Bonds explained simply: is now the right time to invest?

For many years, bonds were probably the least attractive investment of all: zero interest rates and price losses to boot. Until recently: after the SNB tightened the interest rate screw considerably, inflation in Switzerland seems to be under control. And so more and more voices are assuming that the interest rate turnaround is already over. So is a revival of the once so popular fixed-interest securities imminent? In this article, we will take a closer look at these and other questions on the subject of “Bonds simply explained”.

Bonds explained simply

Bonds are fixed-interest securities issued by issuers (debtors) such as companies, governments or other institutions for the purpose of raising capital .

The term “bond” is mainly used in Switzerland, while in Germany “Anleihe” and internationally “Bond” are used as synonyms.

When you buy a government bond or a corporate bond, you lend money to the issuer for a fixed term and at a fixed interest rate. This so-called coupon interest is paid out to you regularly (often annually).

For domestic bonds, 35% withholding tax is deducted, which you can reclaim in full by declaring it in your tax return.

At the end of the term, the issuer undertakes to repay the nominal value of the security.

There are different types of bonds depending on the issuer:

• Government bonds: A state is a debtor.
• Medium-term notes: A bank is the debtor (bank bonds).
• Corporate bonds: A private company is the debtor (corporate bonds).

If you do not want to wait until the end of the term, you can sell the bond at the bond price. If you sell prematurely, however, you must expect price markdowns. You can trade many bonds on the stock exchange.

Swiss bond market: the wind has changed

The popularity of bonds depends heavily on the interest rate level. This is currently at 1.75% (key interest rate), the highest it has been since 2008.

As a result of rising inflation, the Swiss National Bank (SNB) heralded a turnaround in interest rates on September 22, 2022. This means that after this interest rate move, key interest rates turned positive again for the first time since 2014 and then gradually rose further to their current level of 1.75%.

However, there has recently been a growing number of voices that believe interest rates have already peaked. For example, the Tages-Anzeiger headlined on November 20, 2023 “Key interest rates should soon fall again”.

This forecast is essentially based on the fact that inflation recently fell to 1.4% (November 2023). This puts inflation well below the threshold of 2% targeted by the Swiss National Bank. If this level can be maintained, further increases in the key interest rate would no longer be necessary.

However, in this article from December 4, 2023, the NZZ assumes that the inflation trend will soon be reversed. This is also based on a forecast by the SNB, according to which inflation could climb back above 2% as early as the beginning of 2024.

High interest rates are known to be a double-edged sword: savers enjoy them, while economic and social debtors (e.g. mortgage borrowers) suffer as a result.

In this article “Bonds simply explained”, we want to take a closer look at the interest rate profiteers and the old and once so popular savings classic.

In the next chapter, we look at the (often underestimated) risks of bonds.

What risks are associated with bonds?

The creditworthiness of the issuer is the most important risk factor. In general, government bonds from countries with a good credit rating are considered safer, while corporate bonds can have a higher risk, especially if the company is financially unstable. The latter are so-called junk bonds, i.e. speculative, high-yield bonds from issuers with a poor credit rating.

In addition to the aforementioned credit risk, special attention must be paid to the interest rate risk for bonds, which is often underestimated. Specifically, rising interest rates lead to falling prices and vice versa.

The interest rate risk can be measured using the “modified duration”. This key risk figure indicates the percentage by which the bond price fluctuates if the market interest rate level changes by one percentage point. A modified duration of 4 therefore means that the bond price falls by 4% if interest rates rise by one percentage point or rises by 4% if interest rates fall by the same amount.

If you hold a bond until maturity, you will get back the amount invested (nominal value at a price of 100). However, in this case you are also exposed to an interest rate risk: If the fixed coupon rate falls below the market rate during the holding period, you will have to accept lower returns (compared to the then current market rate).

You should also keep an eye on the liquidity risk. This means that you may not be able to sell prematurely due to a lack of demand, or only at a significant discount.

After all, you are taking a currency risk when you invest in foreign bonds.

Despite these risks, bonds are considered a safer asset class than equities.

Why should I invest in bonds at all?

Due to their low volatility and low default risk, bonds with a first-class credit rating – which are the subject of this article – are considered one of the best-known asset classes in multi-asset portfolios.

Bonds, together with traditional bank savings and fixed-term deposit accounts, cover the low-risk part of your assets. They therefore contribute to better diversification of your portfolio.

However, in times of negative and low interest rates, the yield on domestic bonds tended towards zero, which is why they were considered unattractive for many years. At least until recently.

As Viac clients, we have also become aware that a bond revival is apparently underway. This year, the Swiss pension pioneer added bond ETFs to its investment universe for the first time since it was founded in 2015! Previously, anyone who wanted to invest their pension money or parts of it in a low-risk way could only do so via the “cash” asset class. (If you would like to benefit from a small bonus as a new Viac customer, simply send us a message to mail@schweizerfinanzblog.ch.)

Understandable, because why should I prefer bonds to cash when the risk is higher and the performance worse?

In which market phases are bonds interesting?

In principle, bonds are worthwhile if surprisingly falling interest rates follow the purchase. (If prices are already expected to fall, as is the case today, then this forecast is already priced into the coupon rate). Unlike a savings account, where the interest rate is constantly adjusted to market conditions, a bond offers a fixed interest rate that is higher than the market rate when interest rates fall.

Interest rates on medium-term notes

Runtime	ZKB*	PostFinance**	BPS (Suisse)***
2 years	1.05%	1.05%	1.375%
3 years	1.05%	1.00%	1.375%
4 years	1.05%	1.00%	1.375%
5 years	1.05%	1.00%	1.375%
6 years	1.05%	1.00%	1.375%
7 years	1.10%	1.05%	1.375%
8 years	1.10%	1.05%	1.375%
9 years	1.15%	1.10%	1.375%
10 years	1.15%	1.15%	1.375%

*ZKB with a rating of "AAA"; 5,000 CHF minimum deposit; 0.1% custody fees per year;
**PostFinance with a rating of "AA"; 5,000 CHF minimum deposit; no custody fees;
***BPS with a rating of "BBB"; 1,000 CHF minimum deposit; no custody fees; all interest rates as of December 1, 2023 (Sources: provider information online).

The fact that the interest rates in the table above remain practically unchanged, even over longer terms, indicates that interest rates are no longer expected to rise.

It is also noticeable that the interest rates offered are very low or comparable to those of savings accounts. Although the interest rate is higher for BPS, the default risk is also higher due to the significantly lower credit rating.

Of course, if you were to take out a 1% cash bond today, this interest rate would be guaranteed for the entire term, whereas the interest rate on a savings account is constantly adjusted to the market interest rate, i.e. in extreme cases it could fall to zero again.

Conclusion on medium-term notes

Medium-term notes from issuers with a high credit rating undoubtedly meet the requirements for a low-risk investment. However, the low interest rate combined with limited liquidity, the requirement to open a securities account and minimum amounts mean that we are looking for better alternatives.

Are bond ETFs the better choice?

The advantages of bond ETFs are obvious: no cluster risk in terms of the issuer’s creditworthiness and generally better liquidity. But we also see a disadvantage: no return predictability, i.e. bond ETFs, like equity ETFs, are a black box in terms of performance.

An attempt at explanation: If, for example, you subscribe to a medium-term note worth CHF 10,000 with a term of 5 years from Zürcher Kantonalbank with the highest credit rating, you will currently receive an interest rate of 1.05% (see also table above). This means that at the end of the term you can precisely determine the value of your investment, namely CHF 10,525 or the invested amount of CHF 10,000 plus five interest coupons of CHF 105 each. With bond ETFs, on the other hand, the expected return depends crucially on the development of the market interest rate.

A (risk-averse) investor who does not want to be exposed to price fluctuations would probably prefer to invest in individual medium-term notes and hold them until maturity.

In contrast to medium-term notes, bond ETFs can also be quite volatile. As a rule of thumb, long-dated bonds and bonds in foreign currencies fluctuate more than short-dated or domestic securities due to currency risk.

If we go back a little further and compare the annual performance over the last five years, we can also see considerable differences. ETFs that are exposed to currency risk (see last two items) and those with long residual terms (see last column) fluctuate the most.

Bond ETFs in the yield check

ETF product title (description)	ISIN	2019	2020	2021	2022	2023*	AR**	MD***
iShares Swiss Domestic Government Bond 1-3 (CH government bonds with remaining maturity of 1-3 years)	CH0102530786	-1.18%	-0.85%	-1.13%	-2.78%	0.49%	1.96%	1.66
iShares Swiss Domestic Government Bond 3-7 (CH government bonds with remaining maturity of 3-7 years)	CH0016999846	-0.54%	-0.45%	-2.05%	-7.69%	3.12%	1.91%	4.83
iShares Swiss Domestic Government Bond 7-15 (CH government bonds with remaining maturity of 7-15 years)	CH0016999861	2.60%	0.57%	-3.35%	-14.19%	8.39%	1.16%	10
iShares Core CHF Corporate Bond (CH corporate bonds)	CH0226976816	2.68%	0.29%	-0.48%	-9.00%	4.67%	0.67%	4.31
iShares Core EUR Corporate Bond UCITS (Corporate bonds in the Eurozone)	IE00B3F81R35	2.41%	2.06%	-5.33%	-18.16%	2.69%	2.66%	4.42
iShares Global Corporate Bond UCITS USD (Global corporate bonds)	IE00B7J7TB45	9.34%	0.24%	0.12%	-15.62%	0.36%	3.48%	5.7

All returns include distributions and are based on CHF, i.e., they account for currency risks (data source: justetf); all corporate bonds with investment-grade ratings; *YTD 1.1. - 30.11.; **AR = Distribution yield over the last 12 months; ***MD = Modified duration in years (data source: provider fact sheets).

As the table above impressively shows, light and shade can come close together over time. While 2023 should be a good year for bond ETFs, the year before was miserable with losses of up to 18%.

Conclusion on the bond ETFs

Neither long-dated (interest rate risk) nor foreign bond ETFs (currency risk) are suitable for low-risk investments. In our opinion, therefore, only short-dated bond ETFs in domestic currency are suitable. This is because they are comparatively stable in value. However, their performance is disappointing, which is why we will continue our search for more attractive savings investments in the next chapter.

– Partner Offer –

The pioneering broker Swissquote (see also our review) offers the largest selection of securities for Swiss investors, including a huge range of ETFs. Many of them are available at a preferential price of CHF 9. With our promotional code “MKT_SFB” you can now secure trading credits. Click on the ad below to go directly to the account opening page.

—–

What alternative savings options are there to bonds?

The securities we have examined so far, be they medium-term notes from individual banks or broadly diversified bond ETFs, have not convinced us at all. This sad interim conclusion motivates us to look for alternative savings opportunities.

However, the following should still apply: Savings deposits should cover the low-risk part of your assets or your asset allocation. This includes a nest egg for unplanned events as well as clearly defined savings goals such as a trip around the world for a milestone birthday.

Savings deposits are characterized by a high level of security. We see the two most important objectives for savings deposits as capital protection and asset preservation.

Capital protection is guaranteed by first-class collateral. This means that for bank accounts this is primarily the deposit protection of CHF 100,000, while for bonds the focus is on a high credit rating of the issuer.

Asset preservation, on the other hand, aims to protect savings deposits from inflation. This means that, ideally, savings deposits should also maintain their purchasing power in the long term.

With the current inflation rate of 1.4% (as at November 2023) and current savings interest rates of around 1%, this target will not be fully achieved and savings assets will decrease slightly in real terms each year.

So let’s take a closer look at two savings options that are potential alternatives to bonds:

Fixed-term deposit” savings alternative

Unlike the “bond” security, the fixed-term deposit is an account solution. It is therefore also subject to deposit protection to the value of CHF 100,000. As with a bond, fixed-term deposits pay you a fixed interest rate for a specific term.

The current interest rate is a modest 1%. The term usually varies between one month and one year. During this time, your money is tied up, i.e. you cannot dispose of it.

However, fixed-term deposits have another, even bigger catch: high entry hurdles. Even at the popular Migros Bank, the minimum deposit is a hefty CHF 100,000.

High entry barriers and no early withdrawal options are two compelling arguments why fixed-term deposits are not a valid alternative to bonds for us.

Savings alternative “savings account”

That leaves the good old savings account. Like fixed-term deposits, it is subject to deposit protection to the value of CHF 100,000. In addition to the security aspect, the savings account is characterized by high liquidity. This means that, depending on the bank, there are few to no restrictions on how you can dispose of the money you have saved.

Unlike fixed-term deposits and bonds, the interest rate on a savings account is variable and constantly adapts to market conditions. Compared to bonds, this is an advantage when prices rise and a disadvantage when prices fall.

In addition, no minimum amounts are required for savings accounts.

For these reasons, we see savings accounts as an interesting alternative to bonds.

In our experience, the Swiss smartphone bank Yuh offers a particularly attractive savings solution in terms of flexibility and liquidity (see also our review “Yuh experiences: What the new star in the Swiss neobank sky has to offer”).

You currently receive 1% interest on your CHF cash balance, with no withdrawal or amount limit. Unique: It doesn’t matter whether you store your cash in the “Pay” or “Save” section of the app. It couldn’t be easier! If you would also like to save with Yuh, you can benefit from a trading bonus of CHF 50 with our promotional code “YUHSFB”.

Conclusion on “Bonds simply explained”

To be honest, we expected the final conclusion to be different. Before our analysis, we expected to be able to make a clear recommendation for the “bonds” asset class.

However, the overall package consisting of unpredictable interest rate risk, low interest rates and limited liquidity did not convince us either with individual medium-term notes or with the broadly diversified bond ETFs.

We have therefore come to the conclusion that saving with a savings account is more attractive overall. This is particularly true of innovative providers such as Yuh, which offer comparatively high interest rates with the greatest possible liquidity and flexibility.

The availability of your cash at any time is particularly important when it comes to the “nest egg” savings goal, as this cannot be scheduled by nature. And that’s where the good old savings account clearly has the edge!

This might also interest you

Disclaimer

Disclaimer: Investing involves risks of loss. You must decide for yourself whether you want to bear these risks or not.

Errors excepted: We have written this article “Bonds simply explained” to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful information possible on the subject of finance. However, if we have made any errors, forgotten important aspects and/or are no longer up to date, we would be grateful if you could let us know.