How to Explain Your Bond Portfolio Losses

How to Explain Your Bond Portfolio Losses

If you’re a treasurer a CFO or any other type of institutional investor, you might have already had to go through the explanation of why your bond portfolio shows big losses.

In the ten days following the US presidential election, rising interest rates hit bond investors hard. After years of sustained rock bottom rates, some institutional investors saw years’ worth of yield wiped out in a matter of days.

Given the low risk profile associated with bonds that kind of result is usually going to raise a lot of questions. Whether you’re tasked with managing the financial resources of a bank, an insurance company, a city or a state, it’s a good idea to have a ready explanation for losses — and, even better, a solution that ensures such setbacks are less likely to occur in the future.

Fortunately, that solution not only exists, it’s cost-effective and widely available.

So let’s talk about it.

The significant value of transparent pricing

Here’s a question that I’m sure has been on the mind of many savvy treasurers over the years:

“What if there were a Kelley Blue Book for fixed income investments?”

It’s certainly a question I’ve considered. A standalone, affordable software tool that could be used to ensure transparent pricing would be enormously valuable. Combined with a few other core functions, such a tool would have the potential to radically change institutional investing for the benefit of treasurers, Chief Financial Officers and other overseers.

There’s good news — that tool is already here, and is being used by governments and organizations to provide transparent pricing and real-time portfolio data. It’s called the Bond Price Valuation Tool (BPV®), developed by PFITR.

Here’s how it works: Unlike stocks, true pricing for bonds isn’t a click away on Google. The company that offers the gold standard on bond pricing, ICE Data Services, uses an advanced algorithm and hundreds of people to determine prices. These prices then filter down to operations such as Bloomberg, S&P, FIS and our firm, PFITR.

Here’s the problem, however: When you use Bloomberg to get bond prices, it’s like buying a car to get a radio — it’s roughly $24,000 per year. Other providers are as much as $100,000. At PFITR we offer a simple ,low-cost alternative ($950 per month on average) for insurance companies, governments, banks, hospitals etc.

Transparent pricing delivered affordably is a service that’s been acutely needed for years — and something I started thinking about long ago. I started working as a stock and bond broker before moving into the institutional bond brokerage business. It was a natural fit. I eventually authored a popular advisory guide — “Public Fund Investing for Dummies,” and spent years training hundreds of treasurers in the aftermath of the 2008 Financial Crisis, helping them understand what went wrong. The lack of transparent pricing, and a natural tension in broker/overseer relationships, are two areas which I felt required immediate attention.

Here’s what I mean when I say “natural tension”: If a broker gets paid $10,000 to make one recommendation and $1,000 to make another, that broker will often gravitate to the more lucrative investment. The treasurer who is supposed to oversee these investments, on the other hand, typically lacks the savvy to object to the broker’s investment strategy — it’s kind of like trying to oversee your auto mechanic while having no repair experience of your own.

True pricing disrupts this by restoring equilibrium to the broker/overseer relationship. With better information, you can make informed decisions that benefit your organization, rather than your advisor.

Now, about answering those tough questions….

Interest rates for the last seven years have been stagnant, and very low. This means many investors chased yield. To get more they went longer and longer on investments. Yet the longer it goes, the more interest rate risk is taken on.

Investors have been insulated from the consequences of this strategy because rates haven’t gone up. Now, however, the proverbial chickens are coming home to roost. One recent example I can relay: An organization wanted to buy $1 million in bonds before the presidential election. The quote before the election was $995,000 for the bond. Ten days after the election, the same bond was priced at $955,000 — that means it lost $40,000 in value. Even worse, we’re talking about a bond only paying $17,000 a year. So, in 10 days, that investment lost more in value than it will make in two years.

This is hardly an isolated incident. Treasurers and CEOs getting financial statements are in for a rude awakening in the coming months, and will ultimately ask “why are these supposedly safe investments dropping so much?”

The BPV® Tool prevents this by visually displaying that risk, showing what happens to the price of a bond before you make a purchase. It also looks at performance history and offers a recommendation as to whether it’s a good time or bad time to buy. Additionally, by offering transparent pricing, it allows treasurers and others in oversight positions a tool to ensure internal control — without the need to be an expert in the industry.

In essence, the tool does three things: It makes sure you’re buying at the right time, it ensures you’re receiving fair market pricing and it checks risk before you buy.

If you’re a treasurer facing tough questions about recent rate-driven portfolio losses, here’s your answer: The deck is stacked against me. I’m overseeing our portfolio from an unbalanced and less-than-transparent position. Given this scenario, it’s imperative to have the tools to make better informed unbiased decisions and assess the interest rate risks before we make a purchase.   There’s a solution, however — the BPV® from PFITR offers full transparency at a cost-effective rate, assesses risk and puts you on equal footing with your broker.

And that’s a recipe for happier conversations in the office the next time the statements roll in.

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