[Explained from an FP perspective] Has the era of 'bond investment' arrived due to rising policy interest rates? Portfolio strategy based on a comparison between government …

Introduction

With the Bank of Japan’s review of policy interest rates and the rise in market interest rates, ‘bond investment’ is gradually gaining attention among individual investors.

Although Japan has long experienced ‘ultra-low interest rates,’ attractive corporate bonds with higher interest rate levels have been appearing one after another recently. I myself recently purchased the ‘Rakuten Group 26th Unsecured Corporate Bond (5.5-year term, 4.37% per annum)’ because I was attracted by the favorable conditions.

This is a significantly higher yield compared to the 5-year government bond yield (approximately 2.39%).

In this article, from the perspective of a Financial Planner (FP), I will explain in an easy-to-understand manner ‘why there are more bonds with favorable conditions now’ and ‘how to perceive the yield spread and risks between government bonds and corporate bonds’.

1. Policy interest rate hikes and the mechanism of the bond market

When policy interest rates are raised, the interest rate level of the entire financial market (government bond yields and corporate procurement interest rates) is raised.

In the bond market, there is a ‘seesaw relationship’ between interest rates and prices.

• Rise in interest rates: The interest (coupon) of newly issued bonds becomes higher.

• Value of existing bonds: The appeal of low-interest bonds issued in the past decreases, and their market price falls (yield adjustment occurs).

In other words, a phase of rising interest rates (or a high level after a rise) is ‘a perfect opportunity for those investing anew to obtain high-yield bonds’.

2. Comparison of government bonds and corporate bonds: How to view the interest rate spread

Let’s compare the specifications of the Rakuten corporate bond I purchased this time with government bonds.

• Rakuten Group 26th Unsecured Corporate Bond: Term 5.5 years / Interest rate 4.37% per annum (before tax)

• 5-year government bond yield: Approximately 2.39%

Compared to 5-year government bonds, there is an interest rate spread (yield spread) of approximately 2.0%. This interest rate spread is the additional reward (risk premium) for the ‘credit risk (default risk)’ that investors bear.

💡 Specific simulation when investing 1 million yen

To see how much impact this actually has, I will calculate the trial balance when investing 1 million yen.

• Annual interest (before tax): 43,700 yen

• Annual interest (after tax, 20.315%): Approximately 34,822 yen

• Total interest received over 5.5 years (after tax): approx. 191,521 yen

By simply holding for 5.5 years, it is calculated that you will earn approximately 190,000 yen (after tax) in interest income on a principal of 1 million yen. In the current interest rate environment, this level can be said to reliably exceed the inflation rate (price increases) and protect the real value of your assets.

3. Credit ratings (JCR vs. S&P) and how to perceive risk

An important factor in making a purchase decision is the ‘credit rating’.

This corporate bond has received an ‘A-‘ (A minus) rating from the Japan Credit Rating Agency (JCR), which is classified under domestic standards as ‘high certainty of debt fulfillment (investment grade)’.

However, if analyzing from an FP perspective, it is also worth paying attention to the ‘differences in evaluation by credit rating agencies’.

[Perspective on credit ratings]

• Domestic rating (JCR, etc.): ‘A-‘ rating (investment grade)

• Foreign rating (S&P, etc.): ‘BB’ rating (speculative rating / high yield)

Foreign credit rating agencies tend to evaluate the speed of investment recovery in the mobile business and the pace of interest-bearing debt reduction more strictly.

Rather than taking ‘A-‘ at face value as 100% safe, it is important to check and judge for yourself whether you can tolerate the 5.5-year default risk, taking into account the progress toward financial improvement of the group as a whole and the profitability of the mobile business.

4. The ‘iron rule’ and points of caution for bond investment from an FP

Although these are high-yield corporate bonds, you need to keep the following points in mind when purchasing.

① ‘Hold to maturity’ is the principle (risk of interim sale)

Bonds will return the face value (principal) if held until maturity.

However, if you sell them midway, they will be traded at the market price at that time, so there is a possibility of a loss on the sale. Especially if policy interest rates rise further in the future, the market price of bonds is likely to fall.

Therefore, the iron rule is to invest in corporate bonds with ‘surplus funds that you definitely do not plan to use for 5.5 years’.

② Role in the portfolio

While you cannot expect explosive price increases (capital gains) like stock investments, they have the strength that ‘the cash flow to be obtained in the future is fixed (income gains)’.

It functions as a ‘defensive and stable component’ that boosts the overall return of assets while suppressing the volatility (price fluctuation) risk of stocks.

Summary: How to expand your options in an era of high interest rates

A period of rising policy interest rates is a chance for individual investors to significantly expand their options for ‘asset classes that can target yields’.

• If you want to minimize risk: Government bonds (government bond yield around 2.39%)

• If you want to target additional returns after carefully examining risks: Highly reliable corporate bonds (such as 4.37% per annum)

Why not consider incorporating corporate bonds as an option into part of your portfolio, in line with your life plan, risk tolerance, and the timing of when you will need the funds?

[Caution/Disclaimer]

This article provides explanations and information from the perspective of a Financial Planner based on market information and various data available at the time of writing, and is not intended to solicit or recommend the purchase or sale of any specific financial product. Please make investment decisions and actual transactions at your own risk, taking into account your own financial situation and risk tolerance.

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