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I'm not sure I'd agree 100%, Bj, in that I'd treat my mortgage-free home as just that, a home to live in and not an investment. Aside from that, I've never favoured the increased allocation to bonds advocated by many (most?) advisers. Retired folk still have to hedge their income against rising costs - rates, power, insurances etc - nothing seems to get cheaper except maybe electronics which don't figure much in a retiree's spending! - and equities have long been the best way to do this, at least in NZ.
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Originally Posted by macduffy
I'm not sure I'd agree 100%, Bj, in that I'd treat my mortgage-free home as just that, a home to live in and not an investment. Aside from that, I've never favoured the increased allocation to bonds advocated by many (most?) advisers. Retired folk still have to hedge their income against rising costs - rates, power, insurances etc - nothing seems to get cheaper except maybe electronics which don't figure much in a retiree's spending! - and equities have long been the best way to do this, at least in NZ.
True...even for a retiree, you need to account that your assets should rise by inflation in addition to providing after tax income. The general CPI is a poor guide as to the inflation in items that retirees have to consume or consider too. Especially when many folks can spend decades in retirement. So a big ask for what bonds actually provide these days after tax.
We will have to dsagree on treating owner-occupied housing as an investment. While it is a home to live in, it as also an investment, in the past the best performing investment for many with mortgages as it leverages up their equity. It provides a valuable annual return in providing accomodation. It can be sold to provide many with a nice modern unit in a retirement village with an additional nest egg left over....(Disc: I hold listed retirement company shares)
If you cannot or choose not to buy a home, then you need more investments or an alternative or higher income to provide what an owner-occupied house provides.
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The wisdom of Contact Energy bonds?
Originally Posted by peat
The thing about a good bond is that its top of the pecking order and so capital loss is almost a zero probability (well maybe not quite ) They should be better than bricks and mortar - they should be rock solid. Hence low returns are acceptable for that part of the portfolio because its actually more about capital preservation.
Peat, Contact 040 bonds are a BBB rated bond with a coupon rate of 4.63%. If I read the market price correctly you can buy them at a market coupon rate of 3.75%. IIRC a BBB rated company has a 1 in 30 chance of a severe capital stress event (going bust without a capital injection) each year. Let's say you are buying the bond in year zero for $10,000, are paying 30% tax, and want to hold for 30 years.
Your total expected income is: 30 x ( 0.0375 x 0.7 x $10,000 ) = $7,875m
After 30 years the chance your investment will still be intact is:
(29/30)^30 = 0.3617
This implies the chance of losing your investment is:
(1-0.3617) = 0.6383
Or in dollar terms your expected capital loss from business failure will be:
$10,000 x 0.6383 = $6383.00
I hope you can see that your expected after tax income barely covers your expected capital loss.
Can you see why I bought CEN shares yielding 6% gross return ahead of the bonds?
SNOOPY
Last edited by Snoopy; 07-09-2017 at 03:24 PM.
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Try this one
Originally Posted by Snoopy
...IIRC a BBB rated company has a 1 in 30 chance of a severe capital stress event (going bust without a capital injection) each year....
If the Bond is rated BBB then I understand that it mean than there is a 1 in 30 possibility, over the 'life' of the bond, that there will be a default on paying the interest or repaying the capital.
But as I don't do Bonds I could be wrong.
Best Wishes
Paper Tiger
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The wisdom of Contact Energy bonds? (iteration 2)
Originally Posted by Paper Tiger
If the Bond is rated BBB then I understand that it mean than there is a 1 in 30 possibility, over the 'life' of the bond, that there will be a default on paying the interest or repaying the capital.
Looking at the Reserve Bank published pdf on credit ratings above. This says:
https://www.rbnz.govt.nz/-/media/Res...8179.pdf?la=en
Approx. probability of default over 5 years (The approximate, median likelihood that an investor will not receive repayment on a five-year investment on time and in full
based upon historical default rates published by each agency.) is '1 in 30'.
So let's look at a 5 year time horizon for Contact 040 bonds.
Let's say you are buying the bond in 'year zero' for $10,000, and are paying 30% tax.
Your total expected income over five years is: 5 x ( 0.0375 x 0.7 x $10,000 ) = $1,312.50
The chance your investment will still be intact after 5 years is 29/30.
This implies the chance of losing part of your investment is 1/30:
The worst case here, should Contact Energy fail, is that you will lose all of your investment. Your 'expected' capital loss in this worst case situation is therefore:
(1/30) x $10,000 = $333.33
Some might call that pessimistic. But even if you don't lose all your investment, a partial recovery of what is left might take years. So I think 'total loss' is the real world scenario you should plan for. So I would argue the expected return over five years is:
$1,312.50 - $333.33 = $979.17
This represents an annual net rate of:
($979.17 /5) / ($10,000) = 2%
Compare that with
1/ Buying the Contact shares at a 6% gross yield ( 4.2% net) on market ( approximately true with a $5.50 share price ) and
2/ The possibility of a capital gain from the shares
then the bonds look very unattractive as an 'income generating investment' and an investment in general.
SNOOPY
Last edited by Snoopy; 07-09-2017 at 04:11 PM.
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Investor
I don't think it's worthwhile relying on a rule of thumb. I intend to have 0% bonds at all age brackets.
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Member
Originally Posted by Investor
I don't think it's worthwhile relying on a rule of thumb. I intend to have 0% bonds at all age brackets.
I also intend to have 0% bonds at all ages and to have enough in the market to ride the rollercoaster.
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the premise (1 in 30) is fully dubious in my opinion, I really dont see CEN falling over in half a decade. Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical.
And if you spend a good number of lines discounting the bond why is the equity investment not also risk adjusted
Snoopy it seems your analysis discounts the bond for an arbitrary risk factor but the equity return should even more heavily discounted because the bond and its interest will be paid as a priority over the share being worth anything or the dividend being dropped.
Last edited by peat; 07-09-2017 at 07:47 PM.
Reason: additional thoughts
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Originally Posted by peat
the premise (1 in 30) is fully dubious in my opinion, I really dont see CEN falling over in half a decade. Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical.
It would be fascinating to know how Graeme Wheeler and the boffins at RBNZ equate a BBB rating with a one in thirty chance that "an investor will not receive repayment on a five-year investment on time and in full." The claim is that 1/30 is from 'historical data' (so not intuitive as you suggest Peat), but what data? Was it gathered in NZ only or is the data global? What industries made up the data?
I think there is a difference between Contact 'falling over' and the bond 'falling over'. In the worst case, a capital injection from shareholders would stop Contact 'falling over'. But probably dividends would be suspended at the same time, and interest on the bonds might be a 'delayed payment' or maybe the interest would not be paid at all? In those circumstances existing bonds might become close to unsalable, unless the bondholder was willing to take a huge haircut.
The problem with this 'probability of failure within five years' is that not all five year periods are equal. At the moment it does seem implausible. But I put it to you that if you think this, you are are probably being influenced by the bombardment of information on present day circumstances. Go back less than two years and Contact has its cash resources drained with a 50c special dividend. What if Tiwai point had announced its closure shortly after that? It didn't happen of course, but that is not the same as saying it could not have happened. Right now a 1 in 30 probability of failure looks ridiculous. But back then if my 'alternative fact' scenario had played out, the chance of failure could have been 1 in 10. Contact's relatively high debt load even today (high for companies in general, not high for power companies in particular) is deemed prudent because they have great security of cashflow. If the cashflow becomes less secure then there would rightly be more attention paid to overall debt levels.
And if you spend a good number of lines discounting the bond why is the equity investment not also risk adjusted
Snoopy it seems your analysis discounts the bond for an arbitrary risk factor but the equity return should even more heavily discounted because the bond and its interest will be paid as a priority over the share being worth anything or the dividend being dropped.
I agree the equity (Contact shares) are likely to be more volatile than the 'Contact Bonds'. I did not discount that return because half of the volatility is negative (the share price might go down) and half is positive (the share price might go up). It is only negative volatility that is of concern for shareholders. Positive volatility is what we all seek and why we are in the game. 'Discounting' a share value and/or dividend because you might get 'positive volatility' makes no sense at all. "Positive Volatility' is an investment objective, not a risk factor.
The big problem with bonds right now is that potential rising interest rates are a real threat to bond values and share values, but in a broad market sense probably more of a threat to bond values. Thus I see bonds right now as higher risk and lower return than shares, even though I acknowledge that shares are also high risk. Traditionally , when all those asset allocation text books were written, bonds and shares were more often than not 'out of sync'. I don't think this is so today, which is why I don't think the traditional textbook advice of the conservative investor weighting their portfolio towards bonds works in today's market.
SNOOPY
Last edited by Snoopy; 10-09-2017 at 04:44 PM.
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Originally Posted by Snoopy
The claim is that 1/30 is from 'historical data' (so not intuitive as you suggest Peat), but what data? Was it gathered in NZ only or is the data global? What industries made up the data? SNOOPY
Good questions but I wasnt actually saying that the statistic was intuitive, I was saying that my view is intuitive. Sorry for that lack of clarity.
"Almost no chance at all certainly not 1 in 30. This strikes me as intuitive rather than mathematical."
Originally Posted by Snoopy
Thus I see bonds right now as higher risk and lower return than shares, even though I acknowledge that shares are also high risk. Traditionally , when all those asset allocation text books were written, bonds and shares were more often than not 'out of sync'. I don't think this is so today, which is why I don't think the traditional textbook advice of the conservative investor weighting their portfolio towards bonds works in today's market.SNOOPY
Its worked pretty well I would've thought , capital gains, no failures (that I can think of) .
For clarity, nothing I say is advice....
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