On Wednesday last, capital markets across the globe (when this article went to press) saw stocks head into a dramatic sell-off while bond yields plunged. To quote the New York Times, “Financial markets are on a roller coaster…. The yield on the ten-year US Treasury note fell below two percent, crossing an important symbolic threshold that indicated investors were rushing for safety.” **

What does that headline mean to the ordinary investor? Not exactly what you may think. It sounds terrible, but reading between the lines — and learning to understand bond characteristics, bond prices (not bond yields) generally move in the opposite direction to stocks. If you owned high-quality bonds, your bond price values went up! Not down. This is what happens when investors get scared and markets get frothy (a minimisation word that means very volatile). Investors sell losing stock positions and bonds are purchased at ever-higher prices.

Those investors who held a high-grade quality bond allocation in their portfolio (and did not sell them) will not see the cumulative losses that a pure stock portfolio will experience. In fact, their bond allocation acts as a safety cushion, smoothing the investment valuation such that the overall portfolio may not even experience a loss.

For the last few months, financial media pundits when they aren’t opining on something else, have been discussing (moaning might be a better term) bond securities:

— The effect that as as yet undetermined US Federal Reserve decision to raise interest rates will have on decreasing bond price values of existing bonds in capital markets;

— Whether a warning-to-the-wise to investors that they should think of selling their bonds in order to not get caught in the downward price push;

— and conjecture on how high bond yields will go if bond prices get deeply discounted.

Yet, exactly the opposite happened this week. Why? This explanation will be forthcoming in part 1B.

Right there, as a usual weekend reader, you are thinking, “Why do I have to read about bonds, I don’t get them, and I am just not interested!”

Ah, but you should be.

If you have a Bermuda National Pension and are a relatively conservative careful person, financially, you chose the Balanced Fund allocation. Guess what, a significant portion of your pension portfolio is right now invested in bonds.

If you have a property insurance policy and I hope you do have coverage for this weekend, of all weekends, with Gonzalo (hurtling northward) and leaving little damage, we hope at press time, you may be too tired and distracted to digest any of this information.

However, when you think of hurricanes, and the damage they can cause, you will want to review your home insurance policy. What does it cover? How do households get restitution for that damage so that they can rebuild, then bonds come into the equation again.

Insurance and reinsurance companies love (if that is the right word) bonds, too. High-grade bonds are used in insurance companies’ investment portfolios to match the liabilities they have in the form of your prepaid premiums — to cover your household and thousands of others when unanticipated damages occur. Bonds are considered safer and more conservative investments than stocks and other types of investments.

Bermuda and reinsurers here are also known for innovative catastrophic bond products that are used for coverage in high peril-type events, such as hurricanes. These bonds are complex in structure, and require a sophisticated knowledge of alternative investments and the property casualty retrocession market.

That’s all for today. A start to understanding bonds and bond funds in the Bermuda Financial Fundamentals Manual.

Even so, you are probably yawning right now and will send this article out to ‘de trash’ for Mondee pick-up.

Don’t throw away the paper just yet. This time. Read a bit more; this is your financial future we are talking about here. Consider that in our still tough Bermuda economic environment there aren’t too many other investments out there you dare invest in, but next section, we will take a look at what bonds are and how they work in your pension portfolio.

Stay safe everyone.

“A Whipsaw Day for Stocks and Bonds”, by William Alden, October 15, 2014, New York Times.

Martha Harris Myron, CPA, CFP, JSM, Masters of Law: International Tax and Financial Services, appointed to the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland; The Pondstraddler Life Consultancy providing planning for international tax, immigration, investment, retirement, legacy, and related financial challenges to the lifestyles of internationally mobile individuals and their businesses residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle. Specific focus for residents of Bermuda, the premier international finance centre. Contact: martha@pondstraddler.com