All Posts By

jessica.higginson@podiem.com

Bond Basics

We associate the term ‘bond’ with mutual connection, whether the subject is chemistry (between atoms, ions, or molecules), personal relationships (between human beings), or finance (between borrowers and lenders). The latter is often thought to be difficult to understand and shrouded in complex mathematics. Actually, bonds can be quite a straightforward concept.

In their simplest sense, bonds are IOUs set up between borrowers and lenders. At the outset, the borrower will determine how much and for how long they would like to borrow, and what they are willing to pay the lender – typically once or twice per year – as appropriate compensation for borrowing their money.

Bonds are also known as fixed income securities. The simple example of a bond setup below illustrates why bonds carry this other name. The future cash flows a lender receives are fixed and predictable. At the outset, a sum is lent. Each year, an amount is paid to the lender (the coupon) and at the end of the term the original sum is returned.

Figure 1: Simple illustration of a 3-year bond with an annual coupon

Borrowers, also known as bond issuers, are prominently composed of governments and companies around the world. A significant difference between bonds and more traditional loans is that bonds are marketable. In other words, the lender in the IOU agreement can sell the right to receive the cash flows to someone else. This is why the lender will more commonly be referred to as the bondholder.

The relationship between risk and return does not come unstuck for fixed income. If the borrower is a large, developed government it is highly likely that bondholders will be repaid and so the government can offer lower coupons. The USA, for example, has never defaulted on its national debt. By contrast, a company on the brink of financial collapse would have to offer much higher compensation to encourage lenders. This is the point where fixed income often becomes less ‘fixed’.

Analysing the ability for companies or governments to pay back lenders is a complex and comprehensive process for investors. Thankfully rating agencies do much of the heavy lifting. S&P, a rating agency, demonstrates[1] on average between 1981 and 2020 bonds with the lowest rating of CCC/C had a 28% chance of defaulting over the next 12-month period, whereas for those rated highest at AAA that chance was zero.

Figure 2: Cumulative average default rate % of global corporate bonds 1981-2020

Data source: S&P (2021). “Default, Transition, and Recovery: 2020 Annual Global Corporate Default and Rating Transition Study”. Rating refers to rating at outset of respective period.

The reader will notice that owners of investment grade bonds are considerably more likely to receive back the capital lent to the borrower compared with high yield bonds (formerly ‘junk’ bonds!). It is for this reason we allocate the fixed income element of your portfolio to these such bonds through the use of investment funds that diversify across many different highly rated bonds. We may often refer to this part of the portfolio as the ‘defensive assets’.

The key takeaways

  • A bond is an IOU between a borrower, such as a government or company, and a lender. The ownership of this IOU can be traded between lenders (bondholders), and with it the right to receive the cash flows from the borrower.
  • The main features of a bond are the maturity (i.e., term of the loan) and credit quality. The latter is determined by rating agencies and gives an insight into a borrower’s credit worthiness.
  • Investment grade bonds provide more certainty of future payments to lenders compared with high yield bonds. A shorter lending term also generally corresponds to higher certainty of repayment. For this reason, when investing in bonds we typically allocate to shorter term, higher credit quality securities.

If you have any questions, thoughts or actions relating to the content of this article please get in touch with us by calling us on 028 9099 6948 or by emailing info@pacem-advisory.com

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1] S&P (2021). “Default, Transition, and Recovery: 2020 Annual Global Corporate Default and Rating Transition Study”

Employee Spotlight – Sean McCann

Each fortnight we will be spotlighting a member of the team so that you can get to know the people behind the Pacem brand. This week we feature one of our Planning analysts, Sean McCann. Sean joined the firm in 2021 from FinTrU, where he worked following university. He completed his Degree in Finance & Investment Management, achieving a First-Class Honours. Sean is undertaking Pacem’s Internship program currently and supporting our Financial Advisory team to assess and advise our clients on all their financial needs.

Sean tells us a bit more about himself below.

Employee name:
Sean McCann

Your role at Pacem:
Planning Analyst

How long have you been with Pacem?
7 months

What does your day-to-day role entail?
My day-to-day role is based around assisting in preparing reports and completing client work alongside our advisors. However, recently I have additionally been providing help with the compliance side of the business, this is an old acquaintance of mine as I previously worked in compliance.

How would you describe yourself in three words?
Diligent, ambitious, and motivated.

Tell us something that might surprise us about you.
I currently hold a golf handicap of 3, probably not a surprise to anyone in the office as its how I spend most of my evenings.

What do you like most about your job?
I enjoy the variety of the job; no two days are the same and you are continually learning and developing as a person.

If you won the lottery, what is the first thing you would do?
I dream of this most weekends but if I was to win it, I’d say I would probably share my wealth with my family and friends, no point in having that amount of money if you’re the only one enjoying it.

Favourite film
Nothing beats a great film; I would have to say my favourite film is Good Will Hunting.

Where is the best place you’ve travelled to and why?
New Zealand, I went out to see family and have to say the main reason I enjoyed it was it was similar to home but with better weather.

Employee Spotlight – Rachael Mason

Each fortnight we will be spotlighting a member of the team so that you can get to know the people behind the Pacem brand. This week we feature one of our Paraplanners, Rachael Mason. Rachael joined the firm as a placement student in 2017 while completing her Degree in Business Studies, achieving a First-Class Honours. Now a full-time Planning Analyst, she is completing her Level 4 Diploma and supporting our Financial Advisory team to assess and advise our clients on all their financial needs.

Rachael tells us a bit more about herself below.

Employee name:
Rachael Mason

Your role at Pacem
Trainee Paraplanner

How long have you been with Pacem?
4 years in January 2022

What does your day-to-day role entail?
I train and mentor our analysts and interns, helping them to write reports and complete client work. I lead on some of our software system initiatives, including a back office system to hold all client data, which ensures client details are kept up to date and accurate. I assist team members with technical queries for clients, liaise with clients about meetings and attend some client meetings to take notes and help our advisors in any way I can.

How would you describe yourself in three words?
Bubbly, determined and meticulous

Tell us something that might surprise us about you.
 I like to do things in twos; I got married twice in one year (well kind of…)! My husband and I had a small wedding in September 2020 and had our big wedding celebration in September 2021, due to COVID-19. I also have a twin brother (he’s just 10 minutes older than me!)

What do you like most about your job?
Everyday is different which makes it extremely interesting. I have been given the opportunity to mentor some of our analysts and interns and this has been very rewarding as I get to see how they are progressing first-hand and share some of my own experience. My role is so varied that I am constantly learning on the job and gaining experience in a range of different areas. We are a great team at Pacem and get on very well, which makes it good fun.

What would you do (for a career) if you weren’t doing this? 
I’ve always loved baking; growing up I helped my mum to bake all the time (this mainly consisted of licking the spoon!). I would love to be a professional baker and go on the Great British Bake Off.

Favourite food:
I love seafood.

What is something you learned in the last week?
We got a puppy last week and so I am learning that the night time whining, constant chewing and difficulty toilet training are all worth it for the cuddles! (I think!)

What interests/hobbies do you have outside of work?
We always did jigsaws growing up and I have rediscovered how much I enjoy these over the past few years. I am a very active person; I play hockey every week for Holywood Ladies and over lockdown I picked up cycling, which has been great fun getting to discover new routes and places.

If, and, then, but…

For those readers interested in financial news (some might call it noise), the unfolding story of Chinese property developer Evergrande (a name which is ironic given its dire financial position) has spooked global equity markets.

The short version of the story is that the company is very highly leveraged i.e. it has borrowed US$300 billion from banks to fund its property developments and has hit material cash flow problems, leaving suppliers and debt repayments at risk.  Property prices have risen dramatically in urban China over the past few years and the Chinese Communist Party (CCP) is now clamping down on bank lending to slow the boom, which is part of Evergrande’s problem.  To add to the drama, Evergrande has also sold high risk retail products to its wealth management arm’s clients, which it appears to have misrepresented as low risk investments.  Some of these investors’ funds have been diverted to shore up the company’s own working capital and some has allegedly been used to pay off other investors, which is the hallmark of a Ponzi scheme.   More acutely, the company needs to meet an interest payment of US$84 billion this week and the markets are waiting with bated breath to see if they manage to do so.  Its bonds are trading at 25 cents on the dollar and its equity has fallen by 85% in value in 2021.  Not pretty.

IF Evergrande default – some have suggested this could be the equivalent of Lehman Brothers collapse that set off the market falls leading into the Global Financial Crisis – AND if this then leads to the collapse of the company with repercussions for lending banks (most of which are Chinese), AND if there is a resultant fire-sale of properties, AND suppliers go unpaid AND this all precipitates a collapse of other development firms, THEN this could cause a major challenge for the CCP (not least that 1.4 million buyers who have put down deposits on unfinished properties) AND impact on Chinese growth on which the world depends.  Could it THEN cause a contagion in global markets resulting in a major decline in stock markets around the world?

BUT, hold on a minute, what started as a potential corporate default has grown – in this story – into a major decline in world growth and a stock market crash!  BUT in this case, much of the debt is in local currency and lent by banks that are mostly owned by the CCP, which can force them to roll or forgive debt and provide unlimited liquidity to the banking system.  It does not mean that things will be easily resolved, BUT it does not mean that the conflated IF, AND, THEN story of conditional probabilities is likely to occur.

It is important to remember that many material world events occur on a regular basis, but do not always end up in negative market outcomes.  Even COVID, which put a dent in equity market valuations in early 2020, has failed to turn into a prolonged downturn.  Global markets are now well above their highs before the COVID-induced falls.  Certainly it is true that on occasion a single event precipitates a market fall, but the problem is that we, as investors, have absolutely no chance of knowing which event this might be and position portfolios ahead of any anticipated fall.  If this were possible, the market would already have fallen! In this particular case, it is important to note that Evergrande’s market cap is under USD6 billion – or put another way, Apple is over 400 times larger – so any portfolio holding would be miniscule at worst.  The company represents around 0.01% of global equities and China is only 4% of the global equity markets. Our suggestion: don’t pay too much attention to the financial ‘news’!

If you have any questions, thoughts or actions relating to the content of this article please get in touch with us by calling us on 028 9099 6948 or by emailing info@pacem-advisory.com

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Employee Spotlight – Lesley Irwin

Each fortnight we will be spotlighting a member of the team so that you can get to know the people behind the Pacem brand. This week we feature one of our accounting & tax directors, Lesley Irwin. Lesley, based in our North Coast office, ran her own practice for over 15 years and has recently merged her firm, Irwin-McAfee Chartered Accountants, with Pacem. Lesley is a Chartered Accountant and a Chartered Tax Advisor and plays a key role in servicing our accountancy clients.

Lesley tells us a bit more about herself below.

Your name:
Lesley Irwin

Your role at Pacem:
Director of Accounting and Tax – based in the North Coast office.

How long have you been with Pacem?
I’ve been part of Team Pacem for almost 5 months. I ran my own practice for over 15 years when a chance phone call with Elizabeth Crossan lead to a merger with Pacem.

What does your day-to-day role entail?
I oversee the provision of a wide range of compliance and advisory services for my clients including annual financial accounts, personal tax returns, payroll, VAT returns and corporation tax.

How would you describe yourself in three words?
Determined, organised, control-freak.

Tell us something that might surprise us about you.
I have a full-on obsession with Formula 1 and have done since I was ten years old. Twenty-two weekends a year are filled with watching fast cars racing all over the world. I do not maintain an allegiance to any team but avidly follow a couple of drivers each year based purely on who seems the most fun, their social media posts and the livery of their cars. At the minute it’s all about McLaren.

What do you like most about your job?
I deal directly with the owners and decision-makers within the business. As an accountant I get to see the internal workings of all types of businesses and all sizes of businesses. There is a wide diversity of clients – from farmers to personal trainers, engineers to close-protection officers and opticians to mechanics. It is absolutely fascinating to see how clients in the same businesses with the same circumstances make completely different decisions, have different goals and different levels of tolerance to their tax bills. Over the last 15 years I’ve been able to see some businesses move on to the next generation when directors or partners retire, and new partners join. Other clients have started their businesses around the kitchen table or spare bedroom and quickly grown to be a success. I get to help and advise clients through pivotal moments for their businesses such as the property boom, recession, Brexit, HMRC digitalisation and now Covid-19. I really enjoy the fact that no two clients have the same approach or outcome. Every workday really is different.

If you won the lottery, what is the first thing you would do?
Part of me thinks the first thing I would do is speak to Daniel and invest the winnings through Pacem wealth – planning for long-term security and growth while providing a solid income. The more realistic part of me thinks I would book some time off work to interview for a personal assistant, chef, chauffeur and glam squad. Then we need to consider the more practical things like mansion on the beach or apartment in a Mediterranean city? Yacht or plane ? Aston Martin or McLaren ?

What would you do (for a career) if you weren’t doing this?
I am doing my dream job at the minute 😊. However, if it doesn’t work out, I’d like to either drive a supercar for a living or become a pilot [preferably of a fighter jet].

Favourite song
Everything by Avicii or Coldplay or Kygo !

If you could learn to do anything, what would it be?
I would love to be able to speak another language fluently.  This has been on my list for years but with little progress.

What is something you learned in the last week?
I have less patience than I thought.

What interests/hobbies do you have outside of work
Covid-19 highlighted that my daily life had become not all that different from lockdown as a busy home life and work life had left little time for other things.  I enjoy reading a good book, swimming or a walk with the dog.  I really look forward to our Summer family holiday each year – it’s great to get all four of us away from the routine and emails to enjoy each other’s company and try out new places, new food and new activities.

Retirement Rule 1

Don’t run out of money

Of all the financial challenges and concerns that we face over our lifetimes, avoiding running out of money in retirement probably sits at the top of the list.  No-one wants to end up relying on meagre state benefits and eating own-brand baked beans every day.  Retirement Rule 1 is crucial but not guaranteed.  As Warren Buffett might say, Retirement Rule 2 is not to forget Retirement Rule 1!

In the good old days, retirees could rely on defined benefit pensions and/or annuities to provide lifelong retirement income. Today, many retirees rely, to a varying degree, on taking money from accumulated pension pots for their retirement income.  That makes outcomes less certain and decisions far tougher.

From time-to-time scary data surface about the state of retirement planning in the UK. Recently, LV – the insurance company – published the results of a survey of 4,000 people relating to how they intend or are handling their pension arrangements[1].  LV estimate that there are around 30 million pension holders in the UK.  The results are a little startling, to say the least. Take a look at the chart below.

As one third (or effectively 10 million people) do not know how to make their retirement pot last, it implies that two thirds apparently do know.  Perhaps these are the two thirds who plan on taking advice!  Not running out of money is a complex problem that taxes even the best financial brains.  It would seem that many people may be overconfident in their assessment of how much they truly know about retirement planning.

The figure below provides an overview of just how tricky this process is and how it must be an ongoing, dynamic process, not a one-off decision at retirement. Knowing what you cannot control and understanding what you can, provides some insight into the complexity of – and solutions to – retirement planning.

Retirement is meant to be a time of financial freedom allowing you to do the things you want to do, when you want to do them and who you want to do them with.  It is a great shame that many people in the UK will fail to achieve even a modicum of financial freedom and lifestyle choice.  As a broad rule of thumb, today, £1 million will buy an inflation-linked annuity income of around £27,500 a year[1].  Yet the median UK pension pot is around £91,000[2] (for those 55-64 years old), which on the same basis will deliver only £2,500 a year.

Taking an income from an investment portfolio may allow a withdrawal rate that is potentially a little higher but needs a lot of care and attention to reduce the risk of running out of money.  Making sure that you optimise the decisions that need to be made – and control all the things you can control – will allow you to maximise the stability, level and longevity of retirement income you need.

That is what a good adviser will help their clients do and where they earn their fees.  The best way to achieve Retirement Rule 1 is to take proper financial planning advice.

If you have any questions, thoughts or actions relating to the content of this article please get in touch with us by calling us on 028 9099 6948 or by emailing info@pacem-advisory.com

[1] https://www.scottishwidows.co.uk/retirement/retirement-explained/taking/pension-options/guaranteed-income/index-linked-annuity/

[2]     Office for National Statistics. https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/datasets/pensionwealthwealthingreatbritain

[1] 10m pensioners risk running out of money, FT.com 26th August 2021

Employee Spotlight – Gemma McShane

Each fortnight we will be spotlighting a member of the team so that you can get to know the people behind the Pacem brand. This week we feature Operations Manger, Gemma McShane, who has been a core member of the team since 2015. Gemma joined the team as a placement student, before completing her degree in Finance & Investment Analysis achieving a First-Class Honours. Gemma completed her Level 4 Diploma in Financial Planning in 2018 and is now responsible for the smooth daily operations of Pacem.

Gemma tells us a bit more about herself below.

Your Name:
Gemma McShane

Your Role:
Operations Manager

How long have you been with Pacem?
6 Years in April past

What does your day-to-day role entail?
My role entails helping with the smooth daily operations of the business; preparing and presenting team meetings, supporting the team with any queries they may have on processes or procedures, attending interviews, helping with induction & training plans for new team members, preparing for management meetings and overseeing ongoing projects. Every day is different – which is why I enjoy my role so much.  

How would you describe yourself in three words?
Organised, diligent & a control-freak! (I sound delightful!)

Tell us something that might surprise us about you…
I’m due my first baby in October – counting down the weeks now!

What do you like most about your job?
The team and the culture within Pacem – every team member is very approachable, which makes working with them very easy!

If you won the lottery, what is the first thing you would do?
Give half of it to charity & split the rest between our immediate families… after we build our dream home of course!

What would you do (for a career) if you weren’t doing this?
I would love to be an Interior Designer – I would need to scrub up on my skills first!

Favourite food
Italian… pizza/pasta

What interests/hobbies do you have outside of work
Having overnight stays at the Galgorm (too often some might say) & attending weddings of family & friends. I also enjoy minding our two-year old nephew – he likes to keep us busy and helps us focus on the more important things in life.

Preferences and their tradeoffs

Investing is all about tradeoffs. Each choice made is paired with an implicit decision not to do some alternative; the ‘opportunity cost’. For example, by investing solely in a basket of UK companies one accepts the risk of losing out if the UK market struggles relative to the rest of the world, and vice-versa. An investment portfolio could be constructed to reflect other preferences, such as the appetite to have exposure to certain companies or industries, adopt a specific level of equity or fixed income risk, or attempt to adjust the average fee paid to managers, to name a few. Choices come with consequences.

Recently, insight provided by Hargreaves Lansdown – the UK’s largest fund platform managing around £120bn[1] – and Interactive Investor – the UK’s largest flat-fee platform[2] – shed some light on the preferences of younger investors coming to market[3].

“The younger generation want things they are passionate about, that they can engage with, that resonate with their particular desires and preferences, whatever those may be. They want things they can be passionate about.”

The data suggest that younger investors have tended to invest in companies they feel strongly about, a standout theme being the electric car industry at present through firms such as Tesla and NIO. Gavin Corr, head of manager selection and due diligence services at Morningstar, went on to say:

“The younger generation will not be happy in a multi-asset balanced 60/40 portfolio, sitting alongside another million other investors that are profiled exactly the same way. This democratisation or mass customisation is coming”
Gavin Corr, Morningstar[4]

The challenge is that preferences naturally come with their own tradeoffs. This is crucial to remember. To avoid a traditional balanced portfolio and instead own a portfolio of ‘clean energy’ firms, perhaps with electric cars, wind turbines and solar energy as themes, one must accept that they own a highly concentrated portfolio of stocks with low levels of diversification, large sector biases and likely with high management costs. This is likely to negatively impact returns in the medium to longer term.

The aim of this short note is not to suggest that these preferences are wrong, in fact investors may benefit from an ‘emotional dividend’ to compensate investors and make the tradeoffs worthwhile[5]. This emotional dividend, however, is rewarded at the cost of actual investment returns and investors may not realise the magnitude of this cost.

A key pillar of our investment philosophy is to accept that capital markets do a good job of pricing securities and therefore markets are difficult to beat. The table below demonstrates this belief by comparing a simple two-fund developed equity and bond portfolio[6] against the cohort of managers running ‘balanced’ portfolios Corr (2021) referred to. Each of the other managers in the figure will have had their own preferences, which evidently come with consequences.

Figure 1: Multi-asset peer group performance – 10 years to Jul-21

Morningstar Direct © All rights reserved. Morningstar category: EAA Fund GBP Moderate Allocation.

The tradeoffs are well demonstrated in the chart above. A traditional 60/40 portfolio holds up exceptionally well. Only 3 of the 116 funds in the sample provided a superior return to the 60/40 ‘balanced’ portfolio, that is without accounting for any funds that may have closed in the last 10-years! Investors who wish to express their preferences in portfolios should be aware they are at a high risk of market underperformance. Sticking to sound, well researched investment principles is key to a successful outcome.

[1] Money to the Masses (2021) https://moneytothemasses.com/saving-for-your-future/…

[2] FT Adviser (2020) https://www.ftadviser.com/investments/…

[3] Citywire (2021) Everything you need to know about young investors. https://citywire.co.uk/…

[4] Citywire (2021) Morningstar: Impersonal 60/40 portfolio won’t impress young clients. https://citywire.co.uk/…

[5] Rational Reminder Podcast (2021) Episode 156: Climate Change vs. The Stock Market.

[6] Portfolio: 60% Vanguard Global Stock Index, 40% Dimensional Global Short-dated Bond. Rebalanced annually.

Coronavirus Job Retention Scheme (CJRS) – update

The CJRS has been extended until 30 September 2021. From 1 July 2021, the government will pay 70% of wages up to a maximum cap of £2,187.50 for the hours the employee is on furlough.

Employers will top up employees’ wages to make sure they receive 80% of wages (up to £2,500) in total for the hours the employee is on furlough. The caps are proportional to the hours not worked.

From 1 August 2021, the government will pay 60% of wages for furlough employees up to £1,875. From 1 July 2021, employers will top up employees’ wages to make sure they receive 80% of wages (up to £2,500).

See: Check if you can claim for your employees’ wages through the Coronavirus Job Retention Scheme – GOV.UK (www.gov.uk)

 Self-Employment Income Support Scheme (SEISS)

HMRC have provided a new video about the SEISS fifth grant.

Work out your turnover so you can claim the fifth SEISS grant

The introduction to the guidance has been edited to explain that you would need to tell HMRC about your turnover if you traded in 2019 to 2020 as well as any of the other tax years listed. The section ‘How to work out your April 2020 to April 2021 turnover’ has been updated with examples of start dates you can use.

See: Work out your turnover so you can claim the fifth SEISS grant – GOV.UK (www.gov.uk)

 

Irwin-McAfee joins Pacem

We are pleased to announce that, from May 2021, we have combined our business with Irwin-McAfee. Though we will be operating as one company, our clients can rely on the same personal, trusting relationships that they are used to. Coming together will create more opportunities and enhance the expert advice we offer our clients.

 

Pictured are Directors Lesley Irwin, Lizzy Crossan and Daniel Glover.