciding which investment product to buy or sell, or when to buy or sell an investment product. An investment in the Fund(s) is subject to investment risks and foreign exchange risks, including the possible loss of the principal amount invested. Investors should consider carefully the risks of investing in the Fund(s) and may wish to seek advice from a financial adviser before making a commitment to invest in the Fund(s). Should you choose not to seek advice from a financial adviser, you should consider carefully whether the Fund(s) is suitable for you. Investors should note that the past performance of any investment product, manager, company, entity or UOBAM mentioned in this publication, and any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance of any investment product, manager, company, entity or UOBAM or the economy, stock market, bond market or economic trends of the markets. Nothing in this publication shall constitute a continuing representation or give rise to any implication that there has not been or that there will not be any change affecting the Funds. All subscription for the units in the Fund(s) must be made on the application forms accompanying the prospectus of that fund.
The above information is strictly for general information only and is not an offer, solicitation advice or recommendation to buy or sell any investment product or invest in any company. This publication should not be construed as accounting, legal, regulatory, tax, financial or other advice. Investments in unit trusts are not obligations of, deposits in, or guaranteed or insured by United Overseas Bank Limited, UOBAM, or any of their subsidiary, associate or affiliate or their distributors. The Fund(s) may use or invest in financial derivative instruments and you should be aware of the risks associated with investments in financial derivative instruments which are described in the Fund(s)’ prospectus. In the event of any discrepancy between the English and Mandarin versions of this publication, the English version shall prevail.
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